To Be or Not to Be? Recent Decision
Stirs Debate over Corporation vs. LLC
Corporations have been recognized in Illinois since the codification of the state's Business Corporation Act of 1933. Decades later, in 1994, the Illinois Limited Liability Company Act gave entrepreneurs the option of forming a new business entity as a limited liability company (LLC), rather than a corporation.
Although there are intrinsic differences between the two forms, as well as noteworthy advantages and disadvantages, the legal protections afforded to individual shareholders/directors of corporations and to individual managers/members of LLCs were, until recently, almost identical. Accordingly, the decision as to which form might be most appropriate for a particular business venture typically revolved around the manner in which the entity would ultimately be managed. The issuance of a new Appellate Court decision on September 26, 2006 in the case of Puleo v. Topel has given this question dramatic new significance.
Case of First Impression Addresses Personal Liability
In a case of first impression under the LLC Act, the Puleo court addressed the narrow issue of whether an individual manager/member of an LLC could be held personally liable for obligations incurred on behalf of the entity after it had been involuntarily dissolved for failure to file an annual report with the Illinois Secretary of State. Invoking legal precedent established by a line of cases interpreting relevant provisions of the Business Corporation Act, the plaintiff in Puleo argued that an individual manager/member was personally liable for a debt incurred by the LLC, unless he could demonstrate that he did not know, or was not in a position to have known, that the entity had been involuntarily dissolved before the debt was incurred.
Legal precedent notwithstanding, the Puleo court examined the LLC Act and focused on two sections that are materially different than their counterparts in the Business Corporation Act. Section 10-10 of the LLC Act, as it was initially written, expressly provided that a manager/member of an LLC could be found personally liable for the company's debts “to the same extent that a [shareholder/director] of an Illinois business corporation is liable in analogous circumstances under Illinois law.” Significantly, however, Section 10-10 was amended by the Illinois legislature in 1998 to provide, among other things, that
- Except under very limited circumstances, a manager or member of a limited liability company is not personally liable for a debt, obligation or liability of the company solely by reason of being or acting as a manager or member, and
- The failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business, is not grounds for imposing personal liability on the managers or members of the company.
Looking beyond Section 10-10 and the obvious significance of the 1998 amendments, the Puleo court also pointed to Section 35-7 of the LLC Act, which addresses the issue of individual liability following the dissolution of an LLC and states that
- A manager or member who, with knowledge of the dissolution, subjects a limited liability company to liability by an act that is not appropriate for winding up the company’s business is liable to the company for any damage caused to the company arising from such liability.
Based upon a common sense interpretation of these 1998 amendments, the Puleo court ruled that an individual manager/member of the involuntarily dissolved LLC was not personally liable for obligations incurred by the entity after it had been dissolved by the Secretary of State.
Implications for Illinois Business Entities
To be or not to be: A corporation or an LLC? While Shakespeare's Hamlet may have enjoyed the luxury of equivocation, that is rarely an option in today’s business world, where changes in the law often have a dramatic impact on decision makers. When considering the issue of personal liability of individuals affiliated with newly formed business entities, the Puleo decision suggests that the parties should give serious consideration to an LLC as the entity of choice over the more traditional corporation. Each situation, however, is unique.
The attorneys at Much Shelist can help you carefully assess your circumstances before making these important decisions. By working with your attorney and other business counselors to examine liability issues on the front end, you can reduce your personal risk and help minimize the likelihood of future disputes.
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