The American business environment is known as a highly litigious place. That’s because unscrupulous elements often take advantage of loopholes in the commercial liability laws, to sue and litigate businesses, owners, and other parties-at-interest in the organization (partners, directors, shareholders). Often, the result of these lawsuits is devastating: Corporations pay heavy sums of money to the plaintiff, and many companies go bankrupt as a result. Forming a Limited Liability Company (LLC) may be the best way to insulate your company, and yourself personally, against some of those liability laws – but there are limitations and risks!
Tough Neighborhood: Texas Commercial Litigation
Since June 14, 2021, business owners in Texas are likely breathing a sigh of relief, now that the Texas Pandemic Liability Protection Act (SB 6 or “PLPA”) has passed. The law offers a degree of retroactive protection to businesses, but only specific to pandemic-related injuries, deaths, or losses. However, longer-term commercial litigation statistics, released by the Texas Judiciary system, don’t bode well for businesses litigation, especially for smaller organizations.
According to those stats, although commercial, contract-related, and other property and injury suits declined year-over-year, the 5-year trend is still on the rise. The short-term respite is attributable to pandemic-related business activity slowdown. Many businesses incorporated in Texas, operate in a tough commercial neighborhood, and may still face the full brunt of the legal system. For some, there may be a way to protect themselves by using the LLC structure to form their business. However, those protections only extend to LLC’s that have done it the right way.
Looking Under the LLC Hood
While LLCs are a great way to seek liability protection, many businesses run afoul of the laws governing the creation of such structures. As a result, you might operate your business for a few months (or years) under a false sense of security. Finally, when the “messed-up” LLC formation does catch up to you, there may be substantial repercussions. Texas laws allow plaintiffs to recover up to $500,000 and $100,000 in claims for bodily injury and property damages respectively – which can put a small business owners’ personal property and wealth at risk.
So, how can the LLC formation process go awry for business owners seeking to build liability protection into their business structures? Well, if you are new to the LLC creation process, or are working with a service provider who is not intimately familiar with the process themselves, there are many risks that business owners might encounter:
Texas LLC Name: This is one of the most serious commercial risks that a botched-up LLC creation can expose a business to. Businesses typically rush into the LLC formation process, without considering the ramifications of the business name they chose. So, what’s in an LLC name? Plenty of grief! A Texas judge ordered a private law school (Houston College of Law) to change its name because it resembled the University of Houston’s law school’s name.
If you, or your company formation service provider, aren’t diligent about doing a name search, or choosing a name that is legally “clear and free”, other businesses (and even clients and customers) may sue you for misleading them.
Texas LLC Operating Agreement: Even though the LLC Agreement isn’t a public document, it still provides plenty of opportunity for considerable grief among LLC members. Sensitive business processes, such as how the business is run, how profits are distributed, and how taxes are paid, are laid out in the agreement.
If handled properly, the LLC agreement offers a framework for the efficient and profitable operating of the business. However, even profitable business operations may be interrupted, if there are disagreements among its members. LLC members might even resort to litigation if the agreement isn’t clear on some issues impacting their rights.
Misunderstood Texas Franchise Tax: By default, Texas-based LLCs don’t pay federal income tax – that responsibility rests with each individual LLC member. However, the State does impose a Franchise Tax on LLCs with over $1,180,000 in total annualized revenue. A common misunderstanding is that, because their annualized revenues fall below the “no tax due threshold” – 90% of Texas LLCs come under this bracket, businesses are not required to file a report with the Comptroller’s office. Wrong – and here’s where the misunderstandings arise: Under the law, even though the LLC doesn’t cross the “no tax due threshold”, it must still file a Franchise Tax Questionnaire with the appropriate authorities
Under Texas Tax Code, §171.362, a 5.0% penalty is imposed on the amount of franchise tax due by an LLC that fails to report or pay the tax when due. If any part of the tax is still unreported or unpaid within 30 days after the due date, the law imposes an additional 5.0% penalty on the amount of tax unpaid. And, not filing a report, or filing it late, even with no tax due, opens the LLC to potential penalties.
Local Compliance: Depending on where, in Texas, your LLC is located, and which industry you operate in, there may be local licensing and permitting requirements. It’s important to remain in compliance with these local laws, because non-compliance could, potentially, restrict the businesses’ operating abilities. Some LLC formation service advisers may not know of all the local requirements, which may put the LLC in jeopardy.
A simple misstep, like choosing the wrong name for your LLC, can often have ripple effects down the line. You may be forced to change that name midstream, once your business is up and running. Not only must you change your name, but you must also work to ensue the name change permeates across other aspects of your business, including:
The Internal Revenue Service (IRS)
Credit Card companies
Permits and Licensing documents
Website domain names
…and much more!
There are many other pitfalls that incorrect LLC formation might expose your business to, such as not designating a Registered Agent, or designating the wrong type of Agent (e.g., a PO Box numbers). However, the above are the top-4 risks that you should, at minimum, be aware of.
Mitigating Your Risks
LLCs offer many liability protections that other forms of business structures don’t offer. With many LLC forming services engaged in up-selling associated services (for which they receive commissions and fees), and others ignorant of the process themselves, or offering outright misleading information, creating an LLC is a hard decision to make. If you are planning on forming a Limited Liability Company, to mitigate the risks of liability to your business and personal assets, then the first step is to seek LLC formation information from credible, reliable sources. Understanding the process, and what it takes to successfully form an LLC is critical in ensuring the formation proceeds without problems.