The single member LLC is a very popular entity with people starting new businesses. That being said, there is a potential time bomb with these entities just waiting to blow.

First, let’s cover the basics. The “member” of the LLC is the owner. As the name suggests, there is only one person in a single member LLC. This simple fact leads to big problems when someone tries to attack the viability of the entity. The issue has to do with something called piercing the corporate veil and it is the last thing any business owner wants to face.

An LLC shares a key trait with a corporation. It provides a shield between the debts or liabilities of the business and the personal assets of the member. This is known as the corporate shield or veil. In lawsuits against smaller businesses, attorneys will often try to “pierce the corporate veil”. To do this, the attorney must convince the court that the single member LLC is a sham. One way to do this is to attack the member for not following the rules and regulations of the LLC. These rules and regulations are found in the Operating Agreement.
 

The Operating Agreement serves a function similar to bylaws in a corporation. The Operating Agreement essentially lays out how the LLC will be run, votes taken and so on. This is also where we find our time bomb. Why? Most single member LLCs have Operating Agreements that are fatally flawed. The problem? They are written for LLCs with two or more members! How do you think the court is going to view a LLC owned by a single person that has bylaws written for an entirely different type of LLC? AS A SHAM!!!

Let’s map out just how badly this is going to look in court for you, the single member of an LLC. The LLC is sued. The attorney for the suing party takes your deposition. You are compelled to bring the corporate books of the LLC. The Operating Agreement is taken out. The attorney goes line by line through the Agreement and asks you questions about how you’ve complied with the rules and regulations. You are quickly going to look bad when he starts asking you how you possibly had committee meetings in a business that has only ONE member? “Sir, did you sit in front of a mirror and talk to yourself?”

The vast majority of single member LLCs in business at this very moment have this problem. Why? They were either formed by a cheap, quickie online service that doesn’t know any better or a lawyer who doesn’t. Their owners spend all their time trying to build the business up without a clue that they are sitting on a ticking time bomb. It’s a shame.

Can this issue be fixed? If you’ve been sued or have a reasonable expectation of being sued, it is simply too late. If you don’t, then a new operating agreement can be created for the single member LLC that corresponds to the fact there is only one member.

Contact me if you have a California single member LLC and are worried about this problem. Changing out the operating agreement is something you must do before you get sued. With over 100,000 attorneys in California, it is only a matter of time.