A limited liability company, also known as an “LLC,” is a hybrid form of business entity that has both the tax structure of a partnership and the limited liability benefit of a corporation. Limited liability companies are among the most popular types of business entities, representing three-quarters of new businesses formed in the United States. The LLC structure combines the pass-through taxation of a sole proprietorship or partnership with a corporation’s limited liability.
The goal of forming an LLC is to ensure that business owners are safe from liability for any legal obligation of the company. In other words, an LLC should ensure that if business owners are sued in connection with the company’s operations, their personal assets are protected from liability.
An LLC is not a corporation; but it shares with corporations the characteristic of limited liability. It shares the characteristic with partnerships of the availability of pass-through income taxation, i.e. profit is not taxed to the LLC as profit, but as income to the owners. An LLC is considered to offer more flexibility than a corporation and may be a good choice for companies with only a small number of owners.
A subsidiary company, whatever kind of legal entity it may be, is a company owned by another company, which is called the “parent company” or “holding company”. The parent company may have a variety of reasons for forming a subsidiary. The alternative would be to make an operation a division within the parent company.
For whatever reason, a company forms a subsidiary to undertake certain business activities, because it wants the subsidiary to be separate from the parent to some degree. It may be a matter of branding and a wish to keep the subsidiary’s brand independent of the parent’s brand.
The owner or owners of a company of whatever type, whether a partnership or a corporation, may choose to form their subsidiary specifically as an LLC in order to achieve an additional layer of asset protection, i.e. to protect the assets of the parent company from liability for the obligations of the subsidiary.
What Is a Subsidiary Limited Liability Company?
A subsidiary LLC is sometimes referred to as a “child” company. It is simply an LLC that is controlled and owned by another company known as the “parent” company. A subsidiary company, of whatever legal status, is a company owned by another company. There is generally some relationship in the nature of their respective business activities.
A subsidiary can be any kind of legal business entity that is available under the law of the state in which it is formed, generally a corporation, partnership or limited liability company. Most multinational corporations organize their operations through the use of subsidiaries. The major stock exchanges would yield the names of many examples of companies organized as parents and subsidiaries. The Walt Disney Company, WarnerMedia, or Citigroup are all examples, as are other well-known businesses, such as Xerox, or Microsoft. They may have multiple levels of subsidiaries.
The main benefit of organizing multiple businesses as subsidiary LLCs under the umbrella of a parent company is that the LLC decreases the risk of losing some of the assets of the parent company, if a subsidiary is sued. As mentioned above, the general rule is that any legal claim is limited to the specific LLC being sued, and a subsidiary company is considered to be separate and independent of its parent entity for most purposes.
Subsidiaries are separate, distinct legal entities not only for the purposes of liability but also for the purposes of taxation and regulation. This is how they differ from divisions, which are businesses that are fully integrated parts of a main company. A division is not legally or otherwise distinct from the main company of which it is a part.
In other words, a subsidiary can sue and be sued separately from its parent and its obligations will not normally be shared with its parent. However, creditors of an insolvent subsidiary may be able to obtain a judgment against the parent, if they can pierce the corporate veil and prove that the subsidiary is an alter ego of the parent, in other words, an extension of it as opposed to a truly independent company.
One of the ways of controlling a subsidiary is achieved through the ownership of shares in the subsidiary by the parent. These shares give the parent the necessary votes to determine the composition of the board of the subsidiary, and so to exercise control. This gives rise to the assumption that ownership of 50% of the shares plus one more share is enough to create a subsidiary company.
There are, however, other ways that control can be exerted, and the exact rules both as to what control is needed, and how it is achieved, can be complex. A parent company does not have to be the larger or “more powerful” entity; it is possible for the parent company to be smaller than a subsidiary,
Are Parent Companies Completely Free from Liability for their Subsidiary Companies?
In short, a parent is never completely free from possible liability for a subsidiary company’s legal obligations. While it is the general rule that a parent company’s assets are protected from legal claims against their subsidiaries, fortunately or unfortunately, there are exceptions to the general rule.
First, a parent company may be liable for its subsidiaries’ actions or obligations when state law sanctions “piercing the corporate veil.” If a court were to hold that a parent company can be held liable for the obligations of a subsidiary, this would constitute “piercing the corporate veil”. Piercing the corporate veil is the same theory that is applied when a person tries to reach the assets of a business owner to satisfy the liabilities of the business, even when the corporate structure is supposed to stand between the corporation and its shareholders or management.
In order to pierce the corporate veil, a person or entity who sues a subsidiary company must demonstrate to a court that the parent company did not operate the subsidiary with sufficient financial or management independence from the parent company, so holding the parent liable for the actions of the subsidiary is justified.
Courts are not generally in favor of piercing the veil of separation between a parent company and a subsidiary. They will, however, do so if it can be shown that there was serious misconduct and abuse between the parent and the subsidiary LLC. Factors that can create a problem for parent and subsidiary are as follows:
- The failure of the two entities to respect business formalities, such as failing to hold separate board meetings;
- The use of shared marketing materials, such as a website;
- Having joint bank accounts or commingling funds in other ways, e.g. using the assets of one company to pay the bills of the other;
- Consolidating financial statements and tax returns;
- Failing to conduct business transactions between the parent and subsidiary at arm’s length, impersonally, based on objective business decision-making;
- The subsidiary engages in business transactions that favor the parent;
- Not providing adequate funding to the subsidiary.
In addition, in some states, parent companies can be sued if they engage in illegal business activities that fall outside of the scope of ordinary business transactions. For instance, the parent company of a subsidiary LLC may be liable if they authorized the subsidiary to engage in an illegal activity, such as illegal dumping of hazardous materials.
What Are the Steps Required to Create a Subsidiary LLC?
The law regarding formation of a subsidiary LLC also vary among the states, but generally the following would be required to create a subsidiary LLC:
- Name the Subsidiary: The owners of a subsidiary are required to select a name for the subsidiary that has not been registered by any other company doing business in the state in which it operates. The subsidiary must include the words “limited company,” “limited liability company,” or the abbreviations “LLC” or “LC”;
- Complete the Articles of Organization: The articles of organization must be completed in order to form the subsidiary. Note that the company is not a corporation and articles of organization, not articles of incorporation, are required. The articles should spell out the parent LLC’s ownership interest in the subsidiary as well as any other information required by the state in which the owners form their LLC.
- Initial Information Statement: Many states require that the owners file a document called an initial information statement. This statement must be filed within a short period of time after the filing of the articles of organization;
- Sign the Articles of Organization: A representative of the parent LLC should sign the articles of organization as “Tom Smith, President of Parent LLC,” and not just “Tom Smith”;
- Draft an Operating Agreement: An operating agreement outlines the relationship between the parent and subsidiary LLCs. Although not necessary for formation, this operating agreement is helpful later if a dispute arises regarding liabilities to creditors; and
- Submit Articles of Organization to the State: Finally, the articles must be submitted to the secretary of state in which the LLC has its headquarters or main office. Upon approval, the subsidiary LLC will be officially formed.
Do I Need an Attorney for Issues with My Subsidiary Limited Liability Company?
As can be seen, forming a single or multiple LLC subsidiaries under a parent company can be a challenging process. The main challenge is to specify how the parent relates to the subsidiary and ensure that nothing is done that would justify piercing the corporate veil. If not formed correctly under the umbrella of the parent company, the parent could become liable for the subsidiary’s obligation.
It could be helpful to contact a well-qualified and experienced corporate lawyer to help you through the process of forming a subsidiary LLC. They can help to avoid problems with liability of the parent company for the liabilities of the subsidiary.