A limited liability company, also known as a “LLC,” is a hybrid type of business organization that has both the tax freedom of a partnership and the structural benefits of a corporation. Limited Liability Corporations are the most popular business type, representing three quarters of new businesses formed in the United States.
The goal of forming a limited liability company is to ensure that business partners are safe from being liable for any damages beyond their initial first investment. In other words, the goal of a LLC is to ensure that business partners are not sued and their assets are protected.
Taking that a step further, a business owner that has multiple LLC companies may choose to create a subsidiary LLC to engage in further asset protection.
In short, a subsidiary limited liability company is just another word for a “child” company. A subsidiary limited liability company is a separate LLC that is controlled by another company that is known as a “parent” company.
A subsidiary is a powerful tool that allows for additional asset protection for business partners by creating a separately filed company. By creating a subsidiary company, a parent company reduces its risk of loss from a big claim, because as a general rule parent companies are not liable for the acts of their subsidiaries.
A parent company is a company that owns specific stock in another business. For example, you may know that Marvel Enterprises, LLC, (the studio responsible for superhero movies such as: Iron Man, Spiderman, Guardians of the Galaxy, and the Avengers, to name a few) was formerly a subsidiary of Marvel Entertainment.
However, in 2009 Marvel Entertainment was acquired by The Walt Disney Company for $4.24 billion. Since 2009, Marvel Entertainment has been a subsidiary limited liability corporation of the parent corporation of The Walt Disney Company. Parent LLCs allow the company to control business operations of child LLCs through significant ownership of the subsidiary company.
Benefits of arranging multiple business under the umbrella of a parent corporation is that subsidiary limited liability companies decrease the risks of losing assets of the parent company if they are sued. As mentioned above, the general rule is that any legal claim is limited to the specific limited liability corporation being sued, as the subsidiary company is considered a separate and independent legal entity.
In short, no. You may be thinking that because the general rule is that a parent corporation’s assets are protected against legal claims against their subsidiaries, that a parent corporation’s assets may never be reached through a legal claim by that subsidiaries’ creditors. Fortunately or unfortunately, this is not the case as there are exceptions to the general rule.
First, a parent corporation may be liable for its subsidiaries’ actions or obligations when state law supports “piercing the corporate veil.” In order to pierce the corporate veil the plaintiff suing the parent company must demonstrate to the court that the parent company failed to allow the subsidiary to operate with sufficient financial independence from the parent company.
The law varies by state, but generally, courts do not favor piercing the corporate veil of a parent company; courts are only likely to do so upon a demonstration of serious misconduct and abuse of the subsidiary corporation, such as intermingling of personal and corporate assets. The case law is very confusing in this area, but generally, fraudulent activities intended to result in financial gain will be enough to pierce the corporate veil.
Second, parent corporations can be sued personally if they engage in illegal activities that fall outside of the scope of ordinary business transactions. For instance, a parent corporation of a limited liability corporation subsidiary may be liable if they authorized the subsidiary to engage in an illegal activity, such as illegal dumping of hazardous materials.
There following steps outline the requirements necessary to create a subsidiary LLC:
- Name Your Subsidiary: This may seem straightforward, but you are required to select a name of the subsidiary that has not been registered by any other company doing business in your state. Lastly, the subsidiary must include the words “limited company,” “limited liability company,” or the abbreviations “LLC” or “LC”;
- Acquire and Complete an Articles of Incorporation: The articles of incorporation must be completed in order to form the subsidiary, and will outline the goals and other information related to the company, such as the parent LLC’s ownership interest in the subsidiary;
- Sign the Articles of Incorporation: You must sign the articles of incorporation as a representative of the parent LLC, this means sign 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 LLC. Although not necessary for formation, this operating agreement will help you down the road if a dispute arises regarding liabilities to creditors; and
- Submit Articles of Incorporation to State: Finally, you must submit the articles of incorporation to the secretary of state. Upon approval the subsidiary LLC will be formed under the parent LLC.
As can be seen, forming a single or multiple subsidiaries under a parent LLC is a somewhat difficult and document intensive endeavor. If not formed correctly under the umbrella of the parent LLC, the subsidiary LLC’s liabilities may pierce through the corporate veil and subject the business partners’ assets to the subsidiaries’ liabilities.
Thus, it may be in your best interests to contact a well-qualified and experienced business lawyer in order to guide you through the process of forming the subsidiary LLC or to represent you in front of a court of law if you have been sued as a parent LLC.