The Station fire triggered the change: Four employees perished in the blaze, but the club had no workers’ compensation insurance. Under state law, the club itself would have to pay their families, but the corporation that owned it, Derco LLC, had lost all its assets.
So who should pay the $1 million fine imposed by the state for breaking the law that requires workers’ comp coverage? And who should pay the burial expenses and cover lost wages?
Last August, a state Workers’ Compensation Court judge found that Derco partners Jeffrey and Michael Derderian were personally liable for the fine. And earlier this month, the court found the brothers liable for more than $200,000 in claims from the four deceased workers’ families.
But there’s still debate over whether state law, as it stood on Feb. 20, 2003, actually shielded partners in limited liability companies from having to personally cover the LLCs’ debts. To avoid future uncertainties, the General Assembly last year changed the law.
Now, while LLC partners are still protected from a range of other personal liabilities, they can be held personally liable for failure to maintain workers’ comp insurance regardless of their role in the company – whether they’re running it, or are just investors.
How big a deal this is depends on whom you ask.
Kristin A. DeKuiper, a lawyer with Holland & Knight with offices in Providence and Boston, posted an “alert” on the firm’s Web site saying it “creates a serious impediment to investment in Rhode Island businesses.”
“The amendment creates potential exposure for limited partners and passive members of LLCs who generally would not be liable for the obligations of the entity,” she wrote. “Anyone doing business as a limited partnership or LLC will need to consider the new risks.”
But H. Peter Olsen, a lawyer with Hinkley, Allen & Snyder, in Providence, said that while the law is unusual, and the firm does mention it to clients as part of a broader discussion of issues involved in forming an LLC, “it becomes kind of a non-issue, because most of our clients carry workers’ comp. They’re all properly insured, and they’re complying with the law.”
LLCs are very common, especially among small businesses. As of January, there were 13,941 LLCs registered with the Rhode Island secretary of state’s office, compared with 25,350 corporations. The number of LLCs is growing, too: in January 2004, there had been 10,924.
LLCs are one of two major options for someone starting a business, along with so-called S corporations. Unlike regular (C) corporations, LLCs and S corporations don’t directly pay taxes on their profits; instead, the profits are passed through to their shareholders, who then pay personal income taxes. (States do often impose a minimum “franchise” tax; in Rhode Island it doubled this year, to $500.)
LLCs are considered more flexible than S corporations, with no limitations on ownership – S corps can’t have shareholders who are nonresident foreigners, for example. For a small-business owner, they’re also easier, without the extra paperwork required of corporations.
And LLCs can more easily accommodate investors, said Pasco Gasbarro Jr., also of Hinkley, Allen & Snyder, because they can set up different types of ownership and compensation. “That could be important in a small company where somebody was coming in as an investor and another person was running the company,” he said.
But that, precisely, is where the risk from the new law comes in, according to DeKuiper. Because even if you’re a passive investor in an LLC, with no involvement in management, you can be held personally liable and even imprisoned if the company doesn’t carry workers’ comp.
“Limited liability companies and limited partnerships conducting business in Rhode Island that employ more than one person should carefully consider the risks to their owners presented by this change in the law,” DeKuiper wrote.
“It may be logical to extend personal liability under (the new law) to general partners and to managers of limited liability companies because they control the business activities of the entity,” she added. But limited partners and passive members of LLCs “generally have no authority to control the business of a limited partnership or LLC,” so they’re unlikely to expect to be held liable for any wrongdoing.
In her article, DeKuiper recommended that investors in limited partnerships and LLCs operating in Rhode Island require evidence of compliance with workers’ comp requirements “as part of the initial due diligence and annual reporting obligations of the general partners or managers.” She also encouraged people forming a business that will have more than one employee to consider organizing as a corporation rather than as an LLC.
Olsen and Gasbarro disagreed, however. There’s a lot more to running a business than workers’ compensation, they said, and this shouldn’t tip the balance. “The way to deal with this risk, frankly, is to carry adequate insurance,” Olsen said.
Susan DeBlasio, a corporate lawyer at Tillinghast Licht, in Providence, offered a similar perspective.
“It’s something I would mention to clients, but I wouldn’t put too much weight on it,” she said.
“It’s not a major factor that I’ve seen clients consider. Because they should be obeying the law, and then you can go to bed at night and not worry about it.”
