Does an LLC Need a Business Purpose?

By Joseph Scrofano

A limited liability company (LLC) is a relatively business entity created by state law. LLCs typically have the advantages of both partnerships and corporations when it comes to taxation, management and personal liability. State laws vary with regard to LLCs. Accordingly, some states require that an LLC have a business purpose while others do not. LLCs are for-profit business entities, so even if a state does not require an official business purpose, an LLC should have a business purpose.

LLC Basics

The IRS does not have a set classification for LLCs. Therefore, the IRS taxes an LLC either as a corporation, partnership or sole proprietorship depending on how the LLC owners, who are called members, elect to be taxed. In partnership or sole proprietorship taxation, the profits and losses from the LLC flow through to the individual members' personal income taxes. Under corporate taxation, the LLC gets taxed on its profits and the members get taxed on any income from the LLC. Even if an LLC elects to get taxed like a partnership, the LLC limits the personal liability of its members. In this way, an LLC is like a corporation.

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State law typically requires that, to form an LLC, the members must file articles of organization with the secretary of state of the individual state where the LLC will do business. State law varies on what information the members must include in the articles of organization. Under some states’ laws, the members must include a statement regarding the business purpose of the LLC. In many states, the members can put a general statement declaring the purpose of the LLC is for “all lawful business.” This language protects the LLC in the event that the business activities change to something the members did not originally anticipate.

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Ultra Vires

Ultra vires is a legal doctrine that states any act a business entity takes that is outside the scope of its business purpose is invalid. Under this doctrine, for example, an LLC could be sued for acts it took outside the scope of what its stated business purpose was. In addition, contracts signed by the LLC in areas of commerce outside its business scope could be held unenforceable. However, the trend in modern business law has made ultra vires all but obsolete. Because most states allow an LLC to state in its business purpose clause that it intends to engage in “all lawful business,” it's virtually impossible for an LLC that has this language to exceed the scope of its business purpose.

Liability

While not all states require an LLC state its business purpose in its articles of organization, its good policy for an LLC to have a business purpose. In most cases, someone who sues an LLC cannot go after the personal assets of its members. This protection is called the “corporate veil.” However, courts will “pierce the corporate veil” in cases where fraud or misrepresentation exists. A typical example of this phenomenon occurs when someone forms an LLC solely for the purpose of hiding assets or using the corporate veil. Most courts will look to see if the LLC has an actual business purpose or if it's simply the “alter ego” of its owner when determining whether to pierce the corporate veil in litigation.

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What Financial Liability Does Each Member of an LLC Accrue?

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