Advance Payment, Indemnification, and the Single-Member LLC

The Colorado statues provide that an limited liability company (LLC) member is entitled to be reimbursed for expenses incurred for the company. LLCs can also provide their members, managers, officers, employees, agents, and so on with indemnification for liabilities they incur for the company. While there are limits to the indemnification that can be provided, because LLCs are contractual entities, the indemnification generally has to be granted within the Operating Agreement.

The first thing to keep in mind is that this is a good reason to actually put together an Operating Agreement for an LLC, even if there is only one member.

There are two reasons for this. First, because the entity is separate from the member’s personal capacity, the creation of the indemnification right in the Operating Agreement creates an obligation between the entity and the member. A single member may be tempted to simply indemnify themselves using funds from the company whether there is a written right or not, but this action can itself be used as evidence that the person is simply using the company as their personal instrument instead of as a separate legal entity. The problem is that the limited liability of the member is based on the LLC being a separate entity, distinct from the member. Actions by the member that appear to treat the entity as the same as the member’s personal assets are suspect and run the risk of being evidence that the LLC should not have a limited liability shield.

Second, the creation of such a provision in an Operating Agreement, while creating an advantage for the member, also reinforce that the member and entity are being treated as separate. This actually reinforces the presumption that the entity is separate and that the limited liability should be respected.

The second thing to keep in mind is that an advance payment provision, with an indemnification provision, gives the member or manager a right to receive payments from the company in advance of any determination of ultimate liability when her or she is personally named for liabilities related to the company. Because of the provisions in the Operating Agreement, the member/manager has the right to receive payments from the company to defend him or herself while the claims are being fought, even if the payment of those costs by the company means the company’s assets are being depleted. In other words, the provisions create a known, legitimate liability obligation for the company that benefits the member/manager so the companies available funds can go to the defense of the member/manager while the claim is pending. 

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