Why licensed professionals cannot form California Limited Liability Companies (LLCs)

October 29, 2023

KEY TAKEAWAYS:

1)??? Licensed professionals cannot form LLCs in California.

?2)??? Licensed professionals may form Professional Corporations or Limited Liability Partnerships.

?3)??? Non-Professional Occupational licensees can form LLCs (e.g., food handlers).

?4)??? Rationale 1: Licensed professionals are held to higher standards of professional conduct.

?5)??? Rationale 2:? Licensed professionals could misuse limited liability protection to shield themselves from professional liability.

?6)??? Rationale 3: Shareholders of a professional corporation or partners in an LLP remain personally liable for their own professional malpractice or misconduct.

?OVERVIEW:

At the SBDC, we meet with many licensed professionals who are seeking to form an entity for their businesses.

The state of California restricts licensed professionals from forming Limited Liability Companies (LLCs).

This restriction has an impact on over 200 licensed professions in California.? As of 2022 there were 3.4M active licensees. In that year, there was a significant increase of 20.5% for new licensees (299k).

If you are a professional licensee, be mindful that you will not be allowed to form an LLC in California.? (Please note that contractors with licenses from the California State Licensing Board can form LLCs.? CSLB licensees with LLCs will face higher bonding requirements than those contractor licensees who form corporations.)

The LLC restriction is due to the nature of these professions. As alternatives, California law permits licensed professionals to form Professional Corporations (PCs) or Limited Liability Partnerships (LLPs).

You may have heard of Professional Limited Liability Companies (PLLCs), however, California does not allow this entity structure.?

You may have also considered establishing a PLLC in a different state and then registering as an out of state entity in California.? Once again, state law will stymie this effort.?

STATUTORY AND CASE AUTHORITY:

The statutory authority for the professional LLC restriction is embodied in the

California Revised Uniform Limited Liability Act - Section 17701.04 (e) as follows:

?“Nothing in this title shall be construed to permit a domestic or foreign limited liability company to render professional services”.

?Further defense of the LLC restriction can be found in Attorney General Lockyer’s opinion #04-103 sent to the California Secretary of State in July of 2004 wherein he concluded that

“A business that provides services requiring a license, certification, or registration pursuant to the Business and Professions Code may conduct its activities as a limited liability company if the services rendered require only a nonprofessional, occupational license.”

?This opinion leaves the door open to ask for the definition of a nonprofessional occupational license.

?A.G. Lockyer answered this query in his opinion by looking to the intent of the legislature, case law and dictionary definitions for the word professional.? In the case of Hollingsworth v. Commercial Union Ins. Co. (1989) 208 Cal.App .3d, professional services were defined as “a calling requiring specialized knowledge and often long and intensive academic preparation”.? A.G. Lockyer also referred back to the Benito Foods v. Veneman (1996) 50 Cal.App .4th , case wherein the court stated that a license that merely requires “character, responsibility and good faith” does not meet the test of being a professional license. As an example, the holder of a food processor’s card does not meet the test for a professional license and would be considered a non-professional occupational license.? Another example of a non-professional occupational license would be that of a locksmith.? Locksmiths are paying the state to allow for the work but there is no mandated state training required for locksmiths and no state required exams to work as a locksmith.

?RATIONALE:

?Let us now take a deeper dive into some of the reasons why most licensed professionals cannot form LLCs in California.

1.??? Professional Accountability and Malpractice:

·???????? Licensed professionals are held to higher standards of professional conduct and ethics. The state licensing boards and authorities closely regulate the conduct and competence of these individuals.

·???????? By forming a Professional Corporation (PC) or Limited Liability Partnership (LLP), the state can more effectively oversee and regulate the activities of licensed professionals to ensure they meet these standards.

·???????? Shareholders and partners in a professional corporation or a limited liability partnership remain personally liable for their own professional malpractice or misconduct.

·???????? This means that if a shareholder or partner, such as a licensed professional like a lawyer, doctor, or accountant, commits malpractice or misconduct while providing professional services, they can be held personally responsible for any resulting liabilities or damages.

·???????? While LLCs provide liability protection for their members, the state of California may have concerns that licensed professionals could potentially misuse this protection to shield themselves from professional liability.

·???????? This could lead to issues where clients or patients are not adequately protected in cases of malpractice or professional misconduct.

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2.??? Ethical Considerations:

·???????? Licensed professionals are typically bound by strict ethical guidelines and regulations that may not align with the flexibility an LLC offers.

·???????? For example, the attorney-client privilege or doctor-patient confidentiality can be compromised if professionals operating as an LLC are not subject to the same ethical rules.

In California, shareholders who form Professional Corporations or Limited Liability Partnerships are generally protected from personal liability for the corporation's or partnership’s professional malpractice, or liabilities incurred by other shareholders, employees, or the entity itself. However, there are important limitations and exceptions to this rule as explained below:

?PIERCING THE CORPORATE VEIL:

While a PC and an LLP provide limited liability for the personal assets of its owners, there are situations where courts may "pierce the corporate veil" and hold shareholders personally liable.

This typically occurs when a court determines that the shareholders have not treated the corporation as a separate legal entity, but rather as an extension of themselves. Factors that may lead to piercing the corporate veil include gross negligence, criminal acts (e.g., fraud), commingling personal and corporate funds, inadequate capitalization, and failure to follow corporate formalities.

ADDITIONAL CONSIDERATIONS REGARDING PERSONAL LIABILITY:

Other points to consider as corporation shareholders or limited partners

Contractual Obligations: Shareholders can be personally liable if they have personally guaranteed loans, leases, or contracts on behalf of the corporation. In such cases, their personal assets may be at risk if the corporation defaults on these obligations.

Taxes and Regulatory Compliance: Shareholders and partners remain personally responsible for their individual tax obligations, including income taxes. Additionally, licensed professionals must still comply with their professional regulatory requirements.

Criminal Acts: Personal liability can also arise in cases of criminal acts committed by shareholders, irrespective of their corporate status.

It's crucial for professional corporation shareholders or limited liability partners to maintain good governance practices, keep personal and business affairs separate, and consult with legal and financial professionals to ensure that they adhere to all applicable laws and regulations.

CONCLUSION:

If you are a licensed professional through a board or an agency in the state of California you should check with your board or agency and the California Secretary of State before filing Articles of Organization for a Limited Liability Company.? The vast majority of licensed professionals are not permitted to form LLCs.? You should consider forming a Professional Corporation or a Limited Liability Partnership.

To fully understand the implications and protections associated with professional corporations in California, it is advisable to consult with an experienced business attorney who can provide guidance tailored to your specific situation and profession.