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Business and Tax
Alert - August 27, 2004
 
Amendment to Rhode Island Law Affects Limited Liability Companies
 
 August 27, 2004
 
Kristin A. DeKuiper- Boston

A recent amendment to Rhode Island’s workers’ compensation law extends personal liability for failure to maintain workers’ compensation insurance to partners (both general and limited) of general and limited partnerships and members and managers of limited liability companies (LLCs). 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. Although the background that prompted the amendment may explain its broad reach, the amendment creates a serious impediment to investment in Rhode Island businesses. Anyone doing business as a limited partnership or LLC will need to consider the new risks presented by the amendment.

The Derco Case

Michael and Jeffrey Derderian were both managers of Derco, LLC (Derco), a company organized under the LLC laws of Rhode Island. Derco operated a business known as The Station, in which more than one person was employed, and for which no workers’ compensation insurance coverage was provided or maintained. When fire destroyed The Station and killed 100 people, the issue of an administrative penalty for failure to maintain workers’ compensation insurance came before the Rhode Island Department of Labor and Training (Department). Hearing Officer Louis J. Vallone assessed an administrative penalty in the amount of $1,066,000 against Derco and referred the matter to the Department of the Attorney General for prosecution of criminal charges against Derco. After an appeal to the Workers’ Compensation Court (WCC) and the WCC Appellate Division, the issue of whether Michael and Jeffrey Derderian could be held personally liable for the failure of Derco to maintain the requisite insurance coverage under the law was sent, on remand, back to the Department and Hearing Officer Vallone.

The Derco Decision

Upon remand, the Department held in February 2004, that the Rhode Island Limited Liability Company Act insulates both members and managers of an LLC from personal liability for the LLC’s obligations. Perry v. Derco L.L.C., LOI No. 03-07, at 1 (R.I. Dep’t of Labor & Training Feb. 27, 2004). Hearing Officer Vallone reasoned that managers of an LLC are not “corporate officers,” as the term is used and understood under Rhode Island General Laws § 28-36-15. Section 28-36-15, as previously written, and allowed for personal liability to attach to “corporate officers” (president, vice president, secretary or treasurer) for failure of the officers’ “employer” to maintain workers’ compensation insurance. Determining that managers of a limited liability company are not “corporate officers” under § 28-36-15, Hearing Officer Vallone held that the Department had no jurisdiction to impose civil or criminal liabilities against managers of a limited liability company, either in their capacities as managers or personally, when the LLC failed to provide and maintain workers’ compensation insurance as required by Rhode Island law. The Derco decision is currently on appeal.

2004 Amendment to R.I. Workers’ Compensation Law Overturns Derco

In response to the Derco decision, the Rhode Island General Assembly amended Rhode Island General Laws § 28-36-15 (the Workers’ Compensation Law), allowing for personal liability to attach to (i) any corporate officer (president, vice president, secretary, or treasurer) of any corporation; (ii) any manager OR member of any limited liability company; and (iii) any general OR limited partner of any general or limited partnership which knowingly fails to provide and maintain workers’ compensation insurance. The amendment became effective on July 2, 2004. Under the amendment, LLCs are no longer insulated from the reaches of § 28-36-15. More importantly, not only are LLC managers severally liable for fines, penalties, or imprisonment for failure to cause the LLC to provide and maintain workers’ compensation insurance, but passive members of the LLC with no management rights or responsibilities are also severally liable and subject to imprisonment. Likewise, both general and limited partners are subject to personal liability and imprisonment for the limited partnership’s failure to maintain workers’ compensation insurance. However, the amendment does not extend liability to corporate shareholders or directors. The amendment is a significant change in the law that will affect the choice of business entity in Rhode Island for many businesses.

Considerations for Business Owners

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. It may be logical to extend personal liability under § 28-36-15 to general partners and to managers of limited liability companies because they control the business activities of the entity. However, limited partners and passive members of LLCs generally have no authority to control the business of a limited partnership or LLC, and thus, have no liability for the obligations of the entity under limited partnership or LLC law. The amendments to § 28-36-15 will not be consistent with the expectations of limited partners and passive LLC members.

Investors in limited partnerships and LLCs operating in Rhode Island that may be subject to the workers’ compensation law should require evidence of compliance with workers’ compensation requirements as part of the initial due diligence and annual reporting obligations of the general partners or managers. Investors should also consider requiring indemnification from the general partners or managers against any potential liability (recognizing that indemnification is not an effective remedy against imprisonment). Finally, persons forming a business in Rhode Island that will have more than one employee should consider using a corporation rather than an LLC or limited partnership. As noted above, the amendments to § 28-36-16 do not extend liability to corporate shareholders or directors.

For more information, e-mail Kristin deKuiper at kristin.dekuiper@hklaw.com or call toll free, 1-888-688-8500.

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