Chapter 17 Reading: Limited Liability Business Forms

LLC members have two options for managing the firm. The firm can be either a

"member-managed" LLC or a "manager-managed" LLC.

Operating agreements typically contain provisions relating to the following areas:

- Management - Profits - Memberships - Dissociation and Dissolution - Member Meetings - Voting Rights

limited liability company (LLC)

A hybrid form of business enterprise that offers the limited liability of a corporation and the tax advantages of a partnership.

limited liability partnership (LLP)

A hybrid form of business organization that is used mainly by professionals who normally do business in a partnership. An LLP is a passthrough entity for tax purposes, but a partner's personal liability for the malpractice of other partners is limited.

family limited liability partnership (FLLP)

A limited liability partnership (LLP) in which the majority of the partners are members of a family.

limited partnership (LP)

A partnership consisting of one or more general partners and one or more limited partners.

members

A person who has an ownership interest in a limited liability company.

limited liability limited partnership (LLLP)

A type of limited partnership in which the liability of the general partner is the same as the liability of the limited partners—that is, the liability of all partners is limited to the amount of their investments in the firm.

operating agreement

An agreement in which the members of a limited liability company set forth the details of how the business will be managed and operated.

Dissociation and Dissolution

Clarifies which events cause the dissociation of a member - such as by death or retirement - and trigger the LLC's dissolution. Provides a method of calculating a buyout price for a member's dissociation.

Once all of the LLC's assets have been sold, the proceeds are distributed:

Debts to creditors are paid first (including debts owed to members who are creditors of the LLC). The members' capital contributions are returned next, and any remaining amounts are then distributed to members in equal shares or according to their operating agreement.

Voting Rights

Details how voting rights will be apportioned, such as according to each members capital contribution or by allowing one vote for each member.

Profits

Establishes how profits will be divided among members.

general partner

In a limited partnership, a partner who assumes responsibility for the management of the partnership and has full liability for all partnership debts.

limited partners

In a limited partnership, a partner who contributes capital to the partnership but has no right to participate in its management and has no liability for partnership debts beyond the amount of her or his investment.

Under the ULLCA, managers in a manager-managed LLC owe fiduciary duties (the duty of loyalty and the duty of care) to the ___________ (This same rule applies in corporate law—corporate directors and officers owe fiduciary duties to the corporation and its shareholders.)

LLC and its members.

If a dispute arises and there is no agreement covering the topic under dispute, the state __________ will govern the outcome.

LLC statute

Because not all states have adopted the ULLCA, some state statutes provide that managers owe fiduciary duties only to the LLC and not to the

LLC's members

Management

Sets forth who will manage the LLC and how future managers will be chosen or removed.

Membership

Specifies how membership interests may be transferred.

articles of organization

The document that is filed with the appropriate state official, usually the secretary of state, when a limited liability company is formed. Typically must include the name of the business, its principal address, the name and address of a registered agent, the members' names, and how the LLC will be managed.

certificate of limited partnership

The document that must be filed with a designated state official to form a limited partnership.

novation

The substitution, by agreement, of a new contract for an old one, with the rights under the old one being terminated. Substituting a new obligation for an old one or substituting new parties to an existing obligation.

Another advantage of the LLC is its flexibility in regard to taxation. An LLC that has two or more members can choose to be taxed as either

a partnership or a corporation.

In contrast to the private and informal agreement that usually suffices to form a general partnership, the formation of a limited partnership is

a public and formal proceeding.

Liability arises when the creditor believes, based on the limited partner's conduct, that the limited partner is a general partner [RULPA 303]. Such conduct includes

acting as a general partner, knowingly allowing her or his name to be used in partnership business, or contributing services to the partnership.

Member-managed LLC

all of the members participate in management, and decisions are made by majority vote

LLPs must be formed and operated in compliance with state statutes, which may include provisions of the UPA. The appropriate form must

be filed with a central state agency, usually the secretary of state's office, and the business's name must include either "Limited Liability Partnership" or "LLP"

The members of an LLC, like the shareholders in a corporation, can lose their limited personal liability in certain circumstances. For instance, when an individual guarantees payment of a business loan to the LLC, that individual is personally liable for the ____________. In addition, if an LLC member fails to comply with certain formalities, such as by commingling personal and business funds, a court can impose _____________.

business's obligation, personal liability

Not only must a limited partnership have at least one general partner and one limited partner, but the partners must also sign a

certificate of limited partnership

When an LLC is dissolved, any members who did not wrongfully dissociate may participate in the winding up process. To wind up the business, members must

collect, liquidate, and distribute the LLC's assets.

The main disadvantage of the LLC is that state LLC statutes are not uniform. Therefore, businesses that operate in more than one state may not receive in these states.

consistent treatment

A number of "safe harbors" protect a limited partner from liability for acting as a general partner [RULPA 303(a)]. For instance, safe harbors allow a limited partner t

consult with the general partner regarding partnership business, act as a contractor or employee of the partnership, and participate in winding up the business. A limited partner who engages in only one of the safe-harbor activities normally is not exposed to personal liability for participating in the management and control of the business.

Also, some states have passed laws prohibiting the withdrawal of limited partners.

continue the business.

If an LLC's members want to reinvest profits in the business rather than distribute the profits to members, however, they may prefer to be taxed as a

corporation

Member Meetings

determines whether or not formal members' meetings will be held.

An LLC that wants to distribute profits to its members almost always prefers to be taxed as a partnership to avoid the ______________ that is characteristic of the corporate entity. Unless an LLC indicates that it wishes to be taxed as a corporation, the Internal Revenue Service (IRS) automatically taxes it as a partnership.

double taxation

A limited partnership consists of at least one __________ and one or more __________.

general partner, limited partners

With the exception of the right to participate in management, limited partners have essentially the same rights as general partners. Limited partners

have a right of access to the partnership's books and to information regarding partnership business. On dissolution of the partnership, limited partners are entitled to a return of their contributions in accordance with the partnership certificate [RULPA 201(a)(10)]. They can also assign their interests subject to the certificate [RULPA 702, 704]. In addition, they can sue an outside party on behalf of the firm if the general partners with authority to do so have refused to file suit

Another similarity between corporations and LLCs is that LLCs are

legal entities apart from their owners.

If the member's dissociation violates the LLC's operating agreement, it is considered legally wrongful, and the dissociated member can be held _________ for damages caused by the dissociation.

liable

A key advantage of the LLC is the limited liability of its members. The LLC as an entity can be held liable for any

loss or injury caused by the wrongful acts or omissions of its members

Most state LLC statutes and the ULLCA provide that unless the articles of organization specify otherwise, an LLC is assumed to be

member managed

When a member dissociates from an LLC, he or she loses the right to

participate in management and the right to act as an agent for the LLC. The member's duty of loyalty to the LLC also terminates, and the duty of care continues only with respect to events that occurred before dissociation.

When an issue is not covered by an operating agreement or by an LLC statute, the courts often apply principles of

partnership law

Under the federal jurisdiction statute, a corporation is deemed to be a citizen of the state where it is incorporated and maintains its principal place of business. The statute does not mention the state citizenship of

partnerships, LLCs, and other unincorporated associations. The courts, however, have tended to regard these entities as citizens of every state of which their members are citizens.

Because the corporation has limited liability by virtue of corporation statutes, if a corporation is the general partner, no one in the limited partnership has

personal liability

General partners are personally liable to the partnership's creditors. Thus, at least one general partner is necessary in a limited partnership so that someone has

personal liability. This policy can be circumvented in states that allow a corporation to be the general partner in a partnership.

Preincorporation Contracts

persons who are forming a corporation may enter into contracts during the process of incorporation but before the corporation becomes a legal entity

An LLP must file an annual report with the state to remain _________ as an LLP in that state.

qualified

Like a partner in a partnership, a member of an LLC has the power to dissociate at any time but may not have the

right to dissociate

An LLC that has only one member cannot be taxed as a partnership. For federal income tax purposes, one-member LLCs are automatically taxed as unless they indicate that they wish to be taxed as corporations.

sole proprietorships

When an LLP formed in one state wants to do business in another state, it may be required to file a ____________ in the second state

statement of foreign qualification

Of course, a partner in an LLP is still liable for her or his own wrongful acts, such as negligence. Also liable is the partner who

supervised the individual who committed a wrongful act.

On dissolution, creditors' claims, including those of partners who are creditors, ________. After that, partners and former partners receive __________. Unless otherwise agreed, they are also entitled to a return of their contributions in __________

take first priority, unpaid distributions of partnership assets, the proportions in which they share in distributions

Members of LLCs are shielded from personal liability in most situations. In other words, the liability of members normally is limited to

the amount of their investments. An exception arises when a member has significantly contributed to the LLC's tortious conduct.

The bankruptcy, retirement, death, or mental incompetence of a general partner will cause

the dissociation of that partner and the dissolution of the limited partnership unless the other members agree to continue the firm

Because state LLP statutes are not uniform, a question sometimes arises as to which law applies if the LLP statutes in the two states provide different liability protection. Most states apply ___________, even when the firm does business in another state

the law of the state in which the LLP was formed

An LLP allows professionals, such as attorneys and accountants, to avoid personal liability for

the malpractice of other partners

Manager-managed LLC

the members designate a group of persons to manage the firm. The management group may consist of only members, both members and nonmembers, or only nonmembers.

The certificate of limited partnership must include certain information, including

the name, mailing address, and capital contribution of each general and limited partner. The certificate must be filed with the designated state official—under the RULPA, the secretary of state. The certificate usually is open to public inspection.

Under the RULPA, a limited partner can withdraw from the partnership by giving six months' notice, unless

the partnership agreement specifies a term. In reality, though, most limited partnership agreements do specify a term, which eliminates the limited partner's right to withdraw. Also, some states have passed laws prohibiting the withdrawal of limited partners.

The major advantage of the LLP is that it allows a partnership to continue as a pass-through entity for tax purposes but limits

the personal liability of the partners.

A limited partner who participates in management and control of the business will be just as liable as a general partner to any creditor who

transacts business with the limited partnership.

Under the ULLCA, the events that trigger a member's dissociation from an LLC are similar to the events causing a partner to be dissociated under the Uniform Partnership Act (UPA). These include

voluntary withdrawal, expulsion by other members, court order, incompetence, bankruptcy, and death. Generally, if a member dies or otherwise dissociates from an LLC, the other members may continue to carry on the LLC business unless the operating agreement provides otherwise.