Ch 17 Limited Liability Business Forms

17 Limited Liability Business Forms

17-1 The Limited Liability Company (LLC)

  • Definition of Limited Liability Company (LLC): A hybrid form of business enterprise that combines the limited liability of a corporation with the tax advantages of a partnership.

  • Preference in Small Businesses: LLCs have become the preferred structure for many small businesses due to their benefits.

  • Regulations: LLCs are governed by state statutes.

17-1a The Nature of the LLC

  • Similarities to Corporations: LLCs share many characteristics with corporations.

    • LLCs must comply with state law for formation and operation.

    • Owners of an LLC, referred to as members, enjoy limited liability similar to corporate shareholders.

    • Member: A person with an ownership interest in a limited liability company.

Limited Liability of Members

  • Protection of Members: Members are shielded from personal liability in most scenarios.

    • Liability is usually restricted to the amount they invested in the LLC.

    • Exceptions:

    • If the business is mismanaged.

    • If a member personally guarantees a firm debt.

17-1b The Formation of the LLC

  • Articles of Organization:

    • Required to form an LLC, must be filed with a central state agency, commonly the secretary of state's office.

    • Definition: The document filed containing basic information about the business.

    • Typical contents include:

    • Business name, which must contain “Limited Liability Company” or “LLC”.

    • Principal business address.

    • Name and address of a registered agent.

    • Names of the members.

    • Management structure of the LLC.

    • Legal Privilege: Forming an LLC is a privilege with attached conditions, including vulnerability to lawsuits.

Preformation Contracts

  • Individuals forming an LLC can engage in preincorporation contracts before the LLC is legally recognized.

    • The promoters who sign are personally liable until the LLC adopts the contracts through novation (replacing old contracts with new ones).

17-1d Advantages of the LLC

  • Limited Liability: Members are not personally liable for LLC debts due to the business's wrongful acts or omissions.

  • Flexibility in Taxation: LLCs can choose to be taxed as a partnership or corporation:

    • Multi-member LLCs typically prefer partnership taxation to avoid double taxation.

    • Corporate taxation may be preferable for companies that wish to retain and reinvest profits.

  • Default Taxation Rules: The IRS defaults to partnership taxation for LLCs unless stated otherwise.

    • Solo-member LLCs are taxed as sole proprietorships unless they opt for corporate taxation.

17-1e Disadvantages of the LLC

  • Nonuniformity of State Statutes: LLC statutes vary between states, which can complicate operations across state lines.

  • Governance: A foreign LLC is typically governed by the law of its formation state, which has practical implications for multi-state enterprises.

17-2a Management of an LLC

  • Management Structure: LLC members can choose between two management styles:

    1. Manager-managed LLC similar to corporate management.

    2. Member-managed LLC similar to partnership management.

  • Default Management: Without specification, an LLC is assumed to be member-managed under most state statutes.

17-2b Fiduciary Duties

  • Duties in Manager-managed LLCs:

    • Managers owe fiduciary duties including duty of loyalty and duty of care.

  • Members’ Duties: If a member is not a manager, they do not owe fiduciary duties, allowing them to compete with the LLC. Duties are owed if the LLC is managed by its members.

17-2c The LLC Operating Agreement

  • Definition: An operating agreement outlines how the LLC will be managed and operated.

  • Compliance: While not universally required, having an operating agreement is advisable for clarity and governance.

  • Disputes: In cases of disputes without coverage in the operating agreement, state LLC statutes will govern.

17-3 Dissociation and Dissolution of an LLC

  • Dissociation: Occurs when a member ceases to be part of the LLC.

  • Member's Right: A member can dissociate at any time but may not always have the right to do so based on circumstances.

Triggers for Dissociation

  • Events include:

    • Voluntary withdrawal

    • Expulsion by other members

    • Court order

    • Incompetence

    • Bankruptcy

    • Death

  • Continuity of Business: The LLC can continue if members dissociate unless otherwise stated in the operating agreement.

Effects of Dissociation from an LLC

  • Loss of Rights: The dissociated member:

    • Loses management participation and agency rights.

    • Termination of duty of loyalty.

  • Duty of Care: This continues for events prior to dissociation.

  • Right to Buyout: Dissociated members can seek buyout of their interest, with prices set by the operating agreement or at fair value.

Wrongful Dissociation

  • Members who dissociate in violation of the operating agreement are liable for damages, impacting the buyout price.

17-3b Dissolution of an LLC

  • Continuation Post-Dissociation: Dissociated members typically cannot force dissolution; remaining members decide on continuation or dissolution.

  • Grounds for Dissolution:

    • Stipulated events in the operating agreement.

    • Majority agreement by members.

    • Court order under certain conditions (e.g., illegal conduct).

17-3c Winding Up of an LLC

  • Process: Dissolved LLCs undergo winding-up to collect, liquidate, and distribute assets.

  • Member Participation: Members not at fault in dissolution participate in winding-up.

  • Debts: Members are not required to contribute further capital if the LLC cannot meet debts.

Asset Distribution Upon Winding-Up

  • Prioritization:

    1. Creditors first.

    2. Return of capital contributions to members.

    3. Remaining assets distributed according to operating agreement or equally among members.

17-4 Limited Liability Partnerships

  • Definition: A hybrid business organization primarily used by professionals functioning in partnerships.

  • Liability Protection: LLPs protect partners from liability due to other partners' malpractice but retain personal liability for one’s own wrongful acts.

Liability in an LLP

  • Non-malpractice Debt: Partners are protected from personal liability for debts without malpractice.

  • Responsibility: Partners can be liable for malpractice debts if they supervised the negligent partner.

17-5 Limited Partnerships

  • Definition: A partnership comprised of general partners and limited partners.

  • General Partner: Responsible for management with full liability.

  • Limited Partner: Contributes capital but does not manage and has limited liability.

Formation of a Limited Partnership

  • Requirements: Compliance with statutory requirements through a certificate of limited partnership.

  • Contents of Certificate: Must include partnership name, address, and individual contributions of partners.

Dissociation and Dissolution of a Limited Partnership

  • General Partner Dissociation: Can voluntarily dissociate, potentially breaching the partnership agreement.

  • Events Leading to Dissociation: Include bankruptcy, retirement, death, and incompetence. Limited partners’ withdrawal must align with the partnership agreement.

Distribution of Assets on Dissolution

  • Priority for creditors' claims against the partnership, followed by partners receiving their contributions and distribution of surplus as profit.

17-5e Limited Liability Limited Partnerships (LLLP)

  • Definition: A type of limited partnership where general partner liability is limited to their investment.

  • Jurisdiction: LLLPs exist in some states, while others might permit registration as LLLPs under similar statutes for LLPs.