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LIMITED LIABILITY COMPANIES AND

LIMITED LIABILITY PARTNERSHIPS

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CHAPTER 39 CHAPTER 39

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Limited Liability Company (LLC)

• Unincorporated business entity that combines the most favorable attributes of general partnerships, limited partnerships, and corporations.

• LLC may elect to be taxed as a partnership.• The owners can manage the business.• The owners have limited liability.

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LLC (continued)

• Created under state law of state in which the LLC is being organized.

• Limited liability company codes regulate formation, operation, and dissolution of LLCs.

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LLC (continued)

• LLC is separate legal entity that can:– Own property– Sue and be sued– Enter into and enforce contracts– Be found civilly and criminally liable for

violations of law

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Uniform Limited Liability Company Act

• Goal of comprehensive and uniform laws for the formation, operation, and dissolution of LLCs.

• Revised in 2006.• Not law unless a state adopts it as its LLC

statute.• Many states have adopted all or part of the

ULLCA as their limited liability company law.

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Taxation of LLCs

• LLC taxed as partnership unless it elects to be taxed as a corporation.– Taxes flow through to individual’s tax returns.– No taxation at the entity level.– Avoids double taxation.

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Powers of an LLC

• Has same powers as an individual– Can own, mortgage, and transfer real estate.– Can own and transfer personal property.– Can enter into contracts and make

guarantees.– Can borrow money and issue notes and

bonds.– Can be sued and sue.

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Formation of an LLC

• An LLC may be organized to operate businesses, real estate developments.– Certain professional groups, such as

accountants, lawyers, doctors, may not operate as LLCs.

• An LLC can be organized in only one state even though it can conduct business in all other states.

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Articles of Organization

• An LLC is formed by delivering articles of organization to the office of the secretary of state of the state of organization for filing.

• Articles include name, address of office, name and address of agent and organizers, type of LLC, other information.– Name must include limited liability company or limited

company or abbreviation thereof.

• Existence begins when articles of organization are filed.

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Duration

• Term LLC– An LLC that has a specified term of duration.– E.g., “period ending January 1, 2050.”

• At-Will LLC – An LLC that has no specified term of duration.

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Capital Contribution

• May be in form of money, tangible or intangible property, services performed or promised to be performed, promissory notes, or other agreements to provide cash or property

• A member’s obligation to contribute capital not excused by death or disability.

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Certificate of Interest

• Document that evidences a member’s ownership interest in an LLC.– Similar to stock certificate issued by a

corporation.

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Operating Agreement

• Agreement entered into among members that governs the affairs and business of the LLC and the relations among members, managers, and the LLC.

• May be amended by the approval of all the members unless otherwise provided in the agreement.

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Conversion of an Existing Business to an LLC

• General or limited partnerships and corporations may wish to convert to an LLC.– To obtain the tax benefits and limited liability

shield of an LLC.– Law permits such conversions.

• Execute agreement of conversion and file articles of organization.

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Dividing an LLC’s Profits and Losses

• Unless otherwise agreed, under ULLCA each member has right to equal share of profits and losses.

• Operating agreement may have other provisions.

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Distributional Interest

• A member’s ownership interest that entitles the member to receive distributions of money and property from the LLC.

• Member may transfer that interest to another party. Transferee receives the right to profit and other distributions of the LLC, but is not a member of the LLC unless otherwise provided in the operating agreement.

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Liability of an LLC

• LLC is liable for loss or injury caused by wrongful act or omission or member, manager, employee, or agent in course of ordinary business, or with authority of the LLC.

• Managers are not personally liable for debts, obligations, and liabilities of LLC.

• Members or managers are personally liable for their own torts.

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Member’s Limited Liability

• Member – an owner of an LLC.• Members have limited liability.• Members are liable for the LLC’s debts,

obligations, and liabilities only to the extent of their capital contributions.

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Limited Liability Company (LLC)

Liability limited to capital Liability limited to capital contributioncontribution

No personal liability for company’s No personal liability for company’s debts and obligationsdebts and obligations

Capital investmentCapital investment

Debt or obligation Debt or obligation owedowedLimited Limited

Liability Liability Company Company

(LLC)(LLC)

Third PartyThird Party

MemberMember MemberMember MemberMember MemberMember

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Member-Managed LLC

• In a member-managed LLC, all members can bind the LLC to authorized contracts.

• Each member has equal rights in the management of the business regardless of the size of his or her capital contribution.

• Any matter relating to the business of the LLC is decided by a majority vote of the members.

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Manager-Managed LLC

• In manager-managed LLC, only the managers can bind the LLC to authorized contracts.

• Members and nonmembers who are designated managers control the management of the LLC.

• Members who are not managers have no rights to manage the LLC unless otherwise provided in operating agreement.

• Certain actions cannot be delegated to managers but must be voted on by members.– E.g., amending operating agreement, admitting new

members.

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Compensation and Reimbursement

• Nonmanager member not entitled to remuneration.– Except for winding-up the LLC.

• Managers of LLC are paid compensation and benefits.– Specified in employment agreements.

• LLC is obligated to reimburse members and managers for payments made on behalf of the LLC.

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Agency Authority to Bind an LLC to Contracts

• All members in member-managed LLC may bind LLC.

• Only managers have authority to bind LLC in manager-managed LLC.– Member cannot bind LLC unless also a

manager.

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Fiduciary Duties to the LLC

Duty of Duty of LoyaltyLoyalty

Duty of CareDuty of Care

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Duty of Loyalty

• Owed by member of member-managed LLC

and manager of manager-managed LLC.• Breaches include:

– Usurping an LLC opportunity– Making secret profits– Secretly dealing with the LLC– Secretly competing with the LLC– Representing any interest adverse to that of the

LLC

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Limited Duty of Care

• Owed by member of a member-managed LLC and manager of a manager-managed LLC.

• Duty not to engage in:– Known violation of law.– Intentional, reckless, or grossly negligent

conduct that injures the LLC.

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Limited Duty of Care (continued)

• Member or manager of an LLC is not liable to the LLC for injuries caused by his or her ordinary negligence.

• The ordinarily negligent member or manager, and the LLC on whose behalf the member or manager was acting when the negligent act occurred, are liable to the injured third party.

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No Fiduciary Duty Owed by Nonmanager Member

• A nonmanager member of a manager-

managed LLC owes no fiduciary duties of

loyalty or care to the LLC or its members.

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Dissolution

• Unless otherwise agreed, member of an LLC has the power to disassociate from the LLC.

• Wrongful disassociation occurs when member withdraws from a term LLC prior to the expiration of the term or from an at-will LLC when the operating agreement eliminates a member’s power to withdraw.– Member may owe damages to LLC and other

members.

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Payment of Distributional Interest

• If no wrongful disassociation, LLC must purchase the disassociated member’s distributional interest.

• Price and terms may be fixed in operating agreement; otherwise, pay fair market value.

• If wrongful disassociation, damages may be offset against price.

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Notice of Disassociation

• Document filed with the secretary of state that gives constructive notice that a member has disassociated from an LLC.

• Effective against any person who later deals with LLC.

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Continuation of a Term LLC

• Members may vote unanimously before expiration date to continue LLC for additional specified term.

• LLC may be continued as an at-will LLC by simple majority vote.

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Winding-Up an LLC’s Business

• The process of preserving and selling the assets of the LLC and distributing the money and property to creditors and members.

• Creditors paid first.• Surplus amounts are distributed to members in

equal amounts.– May be modified by operating agreement.

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Articles of Termination

• Document filed with the secretary of state that terminates the LLC as of the date of filing or upon a later effective date specified in the document.

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Limited Liability Partnership (LLP)

• Usually restricted to partnerships of professionals, such as accountants, lawyers, doctors.

• All partners are limited partners.– No general partners.– No partners are personally liable; all have limited

liability.

• LLPs have flow-through tax benefits.– No taxes at entity level.

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Limited Liability Partnership (LLP) (continued)

Liability limited to capital Liability limited to capital contributioncontribution

No personal liability for partnership’s No personal liability for partnership’s debts and obligationsdebts and obligations

Capital investmentCapital investment

Debt or obligation Debt or obligation owedowedLimited Limited

Liability Liability Partnership Partnership

(LLP)(LLP)

Third PartyThird Party

Limited Limited PartnerPartner

Limited Limited PartnerPartner

Limited Limited PartnerPartner

Limited Limited PartnerPartner

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Articles of Partnership

• LLP created formally by filing articles of partnership with the secretary of the state in state in which LLP is organized.

• LLP is domestic LLP in the state in which it is organized.

• An LLP must register as a foreign LLP in any other state in which it wants to conduct business.

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Liability Insurance Required

• Many state laws require LLPs to carry a minimum of $1 million of liability insurance that covers negligence, wrongful acts, and misconduct by partners or employees of the LLP.

• Quid pro quo for limited liability of partners.