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Chapter 39Limited Liability Companies and

Limited Liability Partnerships

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Limited Liability Companies• An unincorporated business

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

• An LLC may elect to be taxed as a partnership.

• The owners can manage the business.

• The owners have limited liability.

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Limited Liability Company (LLC)

• Limited liability companies are creatures of state law, not federal law.

• Limited liability companies can only be created pursuant to the laws of the state in which the LLC is being organized.– Limited liability company

codes regulate the formation, operation, and dissolution of LLCs.

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Limited Liability Company (LLC) (continued)

• Legal Entity – An LLC is a separate legal entity (an artificial person) 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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The Uniform Limited Liability Company Act

• A model act that provides comprehensive and uniform laws for the formation, operation, and dissolution of LLCs.

• The ULLCA is 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• LLCs are taxed as

partnerships unless it elects to be taxed as a corporation.– Taxes flow through to

individual’s tax returns.– No taxation at the entity level

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Powers of an LLC• An LLC has the same

powers as an individual– It can own, mortgage, and

transfer real estate.– It can own and transfer

personal property.– It can enter into contracts and

make guarantees.– The LLC may borrow money,

and issue notes and bonds.– An LLC can be sued and can

sue.

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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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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.

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

• Tortfeasors are still personally liable for injuries they cause.

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Formation of an LLC• An LLC may be organized to

operate businesses and real estate developments.– May not be certain

professional groups.

• 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.– The existence begins when the

articles of organization are filed.

• Articles include name, address of office, name and address of agent and organizers, type of LLC.

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Duration• Term LLC

– An LLC that has a specified term of duration

• At-Will LLC – An LLC that has no specified

term of duration

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Capital Contribution• Money, tangible or intangible

property, services performed or promised to be performed, promissory notes, or other agreements to provide cash or property

• Not excused by death or disability

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Certificate of Interest

• Document that evidences a member’s ownership interest in an LLC.– Acts the same as a stock

certificate issued by a corporation.

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Operating Agreement• Agreement entered into

among member 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

• Some existing businesses may want to convert to an LLC.– To obtain the tax benefits and

limited liability shield of an LLC.– Law permits such conversions.

• Agreement of conversion sets forth terms.

• Articles of organization must be filed with the secretary of state.

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Dividing an LLC’s Profits and Losses

• ULLCA mandates that 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 in an LLC that entitles the member to receive distributions of money and property from the LLC.

• A transferee of a distributional interest in an LLC receives the right to receive profit and other distributions of the LLC.

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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 irrespective 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 a manager-managed LLC, only

the managers can bind the LLC to authorized contracts.

• The members and non-members who are designated managers control the management of the LLC.

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

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Compensation and Reimbursement

• A non-manager member is not entitled to remuneration.– Except for winding-up the LLC.

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

agreements.

• An 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.– Members cannot bind LLC

unless they are 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• Duty owed by a member of a member-

managed LLC and a manager of a manager-managed LLC.

– Must be honest in dealings with the LLC and not act adversely to the interests of the LLC.

• Breaches of the duty of loyalty by a covered member or manager 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• A duty owed by a member of a

member of a member-managed LLC and a manager of a manager-managed LLC to not engage in conduct that injures the LLC:– A known violation of law– Intentional conduct– Reckless conduct– Grossly negligent conduct

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Duty of Care (continued)

• A member or manager of an LLC is not liable to the LLC for injuries caused to the LLC 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 a Nonmanager Member

• A nonmanager member of a manager-managed LLC owes no fiduciary duties of loyalty, care, or good faith and fair dealing to the LLC or its members.

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Dissolution• The ULLCA gives a member of an

LLC the power to disassociate from the LLC.

• Wrongful disassociation– Occurs when a 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.

– This could cause the dissolution of the LLC.

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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, must pay fair market value.

• If wrongful disassociation, payment made at expiration of term.– Damages may be offset against

price.

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Notice of Disassociation

• A 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 an LLC• Members may vote

unanimously to continue LLC before the expiration of the 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 are 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 that is filed with the

secretary of state (of the state in which the LLC is organized) 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)

• A special form of partnership where all partners are limited partners and there are 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’s must be created

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

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

• An LLP must register as a foreign LLP in any 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.