©2001 West Legal Studies in Business. All Rights Reserved. 1 Chapter 18: Limited Liability Companies and Limited Partnerships

©2001 West Legal Studies in Business. All Rights Reserved. 2 IntroductionIntroduction Limited liability companies are relatively new creatures of state statute. An LLC is a hybrid entity that combines the limited liability of a corporation and the tax advantages of a partnership. LLC’s are increasingly become the entity of choice for businesses.

©2001 West Legal Studies in Business. All Rights Reserved. 3 § 1: LLC’s 1997 IRS rules provide that any unincorporated business (including LLC’s) will automatically be taxed as a partnership unless otherwise indicated on the tax return. LLC’s are attractive in today’s global business environment because they allow foreign investors to own interests.

©2001 West Legal Studies in Business. All Rights Reserved. 4 LLC Formation Like corporations, LLC’s are creatures of state law. The owners are called “members” (not shareholders) and their ownership is called an “interest” (not shares). LLC’s are formed by filing articles of organization with the Secretary of State. (see LLC rules at Texas Secretary of State).LLC rules

©2001 West Legal Studies in Business. All Rights Reserved. 5 LLC Formation [2] Articles of Organization require: –Name of Business and Principal Address; –Name and Address of Registered Agent; –Names of the Owners; and –How the LLC will be managed. Business name must include LLC or Limited Liability Company.

©2001 West Legal Studies in Business. All Rights Reserved. 6 LLC Formation [3] An LLC is a legal entity separate from its owners. For federal jurisdiction based on diversity, an LLC may be treated differently than a corporation. For diversity purposes the citizenship of an LLC is the citizenship of its members, which may live in multiple jurisdictions. Case 18.1: Cosgrove v. Bartolotta (1998).Cosgrove v. Bartolotta

©2001 West Legal Studies in Business. All Rights Reserved. 7 LLC Advantages & Disadvantages AdvantagesDisadvantages Member liability is limited to amount of investment. State statutes are not uniform. Can be treated as a “pass through” entity for tax purposes. Not all states recognize LLC’s. Profits can be distributed to members without the double taxation of a corporation. Members pay personal income tax on received dividends.

©2001 West Legal Studies in Business. All Rights Reserved. 8 LLC Operating Agreement The operating agreement is analogous to corporation’s bylaws. Operating agreements are usually written and contain provisions relating to management, dividends, meetings, transfer of membership interests, and other significant issues. Generally, if the operating agreement is silent, courts will apply partnership principles. Case 18.2: Hurwitz v. Padden (1996).Hurwitz v. Padden

©2001 West Legal Studies in Business. All Rights Reserved. 9 LLC Management There are two options for management, generally set forth in the articles of organization: –Member-Managed: all of the members participate in management, like a partnership. –Manager-Managed: members are elected to manage the LLC. If the articles are silent, statutes provide either that each member has one vote or votes are made based on percentage of ownership.

©2001 West Legal Studies in Business. All Rights Reserved. 10 § 2: LLP’s Creature of state statute, similar to an LLC except that an LLP is designed for professionals who normally do business as a partnership (lawyers and accountants). LLP allows partnership to limit personal liability of the partners but allows “pass through” tax advantages.

©2001 West Legal Studies in Business. All Rights Reserved. 11 LLP Liability Recall that partnership law makes all partners jointly and severally for another partner’s tort, including personal assets. The LLP allows professionals to avoid personal liability for the malpractice of other partners. Supervising Partner is also liable for acts of subordinate.

©2001 West Legal Studies in Business. All Rights Reserved. 12 Family Limited Liability Partnerships FLLP is a limited liability partnership in which the majority of the partners are related to each other. Used frequently for agriculture.

©2001 West Legal Studies in Business. All Rights Reserved. 13 § 3: Limited Partnerships Agreement of two or more persons to carry on a business for profit with at least one general partner and one limited partner. Limits the liability of some of its owners, the limited partners, to the amount of their investment. Creature of state statute. Filing a certificate with the Secretary of State is required.Filing a certificate with the Secretary of State is required.

©2001 West Legal Studies in Business. All Rights Reserved. 14 Limited Partnerships The General partner assumes all management and personal liability. Limited Partner contributes cash but has no management rights. Liability is limited to the amount of investment. A limited partner can forfeit this “veil” of immunity by taking part in the management of the LP. Case 18.3: Miller v. Dept of Revenue (1998).

©2001 West Legal Studies in Business. All Rights Reserved. 15 Rights and Liabilities of LP General partners are personally liable to 3 rd parties for breach of contract and tort liability. However, a corporation (or an LLC) can be a general partner and have limited liability. Limited partners have the right to inspect the LP’s books and be informed of the LP’s business.

©2001 West Legal Studies in Business. All Rights Reserved. 16 Rights and Duties of the LP [2] On dissolution, the limited partner is entitled to return of capital contributions. LP interests are considered securities and regulated by both federal and state securities laws. Limited partners’ liability is limited to the capital investment.

©2001 West Legal Studies in Business. All Rights Reserved. 17 LP Management Only General Partners can manage but they have a fiduciary obligation to LP’s. LP’s enjoy limited liability as long as they do not engage in management functions. An LP will be liable to a 3 rd party if the 3 rd party believes, based on conduct, that the LP is a general partner. Case 18.4: BT-I v. Equitable Life (1999).

©2001 West Legal Studies in Business. All Rights Reserved. 18 Dissolution of the LP Dissolved in much the same way as a general partnership. Retirement, withdrawal, death bankruptcy or mental incompetence of a general partner will trigger dissolution unless the remaining GP’s consent to continue. Creditors are paid first then partners.

©2001 West Legal Studies in Business. All Rights Reserved. 19 § 4: LLLP’s Limited Liability Limited Partnership is a type of limited partnership. Difference between LP and LLLP is that the general partner has limited liability, like a limited partner, up to the amount of investment. Most states do not allow for LLLP’s.

©2001 West Legal Studies in Business. All Rights Reserved. 20 §5: Forms Compared EntityAdvantage(s)Disadvantage(s) Sole Proprietorship Easy to create and maintain.Owner is personally liable. PartnershipEasy to create and maintain. Pass-through taxes. Owners are personally liable. Limited Liability Company Pass-through taxes; limited liability of owners. Moderately expensive to create and maintain. Annual franchise taxes, forms with Secretary of State. Not accepted in all states. Corporation (Chapter 19) Limited Liability of owners; accepted in all states. More difficult to create and maintain. Double taxes (unless sub-S);

©2001 West Legal Studies in Business. All Rights Reserved. 21 Law on the Web Comparison of Different Business Entities.Comparison of Different Business Entities LLC Formation On-Line at Bizcorp.com.LLC Formation On-Line at Bizcorp.com LLC’s at Nolo.com.LLC’s at Nolo.com Wordes, Wilshin, Goren & Conner.Wordes, Wilshin, Goren & Conner Legal Research Exercises on the Web