© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Chapter 39 Limited Liability Companies and Limited Liability Partnerships

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Limited Liability Company (LLC) Liability limited to capital contribution No personal liability for company’s debts and obligations Capital investment Debt or obligation owed Limited Liability Company (LLC) Third Party MemberMember MemberMember

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Duration Term LLC –An LLC that has a specified term of duration At-Will LLC –An LLC that has no specified term of duration

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

Prentice Hall, 2001© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman24 Fiduciary Duties to the LLC Duty of Loyalty Duty of Care

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Limited Liability Partnership (LLP) (continued) Liability limited to capital contribution No personal liability for partnership’s debts and obligations Capital investment Debt or obligation owed Limited Liability Partnership (LLP) Third Party Limited Partner

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.