Chapter 38
Limited Liability Companies
and Limited Partnerships
Introduction
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.
§ 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.
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 Formation [2]
Articles of Organization require:
Name of Business.
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.
LLC Citizenship
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.
LLC Advantages
& Disadvantages
Advantages
Member liability is limited to
amount of investment.
Disadvantages
State statutes are not uniform.
Can be treated as a “pass through” Not all states recognize LLC’s.
entity for tax purposes.
Profits can be distributed to
members without the double
taxation of a corporation. Members
pay personal income tax on
received dividends.
LLC Operating Agreement
Operating agreement is analogous to
corporation’s bylaws.
Operating agreements may be oral 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.
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.
§ 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.
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.
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.
§ 3: Limited Partnerships
Entity that limits the liability of some of its
owners (the limited partners).
Creature of state statute. Filing a certificate
with the Secretary of State is required.
Agreement of two or more persons to carry on
a business for profit with at least one general
partner and one limited partner.
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.
Rights and Liabilities of LP
General partners are personally liable to
3rd 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.
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.
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 3rd party if the
3rd party believes, based on conduct, that
the LP is a general partner.
Dissolution of the LP
Dissolved in much the same way as a
general partnership (Chapter 33).
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.
§ 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.
Case 38.1: Skywizard.com, LLC v.
Computer Personalities, Inc.
(LLC Formation)
FACTS:
Skywizard.com, an ISP, entered into an agreement
with Computer Personalities Systems, Inc. (CPSI),
a computer retailer.
CPSI agreed that beginning September 1, it would
run, a “special promotion,” one weekend per
month so that a a customer who bought a
specified computer would receive a year’s free
Internet service through Skywizard.
For each computer sold under this promotion,
CPSI agreed to pay Skywizard $79.
Case 38.1: Skywizard.com, LLC v.
Computer Personalities, Inc.
(LLC Formation)
FACTS (cont’d)
By March 2000, most of the ISP’s subscribers were
people who had bought computers through CPSI,
including about a third of those who bought the “special
promotion” computers.
CPSI failed to run the promotion on September 1, and
Skywizard sued for breach of contract.
HELD: FOR SKYWIZARD. $100.00
However, damages could not be determined due to the
newness of the business.
The court held that CPSI breached the contract but that
damages could not be determined.
Case 38.2: Hurwitz v. Padden
(LLC Operating Agreement)
FACTS:
Hurwitz and Padden formed a law firm as a partnership
without a written agreement.
They shared all proceeds on a fifty-fifty basis and
reported all income as partnership income. Later,
Hurwitz filed articles with the state to establish the firm
as an LLC.
More than three years later, Padden told Hurwitz that
he wanted to dissolve their professional relationship.
They failed to resolve a division of fees from several of
the firm’s cases.
Hurwitz sued, seeking a distribution of the fees on a
fifty-fifty basis.
Case 38.2: Hurwitz v. Padden
(LLC Operating Agreement)
HELD: FOR HURWITZ.
The court applied partnership law and entered a
judgment in favor of Hurwitz.
The state LLC act specifically incorporated the
definition and use of the term “dissolution” from
the Uniform Partnership Act (UPA).
The firm had no written agreement regarding the
division of receipts before or on dissolution, the
disputed fees related to work acquired before the
dissolution, and before the dissolution, the firm
divided receipts equally between the parties.
Case 38.3: Miller v. Dept. of Revenue
(Formation of Limited Partnership)
FACTS:
Loverin and Miller formed an LP and bought a lowincome housing project and retained Rockwood
Development Corporation to manage it. Loverin
and Miller were the general partners and
Rockwood the only limited partner/
The certificate allocated 2 percent of the
profits/losses to Loverin and Miller and 98 percent
to the limited partners. Eventually 21 other limited
partners invested, but none signed the articles or
the certificate.
Case 38.3: Miller v. Dept. of Revenue
(Formation of Limited Partnership)
FACTS (cont’d):
American Properties Corporation (APC) replaced
Rockwood, and Loverin, Miller, and the president
of APC signed a document that purported to
amend the articles. The document provided that
the partners could reallocate profits and losses as
they “may agree.”
On their income tax returns, Loverin and Miller
allocated 99.9 percent of the losses to
themselves.
Oregon Department of Revenue reallocated the
losses according to the provisions in the original
articles—2 percent to general partners and 98
percent to limited partners. Miller sued.
Case 38.3: Miller v. Dept. of Revenue
(Formation of Limited Partnership)
HELD: AGAINST MILLER.
“There is no evidence in this record that
the amended articles were signed by the
21 limited partners” other than APC.
Without those signatures, the amended
articles were not effective, and Loverin and
Miller could not rely on them to allocate
profits and losses.
Case 38.4: BT-I v.
Equitable Life Insurance
(Limited Partners and Management)
FACTS:
BT-I and Equitable entered into a limited
partnership to develop and operate an office
building and retail complex.
BT-I was the limited partner, and Equitable was
the general partner with the sole right to manage
the firm.
Banque Paribas lent the firm $62.5 million and
Equitable bought it for $38.5 million. On the due
date, Equitable demanded full payment from the
partnership, but none was made and foreclosure
resulted.
BT-I sued Equitable claiming breach of fiduciary
Case 38.4: BT-I v.
Equitable Life Insurance
(Limited Partners and Management)
HELD: FOR BT-I.
A general partner of a limited partnership is
subject to the same restrictions, and has the same
liabilities to the partnership and other partners, as
in a general partnership.
Equitable’s conduct in buying and foreclosing the
loans went far beyond whatever safe harbor might
be found in the partnership agreement.
Equitable was still a fiduciary, and its conduct must
be measured by fiduciary standards.