Limited Liability Companies
Chapter 6
Introduction
 A limited liability company is a cross
between a partnership and a corporation,
owned by members who may manage the
company directly or delegate to officers or
managers who are similar to a
corporation’s directors.

A limited liability company is a hybrid
between corporations and partnerships,
with all of the advantages of limited
partnerships and none of its
disadvantages.

The limited liability company was designed
as a vehicle to keep the attractions of a
limited partnership while avoiding its
downside: liability for the general partners.

Under a limited liability company
arrangement, none of the owners face the
specter of unlimited liability.

Their personal assets are not in danger.
"In general, the purpose of forming a
limited liability company is to create an
entity that offers investors the protections
of limited liability and the flow-through tax
status of partnerships" (Jonathan R.
Macey, The Limited Liability Company:
Lessons for Corporate Law, 73 Wash. U.
L.Q. 433, 434 (1995)).
Organization of a
Limited Liability Company

Limited liability companies do not have general
partners.

Instead, the persons responsible for the day-today management of the business are referred to
as managers.

The investors in the business are called
members.

The members have voting rights about business
decisions and are permitted to take an active
role in the operation of the business.

Managers may also be members.

They all enjoy the protection of limited liability, so
there is no practical reason to bar managers
from also investing in the business as members.

A limited liability company has at least one
member who has membership interest in the
company. Managers control the business and
are permitted to be members.

Members of a limited liability company retain the
right to vote on changes in the operating
agreement and to set limits on the addition of
new members into the company.

Members own a percentage of the company, but
the company itself has a separate existence.

In other words, limited liability companies can
act like individuals.

For example, limited liability companies can own
property.

In limited liability companies, an individual
member’s liability is again restricted to the
amount of his or her contribution to the
business.

Like limited partnerships, contributions to
limited liability companies can come in the
form of cash or services.

Members of limited liability companies
face no personal liability for the company's
debts, judgments, or other assessments.

Unlike limited partnerships, managers are
also protected by limited liability.
Advantages of Limited Liability
Companies

Limited liability companies enjoy certain advantages over
the corporate model.

The way that taxes are assessed against limited liability
companies is different from the method used to assess
taxes against corporations.

Limited liability companies offer great flexibility to their
owners and protection for everyone involved in the
enterprise.
Tax Advantages of the LLC

The best advantage of a limited liability company
structure is the tax benefit.

Similar to limited partnerships, a limited liability
company has the pass-through feature of tax
treatment.

Members can deduct business losses on their
personal income taxes.

In 1988, the IRS ruled that limited liability
companies should be taxed like limited
partnerships rather than as corporations,
which legitimized limited liability
companies as a business structure.

As long as a limited liability company
meets certain prerequisites, it is taxed in
exactly the same way as a limited
partnership.

In 1996, the IRS again revisited the issue of
limited liability companies and corporations.

Under the new rules, business organizers can
choose their business type and as long as it
qualifies under state law, the IRS will treat it by
its own classification.

Under this rule, a company that calls itself a
limited liability company and is organized and
registered under state law as a LLC will be taxed
as one.
IRS Entity Classifications
Factors to ensure that a business will be
considered a limited liability company by the IRS:



Does the business have a fixed date for
termination?
Will the business terminate on the death,
retirement, or bankruptcy of a member?
Are there limitations on the power of the business
to transfer ownership interests to others?
(con’t)
IRS Entity Classifications (con’t)




Are there provisions that provide limited liability for
managers and members?
Has the business filed with the state as a limited liability
company?
Has it filed articles of organization?
Does it have an operating agreement?
If the answer to all of these questions is yes, the
IRS will probably rule that the business is a
limited liability company.
Creation of a Limited
Liability Company

Depending on the state, the regulations
concerning the creation, day-to-day operation,
and dissolution of limited liability companies can
vary considerably.

Many states enacted tax legislation to
encourage companies to form their limited
liability companies in their states.

Creating a limited liability company is a relatively
simple process involving filing appropriate
documentation, such as the articles of
organization and name reservation forms.

In addition, the parties will also draft an
operating agreement.
Limited Liability Companies as
Creatures of Statutes

This business structure derives exclusively from
state statutes, and the statutes must be closely
followed in order to create a viable limited
liability company.

There is no common law of limited liability
companies.
The Uniform Limited Liability
Company Act

The Uniform Limited Liability Company
Act grew out of a need for a uniform
system of creating, maintaining, and
dissolving a limited liability company.
Filing Requirements

Limited liability companies are formed first by
filing the appropriate documentation with the
state secretary of state office.

One piece of this documentation is the
application to reserve a specific name.

In addition to that filing, most states require
limited liability companies to file a copy of their
articles of organization.
Reserving a Company Name

All states have provisions that allow a
prospective company to reserve a company
name before they officially file for limited liability
company status.

This application reserves the name and prevents
others from using it before the company has
completed its application process.
Naming Restrictions on a
Limited Liability Company

The official name must contain the words
"limited liability company" or the abbreviation
“LLC.”

This is to put the public on notice that it is
dealing with a company that enjoys the
protections of limited liability.
Articles of Organization

Similar to the Certificate of Limited Partnership,
the Articles of Organization set out the details of
the limited liability company.

The articles of organization will list the name of
the agent for service of process, the mailing
address of the principal office of the company,
the style of management, and any other matters
that the owners feel they wish to make a part of
the public record.
Operating Agreement

The operating agreement forms the entire
framework for all interactions between members
in a LLC.

The agreement sets out the many issues
involved in creating, running, and eventually
dissolving the business.
Any operating agreement should address the
following issues:







Finance and management
Members’ percentage of interest in the LLC
Members' rights and responsibilities
Members' voting power
Allocation of profits and losses
Rules for meetings and votes
Transfer issues
Judicial Interpretation of
Operating Agreements

Courts are often called upon to interpret the
language in operating agreements in the same
way that they must interpret the language in
contracts and partnership agreements.

When an operating agreement contains
ambiguous or contradictory terms, courts must
attempt to resolve these conflicts in order to
keep the company functioning.
Unwritten or Nonexistent
Operating Agreements

Given the importance of the operating
agreement, it might seem odd to consider the
fact that the laws authorizing limited liability
companies do not actually require one.

Most states opt for an approach that takes a
very liberal view of what constitutes an operating
agreement.
Transfer of Interests

Modern law allows members to freely transfer
their interests to others.
Dissolution of a Limited
Liability Company
Limited liability companies can be
dissolved by a number of actions:

A limited liability company might have a
specific life span. The company may have
been created with a specific time period in
mind. When that time period is up, the
company will automatically dissolve.

The company may have been formed with a
specific purpose in mind, and when that purpose
is satisfied, the operating agreement authorizes
the termination of the company.

The withdrawal of a member will also trigger the
dissolution of the limited liability company.

There are usually provisions in the operating
agreement that allow the members to expel one
of their own for a specific reason and thus keep
the limited liability company functioning.
Members can be removed from the company by
the votes of the other members. A member may
lose his membership for any of the following
reasons:



Filing a personal bankruptcy
Death
Declaration of mental incompetence
Consequences of
Member Withdrawal

When a member withdraws from a limited
liability company, he or she is entitled to a return
of their original contribution.

Contribution consists of the monetary investment
that the member made in the business.

Contribution can also come in the form of
services provided, property transferred, or
anything else of value.
Summary

Limited liability companies offer several
advantages over other types of business
structures.

In a limited liability company, there are no
general partners.

Instead, all members are protected by limited
liability.
Summary

Limited liability companies offer some of the
same advantages as limited partnerships.

For instance, business profits and losses are
"passed through" on the individual owner’s
income tax returns.

This avoids the problem of double taxation,
where the business and the individual owners
must each file a separate income tax return.
Summary

Limited liability companies are organized with managers
and members.

Managers run the day-to-day operation of the business,
while members enjoy the profits from the business.

In limited liability companies, managers may also be
members.

This means that all of the participants are protected by
limited liability coverage.
Summary

Limited liability companies are organized in operating
agreements that set out the rights and responsibilities of
all members.

In order to be recognized as a limited liability company,
the business must file appropriate documentation with
the state.

This documentation includes not only a notice that the
business intends to operate as a limited liability
company, but also articles of organization.

These articles of organization are the bylaws for how the
business will be run.
Summary

Limited liability companies can terminate in several
different ways.

The operating agreement may set a specific date of
termination of the business, or the company may
terminate upon the death or bankruptcy of a member.

Limited liability companies have great flexibility in their
day-to-day operation, but they do have some limitations.

For instance, the business must contain the words
"limited liability company" or the abbreviation “LLC” in
order to be considered a valid legal entity.