The Use of LLCs in Structuring
Transactions
July 23, 2008
John R. Heronimus, Esq.
Replacing Joint Ventures
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Simple Question posed by Lee Reichert circa
1999:
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“Hey John, what’s a Joint Venture? Do a little
research if you have the time.”
Replacing Joint Ventures
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What is a Joint Venture?
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Special combinations of two or more persons for a
specific undertaking, in which a profit is jointly
sought without any partnership designation as
such and without intent to pursue a general or
continuing business.
- Rabkin and Johnson (Legal Forms with Tax Analysis)
Replacing Joint Ventures
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No, seriously, what is a Joint Venture?
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A legal entity in the nature of a partnership engaged in the joint
undertaking of a particular transaction for mutual profit. An
association of persons or companies jointly undertaking some
commercial enterprise; generally all contribute assets and share
risks. It requires a community of interest in the performance of
the subject matter, a right to direct and govern the policy in
connection therewith, and duty, which may be altered by
agreement, to share both in profits and losses.
-Black’s Law Dictionary
Replacing Joint Ventures
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Do you have a shorter version?
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An enterprise undertaken by several persons jointly to
engage in a common plan or project for their mutual
benefit with a sharing of capital, skill and effort.
- Glover & Wasserman (Partnerships, Joint Ventures &
Strategic Alliances)
Replacing Joint Ventures
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Now for something completely ironic…
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The most common definition is a business venture that
involves two or more entities working together to
achieve mutually agreed upon business objectives. To
the extent companies desire to structure their
relationship as a separate legal entity, that entity
typically is referred to as a "joint venture."
- Fogler & Reichert (circa 2002)
Replacing Joint Ventures
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How about in 10 words or less?
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Isn’t it just a general partnership for a specific
purpose?
- My Dad
Replacing Joint Ventures
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A Brief History: General Partnership
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A writing NOT needed to form.
Joint ownership of assets.
Share profits and losses.
Joint and several liability.
Ongoing business.
Replacing Joint Ventures
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A Brief History: General Partnership
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In the beginning…
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As early as 476 A.D., groups of Saxon miners in
Western Europe owned and operated Saxon mines
together and financed their enterprises with individual
capital contributions from the miners or periodic
assessments from the miners in relation to production.
If a Saxon miner failed to pay his initial capital
contribution or periodic assessment when called for, his
name was permanently struck from the list of owners
unless he paid within four days.
Replacing Joint Ventures
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A Brief History: General Partnership
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Cost-Book System Develops
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The primitive Saxon miner form of business was later
formalized in England by copper and tin miners.
Because capital was scarce and there were many
shareholders, more detailed records were needed.
A manager was appointed to manage the mine and keep
meeting minutes and financial records in a “cost-book.”
Replacing Joint Ventures
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A Brief History: General Partnership
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Note the legal concepts developing early on:
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Capital contributions from Saxon miners to the
enterprise.
Capital calls or assessments against Saxon miners to
fund the enterprise.
Appointment of managers to run the cost-book
enterprise.
Keeping of minutes and financial records in the costbook system.
Replacing Joint Ventures
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A Brief History: General Partnership
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Codified Framework:
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English courts began to recognize common law
partnership principles.
First statutory framework was England’s Partnership Act
of 1890.
Adoption of Uniform Partnership Act of 1914 across the
U.S.
Revised Uniform Partnership Act of 1994 in U.S.
Refined in Colorado by Uniform Partnership Act of 1997.
Replacing Joint Ventures
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A Brief History: Mining Grubstake Contract
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Common in Western American gold mining history in the
mid 1800s.
Investor supplies food and supplies (or “grub”) to a gold
prospector in exchange for a share (or “stake”) in any
gold that was found.
If gold is found and a claim is staked, the investor and
prospector jointly owned the claim as tenants in
common.
Replacing Joint Ventures
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A Brief History: Mining Grubstake Contract
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Note similarities to General Partnership:
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Writing not needed to form
Joint ownership of the claim once located
Generally share profits and losses
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But note as well, introduction of certain limitations on
losses. In contrast to a General Partnership, investor and
prospector each bear their respective losses.
But NOT a General Partnership. Could become a
Mining Partnership if the investor and the
prospector work the claim together in an ongoing
enterprise after it is located.
Replacing Joint Ventures
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A Brief History: Mining Partnership
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In Smaller v. Leach (1957), the Colorado Supreme
Court compared a Mining Partnership to a
Grubstake Contract:
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“The line of demarcation between the ordinary
‘grubstake’ contract and a mining partnership is
sometimes difficult to determine. Generally, it may be
said that if the agreement extends beyond the discovery
and location [of a claim], and contains a stipulation for
exploiting and developing [a claim], a mining partnership
arises when actual work commences.”
Replacing Joint Ventures
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A Brief History: Mining Partnership
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Mining Partnerships are similar to General
Partnerships:
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Writing not needed to form.
Joint ownership of assets.
Share profits and losses.
Replacing Joint Ventures
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A Brief History: Mining Partnership
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However, Mining Partnerships were adapted to
meet the needs of miners and therefore introduce
some key differences:
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Generally, if a partner leaves a General Partnership, the
General Partnership dissolves. Miners did not want to
go through a dissolution process every time a mining
partner died, went into bankruptcy, or transferred his
interest. Therefore, these interruptions do not dissolve a
Mining Partnership.
Replacing Joint Ventures
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A Brief History: Mining Partnership
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Key distinction between Mining Partnerships and
General Partnerships:
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Since a mining partner may freely transfer his interest in
the mining partnership to a third party without dissolving
the mining partnership, mining partners do not have the
general partners’ implied authority to bind each other
unless it is necessary to the mining partnership.
Therefore, a certain limitation of liability concept is
introduced because a mining partner is less at risk to be
liable for other mining partner actions.
Mining Partnership limited to specific undertaking as
opposed to an ongoing business (the mining operation).
Replacing Joint Ventures
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A Brief History: Summary
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As business enterprises developed from the early first century
through the twentieth century, key legal concepts were
introduced to meet new business needs:
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Capital contributions from Saxon miners to the enterprise.
Capital calls or assessments against Saxon miners to fund the
enterprise.
Appointment of managers to run the cost-book system.
Keeping of minutes and financial records in the cost-book system.
Limitations on losses in grubstake contracts.
No automatic dissolution of mining partnership.
Freely transferable interest in mining partnership.
Limited authority to bind other partners in a mining partnership.
Certain limitations on partner liability in a mining partnership.
Replacing Joint Ventures
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So what is a Joint Venture?
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Historically it has been termed a “joint adventure”.
It has been used by various courts and commentators
alike as a synonym for many kinds of entities and
business relationships:
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In a 1959 Wyoming Supreme Court Case the terms
“grubstake” and “joint adventure” were used
interchangeably.
A 1950 law review article noted that “The search for the
historical development of joint ventures as a legal
concept is intriguing and elusive.”
NO KIDDING
Replacing Joint Ventures
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So what is a Joint Venture?
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Similarities to General Partnership:
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Do not need writing to form.
General sharing of profits and losses.
Joint and several liability.
Differences from a General Partnership:
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Limited to a specific undertaking.
Joint ownership of assets NOT needed.
Must have joint operation of the venture business.
Replacing Joint Ventures
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So why use a Joint Venture?
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In practice, there is very little reason to. Limited
liability companies can be used to achieve better
results in virtually every circumstance because
they can be formed to include many of the good
components of the historical ways of doing
business, and can keep out many of the bad.
Replacing Joint Ventures
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How is an LLC formed?
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File Articles of Organization with the Secretary of
State.
Complete basic organizational tasks:
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Organizational meeting/consent to elect managers,
appoint officers, issue membership interests in return for
capital contributions, etc.
Fund LLC bank account.
Apply for E.I.N.
Enter into Operating Agreement.
Replacing Joint Ventures
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What are the main benefits of using LLCs?
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Limitation of liability for members.
Accepted tax pass-through treatment.
Flexibility.
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In Colorado, almost all statutory requirements of
formation can be modified by the Operating Agreement.
The purpose is stated in C.R.S. 7-80-108(4):
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“It is the intent of this article to give maximum effect to the
principle of freedom of contract and to the enforceability of
operating agreements.”
Structuring Transactions:
Real Estate Development Model
Developer
Entity, LLC
Manager and Sole Member
Development North, LLC
Development East, LLC
Development West, LLC
North Property
East Property
West Property
Structuring Transactions:
Real Estate Development Model
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Signature Block for Development North, LLC:
Development North, LLC,
a Colorado limited liability company
By:
Developer Entity, LLC,
a Colorado limited liability company,
its Manager
By:
Joe Developer, Manager
Structuring Transactions:
Real Estate Development Model
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Land Banks:
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Some Real Estate Developers will set up separate
unaffiliated entities to serve as “land banks”
whose sole purpose is to hold raw ground prior to
development.
When ready for development, there is a sale from
the land bank to the development company and
capital gains are realized for a portion of the
proceeds as opposed to ordinary income in the
hands of the developer.
Structuring Transactions:
Mining Industry Model
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Players:
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One group has the knowledge, mining claims, and
data. (In the old grubstake contract, they would
have been the prospector).
One group has the money to finance exploration
and development. (In the old grubstake contract,
they would have been the investor.)
Structuring Transactions:
Mining Industry Model
Jim
Jon
Lara
Lisa
Prospector, LLC,
a Colorado limited liability company
Investor, Inc.,
a Colorado corporation
40%
60%**
ShowMeTheMoney, LLC,
a Colorado limited liability company
Claims
Surface Lease, Surface
Use Agreement, Water
Permits, DEQ Permit
**Note: Investor Inc. 60% held in escrow
pending full purchase of 90%.
Structuring Transactions:
Mining Industry Model
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War Story 1: Those Crazy Australians
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In transaction similar to previous chart, Australians and
local counsel insisted on setting up as Joint Venture.
I said “Why?”
Answer: “Because that’s what we always use.”
Had to modify the Australian law firm form Joint Venture
Agreement to be a Colorado limited liability company
operating agreement to keep them happy.
Structuring Transactions:
Mining Industry Model
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War Story 2: HOA with a Big Asset.
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HOA finds out it owns a big mineral asset it didn’t
realize it had.
HOA is a nonprofit corporation subject to the rules
of CCIOA.
How do we sell big mineral asset and realize as
much income as possible for members of POA?
Why, we form an LLC of course!
Structuring Transactions:
Mining Industry Model
HOA
Members
HOA
Members
HOA, Inc.,
a Colorado
nonprofit
corporation
HOA, Inc.,
a Colorado
nonprofit
corporation
Economic Members
Voting Member
Mineral
Asset
New LLC, a Colorado
limited liability
company
Mineral
Asset
Closing Comments
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What do you do if a crazy Australian insists on using a Joint Venture?
Say this:
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“So if I understand you correctly…for this transaction you’d essentially like to
achieve the investor/prospector relationship of a traditional Grubstake
Contract, including limitations on certain losses found therein, yet you’d like
the enterprise to continue beyond the exploration and location phase and
achieve a way to limit the authority of the members to bind other members
as found in a Mining Partnership.”
“Well…yes.”
“Will we need to have managers or officers running the operation similar to
the old English cost-book system?”
“Well, I suppose so, yes.”
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“O.K., most importantly, do you want to limit the liabilities of the members?”
“If possible, of course!”
“Then have I got an entity for you. Let me tell you about the Limited Liability
Company…”