Chapter 13
Limited Liability Companies
Introduction
The limited liability company (LLC) is fast becoming the “entity of choice” in American
business. LLCs offer business owners the limited liability protections of incorporation with the
benefit of partnership taxation. While LLCs are often compared to the limited liability
partnership, they offer their members more extensive personal liability protections. They combine
the best of corporations (liability protections) with the best of partnerships (taxation benefits).
Lecture Notes
 Limited Liability Company Defined
An LLC is an unincorporated entity that offers its members:
management rights
limited personal liability
pass-through taxation of partnerships
Advantages
limited liability for all members, including managers
pass-through taxation
flexibility of management
Disadvantages
limited duration (depending on state statute)
limited transferability of interests
lack of interstate uniformity
 Liability
Members of an LLC are not personally liable for the debts or obligations of the LLC, in
the absence of fraud. In this manner, they look very much like a corporation.
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Note: State statutes generally require LLCs to carry appropriate insurance coverage to
protect the public from the negligence or malfeasance of the LLC or its members.
 Management
All members of an LLC have the right to participate in management. If the LLC members
“opt out” (i.e., waive their management rights), they can elect a board of managers.
Board of Managers
An LLC board of managers operates like a corporate board of directors.
 Taxation
An LLC may elect to be taxed by the IRS as a partnership, thus avoiding the double
taxation suffered by corporations.
 Formation
An LLC is formed much like a corporation:
1. Register business name, with “LLC” designation, with the secretary of state.
2. File articles of organization with secretary of state.
3. Obtain required business and professional licenses and permits.
4. Review Taxation Filings.
a. Apply for sales tax permit, if goods will be sold.
b. Apply for tax identification number with the IRS and state.
c. File IRS Form 8832 electing partnership or corporate taxation.
5. If employees will be hired
a. Establish employee withholding accounts.
b. Establish unemployment and workers’ compensation coverage.
6. Draft comprehensive operating agreement.
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 Name
As with all businesses that offer its members personal liability protections, the LLC must
notify the public of its status and the limited liability protections of its members with the
appropriate designation “LLC” or “Ltd. Liability Co.”
 Purpose
Most states prohibit insurance companies, banking institutions, and some professions
(e.g., accountants) from forming an LLC. The main purpose is to protect the public from
the unlimited liability protections of these types of businesses, and hold companies and
their agents accountable for the services they render.
 Registration
An LLC must file articles of organization with the secretary of state. This filing provides
contact information about the LLC (registered agent, registered office), as well as
information about management of the LLC.
 Operating Agreement
An LLC operating agreement is similar to a partnership agreement. While it is not
mandatory, it is recommended and should be drafted for all LLCs.
The operating agreement should include
voting and management rights of members
capital contributions of members
profit sharing
duration
signatures of all members
 Termination
Termination of an LLC is a two-step process:
1. dissolution
2. winding up
Step One: Dissolution
An LLC is generally dissolved due to
termination per operating agreement
statutory duration period expired
death, bankruptcy, etc. of member
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agreement by members
court order
Step Two: Winding Up—Turning Assets into Cash
The LLC must turn its assets into cash (liquid assets) and distribute the “profits” as
follows:

Creditors’ Claims
Creditors are paid the amounts due before profits can be distributed to members.

Distributions to Members
After the debts of the LLC are paid, any remaining profits will be distributed
to the members.

File Articles of Termination
An LLC is not legally dissolved until it notifies the secretary of state that it has
dissolved and liquidated its assets.
Note: As a practical matter, most businesses fail to complete this step. However, it is
advisable that the paralegal make sure that the articles of termination are filed. This
avoids embarrassment when the client receives a letter from the secretary of state
stating that the LLC has not been formally terminated with the state (yet the client
paid your firm handsomely to take care of the dissolution process).
Answers to Study Questions in Review
1.
What is a limited liability company (LLC)?
An LLC is like a corporation with its expansive personal liability protections; however,
it provides partnership taxation to its members. LLCs offer all members management
rights, limited personal liability, and the pass-through taxation of a partnership.
2.
Who are the managers of a LLC?
All members of an LLC have management rights.
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3.
Do LLCs offer more liability protections than a limited liability partnership (LLP)?
Yes. Generally LLPs protect partners only from liability for the negligence and
malfeasance of other partners; individual partners remain liable for their own
negligence and malfeasance and that which they participated in, supervised, or had
knowledge of. In contrast, an LLC generally offers its members absolute immunity for
the debts and obligations of the LLC, including those arising from tort.
4. What is the disadvantage of including an expansive purpose clause that allows a company to
transact “any and all lawful business,” in an LLC’s articles of organization?
It grants the members and managers authority to act on behalf of the LLC in any lawful
business. Thus a member or manager may bind the LLC to transactions that have not
been properly approved.
5. How would a professional limited liability company designate its status in its name?
By including “PLLC” in its partnership name
6. What document can be drafted for an LLC that establishes the operating procedures and the
rights and duties of LLC members?
The operating agreement
7. Is an LLC taxed as a partnership or as a corporation? Explain.
An LLC is taxed as a partnership as long as it does not share more than two of the four
corporate characteristics (continuity of life, centralization of management, limited
liability, free transferability of interests).
8. Have all states adopted LLCs as a business form?
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No. A state that has not adopted LLCs as a business form may treat a foreign LLC as
either a corporation or a partnership. This lack of uniformity is a major disadvantage
of the LLC.
9. What is centralization of management, and do LLCs have centralized management? Under
what conditions is a board of directors appointed to manage an LLC?
Centralized management occurs when a limited number of individuals have the
authority to participate in the management of a business. LLCs are generally
considered to have decentralized management because all members have the right to
manage. A board of directors may be appointed to manage an LLC if the members
waive their management rights.
10. What fiduciary duties do members of an LLC owe to the company and to each other?
The ULLCA impose the duty of care and loyalty on members of an LLC.
11. Members of LLCs are generally granted immunity from personal liability for the obligations
of the LLC. What are the exceptions to this general rule?
1. Members are liable for the capital contributions that they agree to make to the LLC.
2. Members, managers, and officers may be held personally liable for violations by the
LLC of environmental laws.
3. Members, managers, and officers may be personally accountable for unpaid federal
and state tax obligations of the LLC.
4. If the LLC is formed for an improper or fraudulent purpose, its members may be held
personally liable for the obligations of the LLC resulting from improper or fraudulent
acts.
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Answers to Case Studies in Review
1.
Cathy, Don, and Steve own “T-shirts à GoGo, LLC.” They produce T-shirts with
personalized logos for local businesses, sports teams, and other organizations. Steve is in
charge of marketing for the company, and during one of his recent rainmaking trips, he
discovered that many businesses want to have their business name and logo imprinted on
pencils, pens, and other business-related items. Steve is excited about the prospect of this
area of expansion and signs contracts with three companies to provide imprinting of their
business name and logo on several business supplies. Steve did not receive Cathy or Don’s
approval for the contracts, and the business does not have the equipment to produce the
products Steve contracted for. The purpose clause of the company’s articles of organization
allows the company to transact “any and all lawful business” and the operating agreement
does not restrict the members’ authority. Did Steve have the authority to bind the LLC to the
new contracts?
Yes. The use of the boilerplate “any and all lawful business” grants members and
managers expansive authority to bind an LLC to unexpected business arrangements.
2.
The Riley family owns and operates a local religious bookstore for profit. The bookstore is
an LLC, and all the members of the family participate in management of the business,
including the parents and four children. While the family generally works well together, it is
difficult for everyone to meet for the weekly management meetings. Everyone is offered the
opportunity to speak on the management issues at each meeting; thus, the meetings usually
take two to three hours. The family finally decides that it makes sense to appoint a board of
managers, which they do. What are the advantages and disadvantages to appointing a board
of managers?
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A board of managers centralizes the management of an LLC and generally simplifies
the management’s decision-making process. However, if a board of managers is elected
to operate an LLC, the LLC has centralized its management (a corporate
characteristic) and therefore jeopardizes its status as a partnership for tax purposes
(because an LLC must avoid “looking like” a corporation for tax purposes).
Project Applications
1. Does your state impose annual reporting requirements on LLCs? (Hint: Contact the secretary
of state to research this issue).
2. Obtain the documents necessary to register an LLC with the secretary of state of your state.
Prepare the documents for the following company:
Joann and Melissa have been partners in an accounting firm for five years. They
work mainly with small businesses. They recently received a letter from their attorney
notifying them that the state has adopted a new business form—limited liability
companies. Joann and Melissa like the extensive liability protections of the LLC. They
ask the firm to draft the registration documents.
Their file contains the following relevant information:
Joann Dollars
100 South West
Somewhere, (your state) 55555
Business Address:
Melissa Cents
340 Bend Drive #6
Somewhere, (your state) 55555
Dollars and Cents
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400 Brooks Street
Somewhere, (your state) 55555
County: Any County
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