978-0134004006 Chapter 39 Lecture Note

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“Justice is the end of government. It is the end of civil society. It ever has been,

and ever will be pursued, until it be obtained, or until liberty be lost in the pursuit.”

James Madison

I. Teacher to Teacher Dialogue

back the implementation of limited liability companies. Traditional interpretations of state laws

allowing for limited liability focused on corporate laws. As such, the possibility for legitimate tax

structure avoidance was severely limited to the rules and regulations covering “Sub–S”

corporations. Subchapter S was first added to the Internal Revenue Code in 1958 and has

Internal Revenue Code § 1361, et al.

With increasing pressures to attract more overseas capital and investment into the United

States, a number of states decided to create new forms of business entities. They would not only

be familiar to overseas investors who were already comfortable with the limited liability

company, but also gain the Internal Revenue Service imprimatur for being taxed like a

Because of all the possible permutations that have evolved since this opening foray into

limited liability company laws, the demand for a uniform statute was not unexpected. This

chapter focuses on the main element of the Uniform Limited Liability Company Act and

revisions as promulgated by the National Conference of Commissioners on Uniform State Laws.

LIMITED LIABILITY COMPANIES

AND LIMITED LIABILITY

PARTNERSHIPS

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generation.

As we have seen in earlier chapters, business entity choices are strategic decisions based on a

number of factors. These elements include choosing the best options for potential capital

investment and financing growth, protection from personal liability, and tax planning. No one

entity format is ideal for all objectives. However, recent trends have led to the use of the limited

accorded to shareholders of a corporation.

II. Chapter Objectives

1. Define limited liability company (LLC) and limited liability partnership (LLP).

2. Describe the process of organizing LLCs and LLPs.

III. Key Question Checklist

 How is a limited liability company organized?

 How is a limited liability company operated?

IV. Text Materials

Introduction to Limited Liability Companies and Limited Liability

Partnership

An LLC is an unincorporated business entity that combines the more favorable aspects of

Limited Liability Company Act – Limited liability companies (LLCs) are creatures of state law,

not federal law. They are allowed to operate as separate legal entities distinct from their members.

Taxation of LLCs – The IRS has held that LLCs will be taxed as partnerships, unless they elect

to be taxed as a corporation.

Powers of an LLC – An LLC is treated as a person in order to be able to carry out its business

affairs.

Formation of an LLC

Limited Liability Companies and Limited Liability Partnerships

An LLC can be organized in only one state, even though it can conduct business in all other

Articles of Organization – The articles of organization contain the name and address of the

LLC, the initial agent for service, and the name and address of each organizer. It should also state

Duration of an LLC – An LLC is considered to be at-will unless it is designated as a term LLC

Capital Contribution to an LLC – Members’ capital contribution can be in any form, including

Certificate of Interest – These certificates act the same as a stock certificate issued by a

corporation.

Operating Agreement – These agreements regulate the company affairs and its conduct.

Conversion of an Existing Business to an LLC – In order for an existing business to take

Dividing an LLCs Profits and Losses – Unless otherwise agreed, the ULLCA mandates that a

Distributional Interest – This is a member’s ownership interest in an LLC. It is personal

property and is freely transferable. The transfer entitles the transferee to receive distributions

members unanimously agree.

Limited Liability of Members

Liability of an LLC – The LLC is liable for losses and injuries caused by its members,

managers, employees, or agents.

contribution.

Case 39.1 Limited Liability Company: Siva v 1138 LLC

2007 Ohio App. Lexis 4202 (2007), Court of Appeals of Ohio

Facts: Siva entered into a written lease agreement with 1138 LLC whereby 1138 LLC leased

Chapter 39

recover damages. Siva received a default judgment against 1138 LLC, but there was no money in

LLC to Siva?

Decision: The court of appeals affirmed the decision of the trial court that dismissed Siva’s

complaint against Hess. No evidence could show that Hess purposely undercapitalized 1138

LLC, or that he formed the limited liability company in an effort to avoid paying creditors. Also,

the evidence did not show that Siva was misguided as to the fact he was dealing with a limited

for the debts, obligations, and liabilities of an LLC beyond their capital contribution. Hess owed

no ethical duty to personally pay the debt. The LLC owed a duty not to spend beyond what they

had, but no individual member owed any duty to make up the shortage. Siva was unethical in

attempting to get the money from a member. Siva should have had Hess guaranty the lease.

they manage.

Liability of the Tortfeasors – Persons who intentionally or negligently cause injury or worse are

personally liable for their actions. This rule applies to members and managers of LLCs.

Management of an LLC

manage the LLC.

 Manager-managed LLC: In this type of LLC, the members designate a manager or

managers to manage the LLC.

Member-Managed LLC – In a member-managed LLC, each member has equal management

rights.

Nonmembers may be managers.

Limited Liability Companies and Limited Liability Partnerships

Agency Authority to Bind an LLC to Contracts – In member-managed LLCs, all members

have agency authority to bind the LLC. In a manager-managed LLC, only managers can bind the

LLC.

Fiduciary Duties

Limited Duty of Care – Members of member-managed LLCs and managers in manager-

managed LLCs owe the fiduciary duty of care to the LLC not to engage in known violations of

Business Environment: Advantages of Operating a Business as an LLC

Some of the advantages of operating a business as an LLC are:

 An LLC can have any number of member-owners.

 An LLC can have nonresident alien member-owners.

one class of interest.

Critical Legal Thinking – An LLC provides limited liability for the owner/operator as opposed

taxation issue as well.

Dissolution of an LLC

Members have the power to withdraw from both at-will and term LLCs unless the operating

Payment of Distributional Interest – If a member terminates without causing a wrongful

disassociation, the LLC must purchase the member’s distributional interest. If there is a wrongful

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Continuation of an LLC – Members of an LLC can unanimously vote prior to the expiration

date for an additional term and file an amendment with the secretary of state or can continue as an

at-will LLC by a simple majority vote.

Limited Liability Partnership (LLP)

LLPs are creatures of state law, not federal law. An LLP can only be created pursuant to the laws

of the state in which the LLP is being organized. These statutes, commonly referred to as limited

Critical Legal Thinking – The LLP requires no general partner who has unlimited personal

liability. The LLP allows for each partner to have limited personal liability but still to participate

in the management of the firm if the partner desires.

Taxation of LLPs – LLPs enjoy the “flow–through” tax benefit of other types of partnerships—

that is, there is no tax paid at the partnership level, and all profits and losses are reported on the

individual partners’ income tax returns.

Business Environment: Accounting Firms Operate as LLPs

Prior to the advent of the limited liability partnership (LLP) form of doing business, accounting

firms operated as general partnerships. As such, the general partners were personally liable for the

debts and obligations of the general partnership. Many lawsuits were brought in conjunction with

however.

Limited Liability Companies and Limited Liability Partnerships

V. Key Terms and Concepts

business to an LLC.

 Articles of amendment—An LLC can amend its articles of organization at any time by

filing articles of amendment with the secretary of state.

 Articles of limited liability partnership—The formal documents that must be filed at the

secretary of state’s office of the state of organization of an LLP to form the LLP.

LLC.

 Distributional interest—A member’s ownership interest in an LLC that entitles the

member to receive distributions of money and property from the LLC.

 Domestic LLC—The LLC is a domestic LLC in the state in which it is organized.

act adversely to the interests of the LLC.

 Flow through taxation—An LLC is not taxed at the entity level, but its income or losses

“flow through” to the members’ individual income tax returns.

 Foreign LLC—If an LLC wants to do business in a state where it is not organized, the

LLP must register as a foreign LLC.

 Limited liability company codes—State statutes that regulate the formation, operation,

and dissolution of LLCs.

 Limited liability of members of LLCs—Members are liable for the LLC’s debts,

obligations, and liabilities only to the extent of their capital contributions.

liabilities.

 Limited liability partnership—A special form of partnership in which all partners are

limited partners, and there are no general partners.

 Limited liability partnership code—LLPs are creatures of state law, not federal law.

These statutes are commonly referred to as limited liability partnership codes.

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 Manager-managed LLC—An LLC that has designated in its articles of organization that

it is a manager-managed LLC.

 Member—An owner of an LLC.

 Member-managed LLC—An LLC that has not designated that it is a manager-managed

LLC in its articles of organization.

 Operating agreement—An agreement entered into among members that governs the

affairs and business of the LLC and the relations among members, managers, and the

LLC.

companies.

 Statement of disassociation—A document filed with the secretary of state that gives

constructive notice that a member has disassociated from an LLC.

 Term LLC—An LLC that has a specified term of duration.

 Tortfeasor—A person who intentionally or unintentionally (negligently) causes injury or

 Wrongful disassociation—Occurs when a member withdraws from (1) a term LLC prior

to the expiration of the term, or (2) an at-will LLC when the operating agreement

eliminates a member’s power to withdraw.