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©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
CHAPTER 6
Limited Liability Companies
THEME
Chapter 6 serves as an introduction to limited
liability companies, focusing on the unique
characteristics of this form of business organiza-
tion.
CHAPTER GOAL
The goal of this chapter is for students to be-
come familiar with the following terms and
topics concerning limited liability companies:
• Limited liability company, member, and
manager
• Limited liability company characteristics
• Limited liability company law in the United
States
• Rights and responsibilities of limited liabil-
ity company members and managers
• Advantages and disadvantages of doing
business as a limited liability company
compared to other forms of business organi-
zation
• Limited liability company organization and
management
• Formalities for forming, operating, and dis-
solving a limited liability company
• Limited liability company lawsuit options
• The role of the paralegal who works with
limited liability companies
• Resources to assist paralegals working with
limited liability companies
SUGGESTED APPROACH
Although as of late 2011 every state in the coun-
try and the District of Columbia had adopted
limited liability company acts, only a handful of
states had adopted versions of the Uniform Lim-
ited Liability Company Act. There is still much
disparity among state limited liability company
acts. Students should be encouraged to locate
the limited liability company act of their home
state and compare it to the Uniform Limited Li-
ability Company Act, which is the primary fo-
cus of this chapter. Links to the limited liability
company act of each state can be found on the
CourseMate website that accompanies this text
at http://www.cengagebrain.com.
Class discussions may focus on the na-
ture of limited liability companies, what makes
them different from other types of business or-
ganizations, and why limited liability companies
have become such a popular and important form
of business entity.
LECTURE NOTES
An Introduction to Limited Liability Com-
panies
1. The limited liability company has many of
the characteristics of a corporation, includ-
ing limited liability for all owners or mem-
bers, but it is usually taxed as a partnership.
2. The limited liability company is an unin-
corporated legal entity distinct from its
owners, who are referred to as members.
3. The members of a limited liability compa-
ny typically have no personal liability for
the debts and obligations of the company.
4. Limited liability company management is
very flexible. All members of the limited
liability company are granted the right to
manage its business unless otherwise pro-
vided for in the limited liability company’s
articles of organization.
5. The statutes of most states provide that
limited liability companies may exist indef-
initely, until the members dissolve it. In
that event, the limited liability company is
an entity at will.
6. Because the limited liability company is an
entity separate from its members, the assets
of the company are owned by the company
itself and not by the members. Therefore,
members may transfer or assign their rights
CHAPTER 6 Limited Liability Companies 39
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
in the limited liability company, but they
may not assign an interest in the compa-
ny’s assets.
7. Individuals, corporations, partnerships,
trusts, and other entities can be members of
limited liability companies.
8. The limited liability company is formed by
filing articles of organization with the sec-
retary of state or other appropriate state au-
thority.
9. The Internal Revenue Service adopted
“Check the Box” regulations in 1997.
When the members of a limited liability
company file an income tax return for the
company, it is taxed as a partnership, un-
less the members check the box on a form
to elect to be taxed as a corporation.
10. Single-member limited liability companies
are disregarded as entities separate from
their owners for income tax purposes, un-
less the sole member elects to be taxed as a
corporation.
11. A few states impose corporate income tax-
es on limited liability companies.
Limited Liability Companies in the United
States
12. Limited liability companies are becoming
an increasingly popular form of business
organization in the United States.
13. The first state statutes providing for limited
liability companies were adopted by Wyo-
ming (in 1977) and Florida (in 1982). The
majority of states adopted limited liability
company acts during the 1990s. The num-
ber of limited liability companies has
grown from fewer than 20,000 in 1993 to
nearly 1.9 million in 2008. Some states re-
port that they are forming more limited lia-
bility companies than corporations each
year.
14. The statutes of most states permit the for-
mation of professional limited liability
companies for doctors, lawyers, and other
professionals. Membership in a profession-
al limited liability company may be re-
stricted to licensed professionals.
15. Members of professional limited liability
companies are personally liable for their
own acts of negligence or malpractice.
Law Governing Limited Liability Companies
16. The Uniform Limited Liability Company
Act was adopted by the National Confer-
ence of the Commissioners of Uniform
State Law in 1994. The uniform law was
drafted to include many of the provisions
that had already been adopted by state
laws.
17. In 2006, the Uniform Law Commission
drafted a new version of the uniform act,
referred to as the Revised Uniform Limited
Liability Company Act. Few states have
adopted either version of the Uniform Lim-
ited Liability Company Act.
18. State and federal securities laws do not ap-
ply to most limited liability companies,
which have a small number of members
who all participate to some extent in the
management of the limited liability
company.
19. Limited liability companies may be subject
to state and federal securities laws if the
members’ interests are determined to be (1)
an investment (2) in a common enterprise
(3) with an expectation of profits to be
derived solely from the efforts of others.
Advantages of Doing Business as a Limited
Liability Company
20. Advantages of doing business as a limited
liability company compared to other forms
of business organizations include the lim-
ited liability offered to all members, the
lack of restrictions on ownership, the in-
creased ability to raise capital for the busi-
ness, the beneficial tax treatment, and the
flexibility of management.
40 PART I Guide for Instructors and Answers to Chapter Review Questions
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
Disadvantages of Doing Business as a Lim-
ited Liability Company
21. Disadvantages to doing business as a lim-
ited liability company include restrictions
that may be placed on the transfer of own-
ership of the company, the possibility of
piercing the limited liability company veil,
the lack of uniformity in limited liability
law among the states, and the formalities
and reporting required of limited liability
companies.
Limited Liability Company Rights and Pow-
ers
22. The limited liability company is a separate
entity that is granted certain powers by
state statutes and its articles of organiza-
tion. Limited liability companies generally
have the same powers as individuals to do
all things necessary or convenient to carry
on business.
Members’ Rights and Responsibilities
23. Members of a limited liability company
may include individuals, corporations,
trusts, and other entities.
24. All members of the limited liability com-
pany are granted the right to manage its
business unless otherwise provided for in
the limited liability company’s articles of
organization.
25. Members of limited liability companies are
granted certain rights under state statutes
and by the limited liability company’s arti-
cles of organization. Following is a list of
rights typically granted to members:
• Each member has an equal right to
manage the limited liability company
or to appoint managers to manage the
company.
• Members have the right to be reim-
bursed for liabilities they incur in the
ordinary course of business of the
company or for the preservation of its
business or property.
• Each member has the right to receive
an equal share of any distribution made
by the limited liability company before
its dissolution and winding up.
• Members have the right to access the
records of the limited liability company
at the company’s principal office or
other reasonable location specified in
the operating agreement.
• Members have the right to certain in-
formation concerning the company’s
business or affairs.
• Members have the right to receive a
copy of the company’s written operat-
ing agreement.
• Members have the right to maintain an
action against a limited liability com-
pany or another member to enforce the
company’s operating agreement and
other rights.
• Members have the right to dissociate
from a limited liability company and
have their shares purchased by the lim-
ited liability company.
• Members generally have the right to
wind up the business of the limited lia-
bility company.
Limited Liability Company Formation
26. The articles of organization of a limited
liability company usually include the
following:
• The name of the limited liability
company
• The address of the initial designated
office
• The name and address of the initial
agent for service of process
• The name and address of each organizer
• The duration of the existence of the
limited liability company
• The name and address of the limited li-
ability company’s initial managers if
the limited liability company is to be
managed by managers
CHAPTER 6 Limited Liability Companies 41
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
• Information concerning the members’
liability for any debts, obligations, and
liabilities of the limited liability com-
pany
27. The name of the limited liability company
must be available for use in the state where
the company is formed, and it must include
language or initials (LLC) indicating that
the entity is a limited liability company.
28. If the organizers of the limited liability
company feel that it is in the best interests
of the company for certain members to be
personally liable for certain debts and obli-
gations of the company, that may be pro-
vided for in the articles of organization.
Otherwise, members generally do not have
personal liability for any debts and obliga-
tions of the company.
Organization and Management of a Limited
Liability Company
29. Limited liability companies may be mem-
ber managed or manager managed.
30. If the limited liability company is member
managed, each member has an equal right
in the management of the company and has
the right to act on behalf of the limited lia-
bility company.
31. If the limited liability company is manager
managed, the organizers or members elect
a board of managers to manage the busi-
ness of the company. The managers are
typically named in the articles of organiza-
tion. In a manager-managed limited liabil-
ity company, the managers act as agents of
the company; the other members do not.
The managers serve in a capacity similar to
that of the board of directors of a corpora-
tion, and they owe a fiduciary duty to the
other members.
32. The following extraordinary matters require
the consent of all members, regardless of
whether the limited liability company is
member managed or manager managed:
• Amendment of the limited liability
company’s operating agreement
• Approval of acts or transactions by cer-
tain members or managers that would
otherwise violate the duty of loyalty
• Amendments to the articles of organi-
zation
• The compromise, as among members,
of an obligation of a member to make a
contribution or return money or other
property paid or distributed in violation
of state statute
• The making of interim distributions
• The admission of a new member
• The use of the company’s property to
redeem an interest subject to a charging
order
• Dissolution of the company
• A waiver of the right to have the com-
pany’s business wound up and the
company terminated
• The merger of the limited liability
company with another entity
• The sale, lease, exchange, or other dis-
posal of all, or substantially all, of the
company’s property with or without
goodwill
33. The operating agreement is the document
that sets forth the agreement of the mem-
bers with regard to the management and
operation of the limited liability company.
It is often similar to the bylaws adopted by
a corporation.
34. The statutes of most states do not dictate
what must be contained in the limited lia-
bility company’s operating agreement. Ra-
ther, state statutes prohibit only provisions
that unfairly restrict the rights of members
or limit the duty of loyalty owed to mem-
bers by managers.
35. Limited liability companies in most states
are subject to annual reporting require-
ments with the secretary of state or other
appropriate state authority, usually on
forms provided by that authority.
42 PART I Guide for Instructors and Answers to Chapter Review Questions
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
Financial Structure of a Limited Liability
Company
36. The limited liability company’s initial as-
sets usually consist of contributions made
by the company’s members. The articles of
organization or the company’s operating
agreement may provide that members must
make additional contributions under certain
circumstances.
37. The limited liability company may sell ad-
ditional member interests to raise funds for
the limited liability company.
38. The profits of the limited liability company
are allocated to the members of the compa-
ny proportionate to their initial contribution
or pursuant to some other formula set forth
in the company’s articles of organization or
operating agreement.
39. Distributions are made to members pursu-
ant to the terms of the operating agreement
or pursuant to state statute.
40. Members of most limited liability compa-
nies report their income in the same man-
ner as partners of a general partnership.
The company’s income is reported to the
Internal Revenue Service on a Form 1065
Partnership Return.
Limited Liability Company Lawsuits
41. As a separate entity, a limited liability
company may sue or be sued in the compa-
ny’s name.
42. A derivative lawsuit may be brought on
behalf of the limited liability company by
one or more members to recover damages
sustained by the limited liability company.
The cause of action in a derivative lawsuit
belongs to the limited liability company.
Specific requirements for bringing deriva-
tive lawsuits are usually set forth in state
statutes.
43. Individual members or classes of members
of limited liability companies may bring
suit against the company to protect their
rights and interests under an operating
agreement or under law. The cause of ac-
tion for this type of lawsuit belongs to the
individual member or members.
Dissolution of the Limited Liability Company
44. One or more members may be dissociated
from the limited liability company without
causing its dissolution.
45. A member may dissociate from the limited
liability company by withdrawing (with
written notice) or transferring all of his or
her interest in the company. A dissociation
may also be caused by the death, bankrupt-
cy, or appointment of a guardian for the
member, or by the unanimous vote of the
other members under certain circumstanc-
es.
46. State statutes and the limited liability com-
pany’s articles of organization typically
provide terms and conditions for the pur-
chase of a dissociating member’s interest in
the company by the remaining partners or
the limited liability company itself.
47. The dissolution of a limited liability com-
pany may occur when stated in the compa-
ny’s articles of organization, when agreed
to by the members, or upon the dissociation
of one or more members under certain cir-
cumstances.
48. State statutes may provide that a limited
liability company will dissolve when it be-
comes unlawful for the company to contin-
ue its business or when a judicial decree is
entered that requires the company to
dissolve.
49. After a decision has been made to dissolve
the limited liability company, the winding
up process will begin.
50. The assets of a dissolving limited liability
company must be distributed in accordance
with the terms of its operating agreement
and with state statute. In general, the assets
of the limited liability company must first
be used to pay creditors of the company be-
fore distributions are made to the members.
CHAPTER 6 Limited Liability Companies 43
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
51. Articles of termination must be filed with
the secretary of state or other appropriate
state authority to terminate the existence of
the limited liability company.
52. Under certain circumstances, such as when
members have used the company to de-
fraud creditors, the limited liability compa-
ny veil may be pierced and the members
may be held personally liable.
Transacting Business as a Foreign Limited
Liability Company
53. A limited liability company is considered a
foreign company in every state, other than
its state of organization, in which it trans-
acts business.
54. A limited liability company must file an
application for a certificate of authority to
transact business as a foreign limited liabil-
ity company with the secretary of state or
other appropriate state authority of the for-
eign state.
The Paralegal’s Role
55. Paralegals can perform a wide variety of
functions to assist with the formation,
maintenance, and dissolution of limited lia-
bility companies.
Resources
56. Paralegals are often asked to research lim-
ited liability law. That research may in-
clude state statutes, the Internal Revenue
Code and Revenue Rulings, case law, and
securities acts.
CASE BRIEFS
Addy, et al. v. Myers, 616 NW2d 359 (ND
2000)
Purpose: This case illustrates the general rule of
limited liability for the members of a limited
liability company, and it shows how members
can be held personally liable for the company’s
obligations by providing personal guarantees.
Cause of Action: Breach of contract
Facts: This case is a dispute between certain
members of a limited liability company called
M.A.H.D. Group, L.L.C. (the “LLC”). The LLC
was formed in 1995 to establish a restaurant in
Bismarck, North Dakota, by the name of Ed Foo
Yungs. The LLC was owned by four families:
Guy and Nancy Myers, Boyd and Deb Addy,
Tom and Kathy Hutchens, and Lance and Lori
Doerr. Each family contributed $42,500 and
owned 25 percent of the company.
Twice, shortly after the restaurant
opened, the owners of the LLC agreed that addi-
tional funds were needed. A total of $45,000
was borrowed from BNC National Bank. Boyd
Addy and Tom Hutchens, the plaintiffs in this
case, personally signed for the funds, which they
loaned to the LLC. The LLC was to repay BNC
National Bank with proceeds from the business.
In February 1997, the owners of the
LLC held a meeting and decided to close the
business. The minutes of a March 1997 meeting,
at which Boyd Addy, Tom Hutchens, Nancy
and Guy Myers, and Lance and Lori Doerr were
present, state that it was agreed that the $45,000
owed to BNC National Bank would be assumed
equally by the Addys, the Myers, and the
Hutchens. Nancy and Guy Myers subsequently
retained an attorney to write a letter requesting
the minutes of the March meeting be revised to
reflect that the Myers had not agreed to assume
any personal liability for the $15,000 (their
share of the $45,000 owed to the bank).
Boyd Addy and Tom Hutchens sued
Guy and Nancy Myers in district court. The trial
court granted summary judgment for Guy My-
ers, because he was not a capital contributor,
owner, manager, governor, or an officer of the
LLC. After a bench trial, the court decided that
Nancy Myers had not guaranteed repayment of
the $15,000 loan, because there was no written
guaranty signed by her, and that she was not
personally liable for debts and obligations of the
LLC due to her status as a member of a limited
liability company.
44 PART I Guide for Instructors and Answers to Chapter Review Questions
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
did not personally guaranty in writing?
Holding: No, the court found that Nancy Myers
could not be held personally liable for the
$15,000 or any part of the LLC’s obligation to
the bank.
Reasoning: Although a majority of the mem-
bers of a limited liability company can take ac-
tion to render the company liable for its debt,
being liable for the debt and the individual own-
ers of the company being personally liable for
its debt. Under N.D.C.C. § 10-32-29, and the
articles of organization of the LLC, owners and
members of the limited liability company are
generally not personally liable for its debt. A
limited liability company is a separate business
entity and its owners or members are not ex-
posed to personal liability for the entity’s debts
nies different from general partnerships?
The most important distinction between
a limited liability company and a general
partnership is that the limited liability
company offers limited personal liability
for its members, whereas a partnership
offers no protection from personal liabil-
ity to its partners. Unlike general part-
nerships, limited liability companies
must be formed by filing articles of or-
pany with merely an oral agreement.
2. If Sandy owes Mike $5,000 that she is un-
able to repay, can she assign to him her
rights as a limited liability company mem-
ber to receive payments as set forth in the
company’s operating agreement?
Yes, members of a limited liability com-
pany can transfer or assign their finan-
Can Sandy assign her entire rights in the
limited liability company to Mike, making
him a new member with the right to man-
age the business?
No, the rights of a member to vote and
partake in the management of the lim-
ited liability company are not transfera-
3. Katherine is a member of a member-
managed limited liability company that de-
signs software called K & A Software Ltd.
Liability Company. Can she enter the com-
pany into a contract for the design of new
educational software for a local college?
Yes, unless prohibited by the operating
agreement of the limited liability com-
pany, Katherine, as a member of a
CHAPTER 6 Limited Liability Companies 45
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
4. Are the members of a limited liability
company always protected from personal
company?
No
What are some circumstances under which
members of a limited liability company
may be personally liable for the company’s
debts and obligations?
of a limited liability company to person-
ally guaranty loans made to the compa-
5. Suppose that you are forming a limited lia-
bility company that will own and operate
auto dealerships. Your company will oper-
take during the organization process to plan
for your future expansion?
To plan for future expansion into other
states, you would want to do a quick re-
view of the limited liability laws in those
what options are available in your state for
transacting business?
Why might a professional limited liability
company be an attractive alternative?
Limited liability companies provide that
professionals such as physicians are not
liable for the debts or obligations of the
company that arise from a wrongful act
7. Why is it important to designate in the arti-
cles of organization whether a limited lia-
partner of a limited partnership?
Unlike limited partners, all members of
LLCs have the right to participate in the
9. Suppose that Dan decides to form a lim-
ited liability company to operate a gro-
cery delivery service with his two sons,
Tom and Bob. Tom and Bob are each
contributing $10,000, but Dan’s initial
46 PART I Guide for Instructors and Answers to Chapter Review Questions
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
contribution is $20,000. Can the LLC’s
operating agreement provide for Dan to
receive distributions that are twice the
amount of the distribution that Tom and
Bob each receive?
Yes, LLC statutes provide for maximum
flexibility when designing the financial
structure of an LLC. The operating
If the operating agreement is silent on the
subject of distributions, how would a
$6,000 distribution be divided among the
three members?
This may vary, but state statutes general-
ly provide for equal distributions to all
10. Suppose that you have formed a limited
liability company in your state to operate a
sporting goods franchise. Your business
has become very successful and you and
your members would like to expand. One
of your members, who will be managing
the new store, lives in a neighboring state
and would like to open a store in his
hometown. Would it be necessary to form a
new limited liability company, or can your
limited liability company own and operate
a store in a neighboring state?
What formalities may be required?
The LLC will be required to qualify to
SUGGESTED ANSWERS TO
PRACTICAL PROBLEMS
The Practical Problems in this chapter ask stu-
dents to research the limited liability company
act of their home state to determine how it may
differ from the Uniform Limited Liability Com-
pany Act. Students are also asked to begin look-
ing at the formalities that must be followed to
form a limited liability company in their home
state. The answers to the problems will, of
course, vary by state.
Resources for answering the Practical Prob-
lems include the following:
CourseMate website that accompanies this
text at http://www.cengagebrain.com.)
2. Office of the secretary of state or other ap-
propriate state authority (See Appendix A
to the text and the CourseMate website that
accompanies this text at
THINKING
The Exercise in Critical Thinking for this chap-
ter asks students to consider the position of an
investor in a manager-managed LLC.
Exercise:
Why might an investor want to be-
come a member of a manager-
managed LLC when the investor
would have no authority to manage
the company? What can a member of
a manager-managed LLC do to influ-
ence the direction of the LLC?
DOCUMENTS FOR THE
WORKPLACE SCENARIO
limited liability company in their home state.
Students may use forms from the CourseMate
website that accompanies this text at
http://www.cengagebrain.com, from the secre-
tary of state’s website in their state, or they can
CHAPTER 6 Limited Liability Companies 47
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
prepare their own documents based on the lim-
ited liability company act in their home state.
Appendix G includes sample articles of organi-
zation that could be filed in any state that
follows the Uniform Limited Liability Company
Act. A sample cover letter is also included.
Students completing this exercise should
learn what documentation is needed to form a
limited liability company, where that documen-
tation is filed, and what other formalities may be
required.
