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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

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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

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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

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• 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

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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

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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

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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

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4. Are the members of a limited liability

company always protected from personal

company?

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

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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