923
Chapter 38
Limited Liability Companies
and Special Business Forms
See Separate Lecture Outline System
INTRODUCTION
The most common forms of business organization when two or more persons are involved are the partnership and the
corporation. In this chapter, the basic features of business forms that combine the tax advantages of the partnership and the
limited liability of the corporation are explained, and some of their advantages and disadvantages are spelled out. This chapter
also briefly reviews less common forms of business organization, including joint ventures, cooperatives, and others.
ADDITIONAL RESOURCES—
924 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
VIDEO SUPPLEMENTS
The following audio and video supplements relate to topics discussed in this chapter—
PowerPoint Slides
To highlight some of this chapter’s key points, you might use the Lecture Review PowerPoint slides compiled for
Chapter 38.
Business Law Digital Video Library
The Business Law Digital Video Library at www.cengage.com/blaw/dvl offers a variety of videos for group or
individual review. Clips on topics covered in this chapter include the following.
• Ask the Instructor
LLCs/LLPs: Why would a Limited Liability Company ever choose to be taxed as a corporation, rather than as a
partnership? Isn’t the main advantage of an LLC the ability to avoid corporate double taxation?—The ability to avoid
double taxation is only one of the advantages of the LLC form of business organization. Members of an LLC might
choose to be taxed at the corporate rate if their individual tax brackets are higher than the corporate tax rate and they
would prefer to reinvest their earnings in the business.
• Legal Conflicts in Business
corporation or an LLC.
CHAPTER OUTLINE
I. The Limited Liability Company
State statutes govern limited liability companies (LLCs). About a fifth of these statutes are based on the Uniform
Limited Liability Company Act (ULLCA). LLCs are taxed as partnerships or, electively, as corporations. Wyoming was the
first state to authorize LLCs, which have, however, existed for more than a century in other countries.
A. TAXATION OF THE LLC
B. THE NATURE OF THE LLC
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LLCs are legal entities apart from their owners, who are called members. An LLC can sue or be sued, enter into
contracts, and hold title to property [ULLCA 201]. Although members usually have limited liability, an LLC entity
may be disregarded in some circumstances.
CASE SYNOPSIS—
Case 38.1: 02 Development, LLC v. 607 South Park, LLC
In March 2004, 607 South Park, LLC, agreed to sell the Park Plaza Hotel to Creative Environments of Hollywood,
Inc., for $8.7 million. In February 2005, Creative Environments assigned its rights in the agreement to 02 Development,
LLC. 02 Development did not exist at the time. Later, after 02 Development’s creation, 607 South Park refused to sell
the hotel. 02 Development filed a suit in a California state court to enforce the deal. The court ruled in 607 South Park’s
favor. 02 Development appealed.
could enforce any pre-organization contract made in its behalf, such as the assignment agreement, if it adopted or
for the necessary funding to close the transaction on time if 607 South Park had given it the opportunity instead of
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Notes and Questions
Are there other rules that apply to corporations that should be applied to LLCs? If so, which ones and why? If all of
the principles that govern corporations should also apply to LLCs, should all distinctions between these two business
forms be done away with? If not, why should any distinctions be retained?
Presumably, 607 South Park repudiated the real estate purchase agreement because it either had, or believed it
could obtain, a better offer for the property. Are there any circumstances under which this reason could justify 607
South Park’s behavior? While there may have been one or more business reasons to repudiate the real estate sales
contract, 607 South Park certainly was not acting in an ethical manner when it did so. Good financial reasons do not
support a justification of behavior that is unethical.
ANSWER TO “THE LEGAL ENVIRONMENT DIMENSION”
QUESTION IN CASE 38.1
Why did the appellate court dismiss 607 South Park’s argument that 02 Development should be required to prove
926 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
that it had funding commitments for $8.7 million? On a motion for summary judgment, the burden of proof is initially
on the party who files the motion (607 South Park in this case). The appellate court pointed out that “607 South Park
introduced no evidence to support an argument based on the proposition of law that 607 South Park is . . .
advocating,” which was that 02 Development had to prove it would have been able to pay the price. Because 607 South
Park showed no proof that 02 Development would have been unable to obtain financing, “the burden of production
never shifted to 02 Development to present contrary evidence.”
ANSWER TO “THE ETHICAL DIMENSION” QUESTION IN CASE 38.1
What might have been some of the reasons that 607 South Park did not agree to sell the property to 02
Development? The owner of the property might have received an offer to buy the property at a higher price, or the
value may simply have appreciated since the time of the agreement with Creative Environments. The owner might
ADDITIONAL CASES ADDRESSING THIS ISSUE —
Recent cases in which courts were asked to “pierce the veil” of a limited liability company (LLC) include the
following.
• Hollowell v. Orleans Regional Hospital, 217 F3d 379 (5th Cir. 2000) (under Louisiana law, the LLC veil may be
pierced where the LLC is operating as the alter ego of its members or where the members are committing fraud or
deceit on third persons through the LLC).
• GMAC Commercial Mortgage Corp. v. Gleichman, 84 F. Supp.2d 127 (D.Me. 1999) (in a piercing claim involving a
different analysis and stated that, where one company pays a major obligation of another and both are owned by the
• Ditty v. CheckRite, Ltd., 973 F.Supp. 1320 (D.Utah 1997) (that a person played an active role in the company’s
• Hamilton v. AAI Ventures, L.L.C., 768 So.2d 298 (La.App. 1 Cir. 2000) (in a suit involving an LLC, the court invoked
the corporate piercing doctrine: “applying the jurisprudence applicable to limited corporate liability, we note there are
limited exceptions to the rule of non-liability of shareholders for the debts of a corporation, whereby the court may
ignore the corporate fiction and hold the individual members or member liable”).
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C. THE FORMATION OF THE LLC
To form an LLC, the articles of organization must include information similar to corporate articles of
incorporation. The business’s name must include and LLC designation.
E. ADVANTAGES OF THE LLC
CASE SYNOPSIS—
Case 38.2: ORX Resources, Inc. v. MBW Exploration, LLC
ORX Resources, Inc., partnered with MBW Exploration, LLC, and others to share the expenses and profits of a
venture to explore and develop a certain tract of land known in Louisiana. Mark Washauer signed the agreement with
ORX on behalf of MBW, which came into existence later. Washauer paid for part of MBW’s participation with personal
checks. When the rest of the payment—more than $84,220—was not forthcoming, ORX filed a suit in a Louisiana state
court against MBW and Washauer. The court pierced the LLC veil and held the defendants jointly and severally liable.
They appealed.
forming the LLC and transacting its affairs, and failure to hold regular member and manager meetings. All of these
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Notes and Questions
What does the outcome in this case suggest to potential members of LLCs who want to avoid the liability to which
Washauer was subject? If a future member of an LLC wishes to avoid the liability imposed on the member in this case,
one option is to carefully observe the formalities for setting up and maintaining the LCC as a business organization
apart from its members’ personal interests. The members might limit each other’s access to, or use of, company funds,
for example. Also, a member might want assurance that the firm is viable and the other members are trustworthy by,
for example, requiring a certain level of financial investment in the business.
Why is the liability of the members of LLCs limited with respect to the firm’s debts and other obligations in the first
place? The liability is limited to encourage business activity. If the member of an LLC were liable for the firms’
928 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
ANSWERS TO QUESTIONS AT THE END OF CASE 38.2
1. One of the advantages of the LLC is that its members enjoy limited personal liability for the company’s obligations.
In view of this fact, does the possibility that a court may hold an LLC member personally liable for the LLC’s debts
reduce the utility of the LLC form of business organization? Explain. One of the main attractions of the LLC is that it
offers limited liability to its owners. If the courts routinely disregarded the LLC form and held members personally
liable, it certainly would diminish the utility of this organizational form. The courts, though, rarely pierce the veil of an
LLC (or a corporation) and only do so when it would be blatantly unfair to a plaintiff, such as a creditor, to do
otherwise. Because piercing the veil of an LLC is such an unusual occurrence, it is hard to imagine how this possibility
could reduce the overall utility of this business organizational form. Clearly, those who decide to avail themselves of
2. What does “jointly and solidarily” (jointly and severally) mean in terms of liability? Would ORX prefer that
Washauer and MBW be held personally liable jointly and severally, rather than that Washauer alone be held personally
liable? Explain. The phrase “joint and several liability” is usually associated with the partnership. In the context of a
have a greater chance of recovering the full debt.
1. Limited Liability
2. Flexibility in Taxation
An LLC offers the tax advantages of a partnership. LLCs with two or more members can elect to be taxed as
3. Management and Foreign Investors
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Advantages of LLCs include its flexible operations and management characteristics.
ENHANCING YOUR LECTURE—
LIMITED LIABILITY COMPANIES
IN FOREIGN NATIONS
Limited liability companies are not unique to the United States. Many nations have business forms that provide
limited liability, although these organizations may differ significantly from domestic LLCs. In Germany, for example, the
GmbH, or Gesellschaft mit beschrankter Haftung (which means “company with limited liability”), is a type of business
entity that has been available since 1892. The GmbH is now the most widely used business form in Germany. A GmbH,
however, is owned by shareholders and thus resembles a U.S. corporation in certain respects. German laws also
impose numerous restrictions on the operations and business transactions of GmbHs, whereas LLCs in the United
States are not even required to have an operating agreement.
FOR CRITICAL ANALYSIS
Clearly, limited liability is an important aspect of doing business globally. Why might a nation limit the number of
member-owners in a limited liability company?
F. DISADVANTAGES OF THE LLC
II. Operation and Management of an LLC
A. THE LLC OPERATING AGREEMENT
Members decide how to operate the business.
1. A Writing Is Preferred
2. Partnership Law May Apply
If an agreement does not cover a point in dispute, the governing LLC statute controls. If an issue comes
under neither an agreement nor a statute, the principles of partnership law apply.
B. MANAGEMENT OF AN LLC
Unless the articles of organization specify otherwise, an LLC is considered to be member-managed. In a member-
managed LLC, all members participate in management [ULLCA 404(a)]. In a manager-managed LLC, the members
designate a group of persons (member or not) to manage the firm. Managers owe fiduciary duties of loyalty and
care to the LLC and its members [ULLCA 409(a), (h)].
ANSWER TO CRITICAL THINKING QUESTION IN THE FEATURE—
INSIGHT INTO ETHICS
Why wouldn’t a manager always owe a fiduciary duty to the members of an LLC? One would think that the
principle of fiduciary duties by a manger to the members of an LLC would go without saying. But, there is a difference
between a fiduciary duty to the entity—here the LLC—and a fiduciary duty to the members of an LLC. Presumably, a
manager of a manager-managed LLC always has a fiduciary duty to the company, just as any manager of any business
can sue a manager for not acting ethically in the best interests of each member. The members can avoid this issue to
C. OPERATING PROCEDURES
The LLC’s operating agreement may also specify procedures for making decisions. If it does not, choosing and
removing managers is done by majority vote [ULLCA 404(b)(3)]. Details concerning meetings and voting rights may
also be included in the agreement. If not, in some states, each member has one vote.
ENHANCING YOUR LECTURE—
HOW DO YOU CHOOSE BETWEEN LLCS AND LLPS?
One of the most important decisions that an entrepreneur makes is the selection of the form in which to do
business. To make the best decision, a businessperson should understand all aspects of the various forms, including
legal, tax, licensing, and business considerations. It is also important that all of the participants in the business
understand their actual relationship, regardless of the organizational structure.
NUMBER OF PARTICIPANTS
discussed in Chapter 26) and limited liability companies (LLCs), have been added to the options for business entities.
An initial consideration in choosing between these forms is the number of participants. An LLP must have two or more
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LIABILITY CONSIDERATIONS
The members of an LLC are not liable for the obligations of the organization. The liability of the partners in an LLP
varies from state to state. About half of the states exempt the partners from liability for any obligation of the firm. In
some states, the partners are individually liable for the contractual obligations of the firm but are not liable for
obligations arising from the torts of others. In either situation, each partner may be on his or her own with respect to
liability unless the other partners decide to help.
DISTRIBUTIONS FROM THE FIRM
Members and partners are generally paid by allowing them to withdraw funds from the firm against their share of
the profits. In many states, a member of an LLC must repay so-called wrongful distributions even if she or he did not
know that the distributions were wrongful. Under most LLP statutes, by contrast, the partners must repay only
distributions that were fraudulent.
MANAGEMENT STRUCTURE
THE NATURE OF THE BUSINESS
The business in which a firm engages is another factor to consider in choosing a business form. For example, with
a few exceptions, professionals, such as accountants, attorneys, and physicians, may organize as either an LLP or an LLC
in any state. In many states, however, the ownership of an entity that engages in a certain profession and the liability
of the owners are prescribed by state law.
FINANCIAL AND PERSONAL RELATIONSHIPS
CHECKLIST FOR CHOOSING A LIMITED LIABILITY BUSINESS FORM
2. Evaluate the tax considerations.
3. Consider the business in which the firm engages, or will engage, and any restrictions imposed on that type of
4. Weigh such practical concerns as the financial and personal relationships among the participants and the
willingness of others to do business with a particular organizational form.
a. The chief benefits of electing corporate status for tax purposes are that the members generally are not subject to self–employment taxes, and
fringe benefits may be provided to employee-members on a tax-reduced basis. The tax laws are complicated, however, and a professional should be
consulted about the details.
III. Dissociation and Dissolution of an LLC
Dissociation occurs when a person ceases to be associated with the carrying on of a business. A member of an LLC has
the power, but may not have the right, to dissociate from the firm. Events that trigger dissociation under the ULLCA are
the same as those under the Uniform Partnership Act.
A. EFFECT OF DISSOCIATION
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IV. Special Business Forms
A. JOINT VENTURE
A joint venture is a relationship in which two or more persons combine their efforts or their property for a single
transaction or project, or a related series of transactions or projects. Unless otherwise agreed, joint venturers
share profits and losses equally. Large organizations often investigate new markets or new ideas by forming joint
ventures with other enterprises.
1. Similarities to Partnerships
CASE SYNOPSIS—
Case 38.3: SPW Associates, LLP v. Anderson
Murdo Cameron developed components to make replicas of the P-51 aircraft. Douglas Anderson agreed to
collaborate on the manufacture of one P-51 for each of them and to make additional P-51s to sell. For the first plane,
which Anderson would build, Cameron would provide an engine, which Anderson would pay for after the plane’s first
The North Dakota Supreme Court affirmed. There are four elements to a joint venture: (1) a contract to engage in
a common undertaking; (2) a contribution of money, property, time, or skill; (3) an interest in, and mutual right to
control, venture property; and (4) an agreement to share profits. Anderson and Cameron had contracted to build two
P-51s, they had contributed money, property, time, and skill, and they each had exerted control over the planes’
components. As for an agreement to share profits, their contract referred to “future aircraft purchases” and “multiple