Chapter 38: Limited Liability Companies and Limited Partnerships

Introduction Limited liability companies are relatively new creatures of state statute. An LLC is a hybrid entity that combines the limited liability of a corporation and the tax advantages of a partnership. LLC’s are increasingly become the entity of choice for businesses.

§ 1: LLC’s 1997 IRS rules provide that any unincorporated business (including LLC’s) will automatically be taxed as a partnership unless otherwise indicated on the tax return. LLC’s are attractive in today’s global business environment because they allow foreign investors to own interests.

LLC Formation Like corporations, LLC’s are creatures of state law. The owners are called “members” (not shareholders) and their ownership is called an “interest” (not shares). LLC’s are formed by filing articles of organization with the Secretary of State. (see LLC rules at Texas Secretary of State).

LLC Formation [2] Articles of Organization require: Name of Business. Principal Address. Name and Address of Registered Agent. Names of the Owners; and How the LLC will be managed. Business name must include LLC or Limited Liability Company.

LLC Citizenship An LLC is a legal entity separate from its owners. For federal jurisdiction based on diversity, an LLC may be treated differently than a corporation. For diversity purposes the citizenship of an LLC is the citizenship of its members, which may live in multiple jurisdictions. Case 38.1: Cosgrove v. Bartolotta (1998).

LLC Advantages & Disadvantages Member liability is limited to amount of investment. State statutes are not uniform. Can be treated as a “pass through” entity for tax purposes. Not all states recognize LLC’s. Profits can be distributed to members without the double taxation of a corporation. Members pay personal income tax on received dividends.

LLC Operating Agreement Operating agreement is analogous to corporation’s bylaws. Operating agreements may be oral and contain provisions relating to management, dividends, meetings, transfer of membership interests, and other significant issues. Generally, if the operating agreement is silent, courts will apply partnership principles. Case 38.2 Hurwitz v. Padden (1996).

LLC Management There are two options for management, generally set forth in the articles of organization: Member-Managed: all of the members participate in management, like a partnership. Manager-Managed: members are elected to manage the LLC. If the articles are silent, statutes provide either that each member has one vote or votes are made based on percentage of ownership.

§ 2: LLP’s Creature of state statute, similar to an LLC except that an LLP is designed for professionals who normally do business as a partnership (lawyers and accountants). LLP allows partnership to limit personal liability of the partners but allows “pass through” tax advantages.

LLP Liability Recall that partnership law makes all partners jointly and severally for another partner’s tort, including personal assets. The LLP allows professionals to avoid personal liability for the malpractice of other partners. Supervising Partner is also liable for acts of subordinate.

Family Limited Liability Partnerships FLLP is a limited liability partnership in which the majority of the partners are related to each other. Used frequently for agriculture.

§ 3: Limited Partnerships Entity that limits the liability of some of its owners (the limited partners). Creature of state statute. Filing a certificate with the Secretary of State is required. Agreement of two or more persons to carry on a business for profit with at least one general partner and one limited partner.

Limited Partnerships The General partner assumes all management and personal liability. Limited Partner contributes cash but has no management rights. Liability is limited to the amount of investment. A limited partner can forfeit this “veil” of immunity by taking part in the management of the LP. Case 38.3: Miller v. Dept of Revenue (1998).

Rights and Liabilities of LP General partners are personally liable to 3rd parties for breach of contract and tort liability. However, a corporation (or an LLC) can be a general partner and have limited liability. Limited partners have the right to inspect the LP’s books and be informed of the LP’s business.

Rights and Duties of the LP [2] On dissolution, the limited partner is entitled to return of capital contributions. LP interests are considered securities and regulated by both federal and state securities laws. Limited partners’ liability is limited to the capital investment.

LP Management Only General Partners can manage but they have a fiduciary obligation to LP’s. LP’s enjoy limited liability as long as they do not engage in management functions. An LP will be liable to a 3rd party if the 3rd party believes, based on conduct, that the LP is a general partner. Case 38.4: BTI v. Equitable Life (1999).

Dissolution of the LP Dissolved in much the same way as a general partnership (Chapter 33). Retirement, withdrawal, death bankruptcy or mental incompetence of a general partner will trigger dissolution unless the remaining GP’s consent to continue. Creditors are paid first then partners.

§ 4: LLLP’s Limited Liability Limited Partnership is a type of limited partnership. Difference between LP and LLLP is that the general partner has limited liability, like a limited partner, up to the amount of investment. Most states do not allow for LLLP’s.

Law on the Web Comparison of Different Business Entities. LLC Formation On-Line at Bizcorp.com LLC’s at Nolo.com Legal Research Exercises on the Web.