© 2004 West Legal Studies in Business A Division of Thomson Learning 1 Chapter 41 Limited Liability Companies and Limited Partnerships Chapter 41 Limited Liability Companies and Limited Partnerships

© 2004 West Legal Studies in Business A Division of Thomson Learning 2 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. 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.

© 2004 West Legal Studies in Business A Division of Thomson Learning 3 § 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 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.

© 2004 West Legal Studies in Business A Division of Thomson Learning 4 Nature of the LLC 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). Members of an LLC enjoy limited liability. Case 41.1: Kaycee Land and Livestock v. Flahive (2002). Can a third party pierce the LLC “veil” and hold managing member liable? 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). Members of an LLC enjoy limited liability. Case 41.1: Kaycee Land and Livestock v. Flahive (2002). Can a third party pierce the LLC “veil” and hold managing member liable?

© 2004 West Legal Studies in Business A Division of Thomson Learning 5 LLC Formation 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. 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.

© 2004 West Legal Studies in Business A Division of Thomson Learning 6 Jurisdictional Requirements 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. 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.

© 2004 West Legal Studies in Business A Division of Thomson Learning 7 Advantages and Disadvantages of the LLC AdvantagesDisadvantages 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.

© 2004 West Legal Studies in Business A Division of Thomson Learning 8 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 41.2: Hurwitz v. Padden (1996). 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 41.2: Hurwitz v. Padden (1996).

© 2004 West Legal Studies in Business A Division of Thomson Learning 9 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. 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.

© 2004 West Legal Studies in Business A Division of Thomson Learning 10 § 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. 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.

© 2004 West Legal Studies in Business A Division of Thomson Learning 11 Liability in an LLP 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. 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.

© 2004 West Legal Studies in Business A Division of Thomson Learning 12 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. FLLP is a limited liability partnership in which the majority of the partners are related to each other. Used frequently for agriculture.

© 2004 West Legal Studies in Business A Division of Thomson Learning 13 § 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 between at least one general partner and one limited partner to carry on a business for profit. 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 between at least one general partner and one limited partner to carry on a business for profit.

© 2004 West Legal Studies in Business A Division of Thomson Learning 14 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 3 rd party if the 3 rd party believes, based on conduct, that the LP is a general partner. 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 3 rd party if the 3 rd party believes, based on conduct, that the LP is a general partner.

© 2004 West Legal Studies in Business A Division of Thomson Learning 15 Rights and Liabilities of Partners 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 41.3: BT-I v. Equitable Life Assurance Society of the United States (1999). 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 41.3: BT-I v. Equitable Life Assurance Society of the United States (1999).

© 2004 West Legal Studies in Business A Division of Thomson Learning 16 Rights and Liabilities of Partners General partners are personally liable to 3 rd 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. General partners are personally liable to 3 rd 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.

© 2004 West Legal Studies in Business A Division of Thomson Learning 17 Dissolution of the LP 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. 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.

© 2004 West Legal Studies in Business A Division of Thomson Learning 18 Dissolution of the LP Dissolved in much the same way as a general partnership (Chapter 36). 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. Dissolved in much the same way as a general partnership (Chapter 36). 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.

© 2004 West Legal Studies in Business A Division of Thomson Learning 19 § 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. 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.

© 2004 West Legal Studies in Business A Division of Thomson Learning 20 Law on the Web Comparison of Different Business Entities. Comparison of Different Business Entities LLC’s at Nolo.com Legal Research Exercises on the Web. Comparison of Different Business Entities. Comparison of Different Business Entities LLC’s at Nolo.com Legal Research Exercises on the Web.