1. Slides developed by Les Wiletzky Wiletzky and Associates Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. PowerPoint Slides to Accompany CONTEMPORARY BUSINESS AND ONLINE COMMERCE LAW 5 th Edition by Henry R. Cheeseman Chapter 29 Limited Liability Companies

2. 29 - 2Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Limited Liability Company (LLC) (1 of 3) An incorporated business entity that combines the most favorable attributes of general partnerships, limited partnerships, and corporations An LLC may elect to be taxed as a partnership The owners can manage the business The owners have limited liability

3. 29 - 3Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Limited Liability Company (LLC) (2 of 3) Limited liability companies are creatures of state law, not federal law Limited liability companies can only be created pursuant to the laws of the state in which the LLC is being organized Limited liability company codes Limited liability company codes regulate the formation, operation, and dissolution of LLCs

4. 29 - 4Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Limited Liability Company (LLC) (3 of 3) Legal Entity Legal Entity – An LLC is a separate legal entity (an artificial person) that can: Own property Sue and be sued Enter into and enforce contracts Be found civilly and criminally liable for violations of law

5. 29 - 5Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. The Uniform Limited Liability Company Act (ULLCA) A model act that provides comprehensive and uniform laws for the formation, operation, and dissolution of LLCs The ULLCA is not law unless a state adopts it as its LLC statute Many states have adopted all or part of the ULLCA as their limited liability company law

6. 29 - 6Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Members’ Limited Liability Member Member – an owner of an LLC limited liability Members have limited liability Members are liable for the LLC’s debts, obligations, and liabilities only to the extent of their capital contributions The debts, obligations, and liabilities of an LLC are solely those of the LLC A member is personally liable if he or she personally guarantees repayment of the debts of the LLC Member Member – an owner of an LLC limited liability Members have limited liability Members are liable for the LLC’s debts, obligations, and liabilities only to the extent of their capital contributions The debts, obligations, and liabilities of an LLC are solely those of the LLC A member is personally liable if he or she personally guarantees repayment of the debts of the LLC

7. 29 - 7Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Limited Liability Company (LLC) Liability limited to capital contribution No personal liability for company’s debts and obligations Capital investment Debt or obligation owed Limited Liability Company (LLC) Third Party MemberMemberMemberMember

8. 29 - 8Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Liability of the LLC An LLC is liable for any loss or injury caused anyone as a result of a wrongful act or omission by a member, manager, agent, or employee of the LLC who commits the wrongful act while acting within the ordinary course of business of the LLC or with authority of the LLC [ULLCA § 302]

9. 29 - 9Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Liability of Managers Managers of LLCs are not personally liable for the debts, obligations, and liabilities of the LLC they manage [ULLCA § 303(a)]

10. 29 - 10Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Taxation of LLCs For federal income tax purposes an LLC is taxed as a partnership unless it elects to be taxed as a corporation Thus, an LLC is not taxed at the entity level Its income or losses “flow through” to the members’ individual income tax returns This avoids double taxation

11. 29 - 11Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Powers of an LLC An LLC has the same powers as an individual to do all things necessary or convenient to carry on its business or affairs: The power to own and transfer personal property Sell, lease and mortgage real property Make contracts and guarantees Borrow and lend money Issue notes and bonds Sue and be sued

12. 29 - 12Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Formation of an LLC Most LLCs are organized to operate businesses and real estate developments An LLC can be organized in only one state even though it can conduct business in all other states The name selected must meet the requirements of the LLC codes of the states that are under consideration

13. 29 - 13Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Articles of Organization articles of organization An LLC is formed by delivering articles of organization to the office of the secretary of state of the state of organization for filing The existence of an LLC begins when the articles of organization are filed The filing of the articles of organization by the secretary of state is conclusive proof that an LLC has been created

14. 29 - 14Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Duration At-Will LLC At-Will LLC – An LLC that has no specified term of duration Term LLC Term LLC – An LLC that has a specified term of duration

15. 29 - 15Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Capital Contribution Member’s Capital Contribution Member’s Capital Contribution – may be money, tangible or intangible property, services performed or promised to be performed, promissory notes, or other agreements to provide cash or property A member’s obligation to contribute capital is not excused by the member’s death, disability, or other inability to perform

16. 29 - 16Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Certificate of Interest Document that evidences a member’s ownership interest in an LLC Acts the same as a stock certificate issued by a corporation

17. 29 - 17Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Operating Agreement An agreement entered into among members that governs the affairs and business of the LLC and the relations among members, managers, and the LLC The operating agreement may be amended by the approval of all the members unless otherwise provided in the agreement

18. 29 - 18Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Conversion of an Existing Business to an LLC (1 of 2) Some existing businesses (i.e., general partnerships, limited partnerships, and corporations) may want to convert to an LLC Want to obtain the tax benefits and limited liability shield of an LLC The law permits such conversions

19. 29 - 19Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Conversion of an Existing Business to an LLC (2 of 2) Agreement of Conversion Agreement of Conversion – Document that states the terms for converting an existing business to an LLC The conversion takes effect when the articles of organization are filed with the secretary of state or at any later date specified in the articles of organization

20. 29 - 20Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Dividing an LLC’s Profits and Losses Unless otherwise agreed, the ULLCA mandates that a member has the right to an equal share in the LLC’s profits [ULLCA § 405(a)] This is a default rule that members can override by agreement and is usually a provision in their operating agreement

21. 29 - 21Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Distributional Interest A member’s ownership interest in an LLC that entitles the member to receive distributions of money and property from the LLC A transferee of a distributional interest in an LLC receives the right to receive profit and other distributions of the LLC

22. 29 - 22Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Member-Managed LLC member-managed In a member-managed LLC, all members can bind the LLC to authorized contracts Each member has equal rights in the management of the business irrespective of the size of his or her capital contribution Any matter relating to the business of the LLC is decided by a majority vote of the members

23. 29 - 23Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Manager-Managed LLC manager-managed In a manager-managed LLC, only the managers can bind the LLC to authorized contracts The members and non-members who are designated managers control the management of the LLC The members who are not managers have no rights to manage the LLC unless otherwise provided for in the operating agreement

24. 29 - 24Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Compensation and Reimbursement A non-manager member is not entitled to remuneration for services performed for the LLC (except for winding-up the LLC) Managers of an LLC are paid compensation and benefits as specified in their employment agreements with the LLC An LLC is obligated to reimburse members and managers for payments made on behalf of the LLC

25. 29 - 25Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Agency Authority to Bind an LLC to Contracts Member-Managed LLC In a member-managed LLC, all members can bind the LLC to authorized contracts Member-Managed LLC In a member-managed LLC, all members can bind the LLC to authorized contracts Manager-Managed LLC In a manager-managed LLC, only the managers can bind the LLC to authorized contracts Manager-Managed LLC In a manager-managed LLC, only the managers can bind the LLC to authorized contracts

26. 29 - 26Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Duty of Loyalty Owed to LLC (1 of 2) A duty owed by a member of a member- managed LLC and a Manager-managed LLC to be honest in his or her dealings with the LLC and not to act adversely to the interests of the LLC

27. 29 - 27Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Duty of Loyalty Owed to LLC (2 of 2) Breaches of the duty of loyalty by a covered member or manager include: 1.Usurping an LLC opportunity 2.Making secret profits 3.Secretly dealing with the LLC 4.Secretly competing with the LLC 5.Representing any interest adverse to that of the LLC

28. 29 - 28Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Limited Duty of Care Owed to LLC (1 of 2) A duty owed by a member of a member of a member-managed LLC and a manager of a manager-managed LLC to not engage in conduct that injures the LLC: A known violation of law Intentional conduct Reckless conduct Grossly negligent conduct

29. 29 - 29Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Limited Duty of Care Owed to LLC (2 of 2) ordinary negligence A member or manager of an LLC is not liable to the LLC for injuries caused to the LLC by his or her ordinary negligence The ordinarily negligent member or manager, and the LLC on whose behalf the member or manager was acting when the negligent act occurred, are liable to the injured third party

30. 29 - 30Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. No Fiduciary Duty Owed by a Non- manager Member A non-manager member of a manager- managed LLC owes no fiduciary duties of loyalty, care, or good faith and fair dealing to the LLC or its members Basically, a non-manager member of a manager-managed LLC is treated equally to a shareholder in a corporation

31. 29 - 31Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Dissolution of an LLC disassociate The ULLCA gives a member of an LLC the power to disassociate him- or herself from the LLC dissolution This could cause the dissolution of the LLC wrongful disassociation A member who wrongfully disassociates from an LLC is liable to the LLC and to the other members for any damages caused by his or her wrongful disassociation

32. 29 - 32Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Winding-Up an LLC’s Business The process of preserving and selling the assets of the LLC and distributing the money and property to creditors and members Creditors are paid first Thereafter, surplus amounts are distributed to members in equal amounts unless the operating agreement provides otherwise

33. 29 - 33Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Articles of Termination Document that is filed with the secretary of state (of the state in which the LLC is organized) that terminates the LLC as of the date of filing or upon a later effective date specified in the document