Limited Liability Companies – Combining The Best Of Two Worlds

Leading commentators have summarized the LLC as ‘a non-corporate business [form] that provides its members with limited liability and allows them to participate actively in the entity’s management.’

Limited liability companies or LLCs, have been a popular form of business for some time now. An LLC offers two main benefits – flexible tax planning and limited liability.

Corporate formalities:

LLCs are intended to be treated as a non-corporate form of business. This means that LLCs do not have to comply with typical corporate formalities like instituting a board of directors, provide for voting rights, conduct meetings, etc. LLCs are also free to tailor their capital needs with a greater degree of flexibility. LLCs can be suitable for many businesses, from a garage-based start-up to a sophisticated joint venture business structure.

Limited liability:

LLCs are regulated by LLC statutes as enacted by each state. LLC statutes generally provide the members of the LLC with a corporate-like limited liability shield. The language of this shield differs from state to state. Essentially, the liability of the member of an LLC is restricted to the amount that he has invested in the enterprise. California law is the most explicit in this explanation, and clearly states that the personal liability of the members of the LLC is similar to the personal liability of the shareholders in a corporation. However, this protection is not absolute. It is subject to certain exemptions which can be broadly categorized as follows:

• False or defective formation of the entity;
• Wrongful conduct by a member;
• Abuse of the shield;
• Capital-related obligations imposed by the LLC statute.

Led by Delaware, the LLC statutes of a few states go beyond the traditional shield of limited liability, and permit LLCs to internally compartmentalize their assets and create individual shields. Under this, the assets of one branch of business can be protected from claims arising out of another branch of business. This is another example of the extreme flexibility offered by LLC statutes.

Management:

Governance and management of a LLC can broadly be divided into the following three areas:

• Right of members to bind the management;
• Power of members and management to bind the LLC to third parties; and
• Rights of members and managers to information pertaining to the LLC.

Management of an LLC can be in one of two forms– management by members or management by managers. Almost all LLC statutes provide for both parallel forms of management, and the LLC has the choice to choose between them. In stark contrast to corporate law, the default rule in most LLC statutes (regarding the form of management) is decentralized management by the members. Under these statutes, in a member-managed LLC, a member has the power to bind the LLC, similar to the general provisions of a partnership. In the event that the LLC breaks up and neither party has an operating agreement to evidence the form of management, the default rule of the LLC statute will apply (regardless of practical or economic considerations). From a practical standpoint, it is important to choose the form of management and to state it in the operating agreement to prevent a future conflict.

Dissolution:

The most common ways in which an LLC is dissolved are (1) upon expiration of a specified term; (2) upon occurrence of a specified event; (3) with consent of the members; and (4) in an LLC that has only one member, the termination of that member’s membership.

In addition, many statutes provide for administrative dissolution for LLCs (on failure to file required reports), and for dissolution by court order (under limited circumstances). The common causes of dissolution of a partnership such as death, bankruptcy or resignation of an individual partner should ideally be dealt with in the operating agreement of the LLC.

Structuring an enterprise as an LLC has several tax-planning benefits as well, which will be dealt with in a later article.