{"id":164,"date":"2014-09-17T00:42:04","date_gmt":"2014-09-17T00:42:04","guid":{"rendered":"https:\/\/courses.candelalearning.com\/buslegalenv\/?post_type=chapter&#038;p=164"},"modified":"2015-04-16T19:29:59","modified_gmt":"2015-04-16T19:29:59","slug":"20-2-limited-liability-companies","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/chapter\/20-2-limited-liability-companies\/","title":{"raw":"Limited Liability Companies","rendered":"Limited Liability Companies"},"content":{"raw":"<div class=\"bcc-box bcc-highlight\">\r\n<h3>Learning Objectives<\/h3>\r\nBy the end of this section, you will be able to:\r\n<ul id=\"mayer_1.0-ch52_s02_l01\" class=\"im_orderedlist\">\r\n\t<li>Understand the history and law governing limited liability companies (LLCs).<\/li>\r\n\t<li>Identify the creation and capitalization of an LLC.<\/li>\r\n\t<li>Understand control and compensation of a firm.<\/li>\r\n\t<li>Recognize liabilities in the LLC form.<\/li>\r\n\t<li>Explain the taxation of an LLC.<\/li>\r\n\t<li>Identify how LLCs are terminated.<\/li>\r\n<\/ul>\r\n<\/div>\r\n<div id=\"mayer_1.0-ch42_s02_s01\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">History and Law Governing Limited Liability Companies<\/h2>\r\n<div id=\"mayer_1.0-ch42_s02_s01_s01\" class=\"im_section\">\r\n<h3 class=\"im_title im_editable im_block\">History of the Limited Liability Company<\/h3>\r\nThe <span class=\"im_margin_term\"><span class=\"im_glossterm\">limited liability company<\/span><\/span> (LLC) gained sweeping popularity in the late twentieth century because it combines the best aspects of partnership and the best aspects of corporations: it allows all its owners (members) insulation from personal liability and pass-through (conduit) taxation. The first efforts to form LLCs were thwarted by IRS rulings that the business form was too much like a corporation to escape corporate tax complications. Tinkering by promoters of the LLC concept and flexibility by the IRS solved those problems in interesting and creative ways.\r\n\r\nCorporations have six characteristics: (1) associates, (2) an objective to carry on a business and divide the gains, (3) continuity of life, (4) centralized management, (5) limited liability, and (6) free transferability of interests. Partnerships also, necessarily, have the first two corporate characteristics; under IRS rulings, if the LLC is <em class=\"im_emphasis\">not<\/em> to be considered a corporation for tax purposes, it must lack at least one-half of the remaining four characteristics of a corporation: the LLC, then, must lack two of these corporate characteristics (otherwise it will be considered a corporation): (1) limited liability, (2) centralized management, (3) continuity of life, or (4) free transferability of interests. But limited liability is essential and centralized management is necessary for passive investors who don\u2019t want to be involved in decision making, so pass-through taxation usually hinges on whether an LLC has continuity of life and free transferability of accounts. Thus it is extremely important that the LLC promoters avoid the corporate characteristics of continuity of life and free transferability of interests.\r\n\r\nWe will see how the LLC can finesse these issues.\r\n\r\n<\/div>\r\n<\/div>\r\n<div id=\"mayer_1.0-ch42_s02_s01_s02\" class=\"im_section\">\r\n<h3 class=\"im_title im_editable im_block\">Governing Law<\/h3>\r\nAll states have statutes allowing the creation of LLCs, and while a Uniform Limited Liability Company Act has been promulgated, only eight states have adopted it as of January 2011. That said, the LLC has become the entity of choice for many businesses.\r\n\r\n<\/div>\r\n<div id=\"mayer_1.0-ch42_s02_s02\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Creation and Capitalization<\/h2>\r\n<div id=\"mayer_1.0-ch42_s02_s02_s01\" class=\"im_section\">\r\n<h3 class=\"im_title im_editable im_block\">Creation of the LLC<\/h3>\r\nAn LLC is created according to the statute of the state in which it is formed. It is required that the LLC members file a \u201ccertificate of organization\u201d with the secretary of state, and the name must indicate that it is a limited liability company. Partnerships and limited partnerships may convert to LLCs; the partners\u2019 previous liability under the other organizational forms is not affected, but going forward, limited liability is provided. The members\u2019 operating agreement spells out how the business will be run; it is subordinate to state and federal law. Unless otherwise agreed, the operating agreement can be amended only by unanimous vote. The LLC is an entity. Foreign LLCs must register with the secretary of state before doing business in a \u201cforeign\u201d state, or they cannot sue in state courts.\r\n\r\nAs compared with corporations, the LLC is not a good form if the owners expect to have multiple investors or to raise money from the public. The typical LLC has relatively few members (six or seven at most), all of whom usually are engaged in running the firm.\r\n\r\nMost early LLC statutes, at least, prohibited their use by professionals. That is, practitioners who need professional licenses, such as certified public accountants, lawyers, doctors, architects, chiropractors, and the like, could not use this form because of concern about what would happen to the standards of practice if such people could avoid legitimate malpractice claims. For that reason, the limited liability partnership was invented.\r\n\r\n<\/div>\r\n<div id=\"mayer_1.0-ch42_s02_s02_s02\" class=\"im_section\">\r\n<h3 class=\"im_title im_editable im_block\">Capitalization<\/h3>\r\nCapitalization is like a partnership: members contribute capital to the firm according to their agreement. As in a partnership, the LLC property is not specific to any member, but each has a personal property interest in general. Contributions may be in the form of cash, property or services rendered, or a promise to render them in the future.\r\n\r\n<\/div>\r\n<\/div>\r\n<div id=\"mayer_1.0-ch42_s02_s03\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Control and Compensation<\/h2>\r\n<div id=\"mayer_1.0-ch42_s02_s03_s01\" class=\"im_section\">\r\n<h3 class=\"im_title im_editable im_block\">Control<\/h3>\r\nThe LLC operating agreement may provide for either a member-managed LLC or a manager-managed (centralized) LLC. If the former, all members have actual and apparent authority to bind the LLC to contracts on its behalf, as in a partnership, and all members\u2019 votes have equal weight unless otherwise agreed. Member-managers have duty of care and a fiduciary duty, though the parameters of those duties vary from state to state. If the firm is manager managed, only managers have authority to bind the firm; the managers have the duty of care and fiduciary duty, but the nonmanager members usually do not. Some states\u2019 statutes provide that voting is based on the financial interests of the members. Most statutes provide that any extraordinary firm decisions be voted on by all members (e.g., amend the agreement, admit new members, sell all the assets prior to dissolution, merge with another entity). Members can make their own rules without the structural requirements (e.g., voting rights, notice, quorum, approval of major decisions) imposed under state corporate law.\r\n\r\nIf the firm has a centralized manager system, it gets a check in its \u201ccorporate-like\u201d box, so it will need to make sure there are enough noncorporate-like attributes to make up for this one. If it looks too much like a corporation, it will be taxed like one.\r\n\r\nOne of the real benefits of the LLC as compared with the corporation is that no annual meetings are required, and no minutes need to be kept. Often, owners of small corporations ignore these formalities to their peril, but with the LLC there are no worries about such record keeping.\r\n\r\n<\/div>\r\n<div id=\"mayer_1.0-ch42_s02_s03_s02\" class=\"im_section\">\r\n<h3 class=\"im_title im_editable im_block\">Compensation<\/h3>\r\nDistributions are allocated among members of an LLC according to the operating agreement; managing partners may be paid for their services. Absent an agreement, distributions are allocated among members in proportion to the values of contributions made by them or required to be made by them. Upon a member\u2019s dissociation that does not cause dissolution, a dissociating member has the right to distribution as provided in the agreement, or\u2014if no agreement\u2014the right to receive the fair value of the member\u2019s interest within a reasonable time after dissociation. No distributions are allowed if making them would cause the LLC to become insolvent.\r\n\r\n<\/div>\r\n<\/div>\r\n<div id=\"mayer_1.0-ch42_s02_s04\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Liability<\/h2>\r\nThe great accomplishment of the LLC is, again, to achieve limited liability for all its members: no general partner hangs out with liability exposure.\r\n<div id=\"mayer_1.0-ch42_s02_s04_s01\" class=\"im_section\">\r\n<h3 class=\"im_title im_editable im_block\">Liability to Outsiders<\/h3>\r\nMembers are not liable to third parties for contracts made by the firm or for torts committed in the scope of business (but of course a person is always liable for her own torts), regardless of the owner\u2019s level of participation\u2014unlike a limited partnership, where the general partner is liable. Third parties\u2019 only recourse is as against the firm\u2019s property. See <em class=\"im_emphasis\">Puleo v. Topel<\/em>, (see Section 20.4.2 \"Liability Issues in LLCs\"), for an analysis of owner liability in an LLC.\r\n\r\n<\/div>\r\n<div id=\"mayer_1.0-ch42_s02_s04_s02\" class=\"im_section\">\r\n<h3 class=\"im_title im_editable im_block\">Internal Liabilities<\/h3>\r\nUnless the operating agreement provides otherwise, members and managers of the LLC are generally not liable to the firm or its members except for acts or omissions constituting gross negligence, intentional misconduct, or knowing violations of the law. Members and managers, though, must account to the firm for any personal profit or benefit derived from activities not consented to by a majority of disinterested members or managers from the conduct of the firm\u2019s business or member\u2019s or managers use of firm property\u2014which is the same as in partnership law.\r\n\r\n<\/div>\r\n<\/div>\r\n<div id=\"mayer_1.0-ch42_s02_s05\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Taxation<\/h2>\r\nAssuming the LLC is properly formed so that it is not too much like a corporation, it will\u2014upon its members\u2019 election\u2014be treated like a partnership for tax purposes.\r\n\r\n<\/div>\r\n<div id=\"mayer_1.0-ch42_s02_s06\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Termination<\/h2>\r\nTermination, loosely speaking, refers either to how the entity\u2019s life as a business ends (continuity of life) or to how a member\u2019s interest in the firm ends\u2014that is, how freely the interest is transferable.\r\n<div id=\"mayer_1.0-ch42_s02_s06_s01\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Continuity of Life<\/h2>\r\nThe first step in the termination of the LLC is dissolution, though dissolution is not necessarily followed by termination.\r\n<div id=\"mayer_1.0-ch42_s02_s06_s01_s01\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Dissolution and Winding Up<\/h2>\r\nThe IRS has determined that continuity of life does <em class=\"im_emphasis\">not<\/em> exist \u201cif the death, insanity, bankruptcy, retirement, resignation, or expulsion of any member will cause a dissolution of the organization,\u201d<span id=\"mayer_1.0-fn42_005\" class=\"im_footnote\">Treasury Regulation, \u00a7 301.7701-2(b)(1).<\/span> and that if one of these events occurs, the entity may continue only with the members\u2019 unanimous consent. Dissolution may occur even if the business is continued by the remaining members.\r\n\r\nThe typical LLC statute provides that an LLC will dissolve upon (1) expiration of the LLC\u2019s term as per its agreement; (2) events specified in the agreement; (3) written consent of all members; (4) an \u201cevent of dissociation\u201d of a member, unless within ninety days of the event all remaining members agree to continue, or the right to continue is stated in the LLC; (5) the entry of a judicial decree of dissolution; (6) a change in membership that results in there being fewer than two members; or (7) the expiration of two years after the effective date of administrative dissolution.\r\n\r\nAnd an \u201cevent of dissociation\u201d is typically defined as (1) a member\u2019s voluntary withdrawal, (2) her assignment of the entire LLC interest, (3) her expulsion, (4) her bankruptcy, (5) her becoming incompetent, (6) dissolution of an entity member (as an LLC, limited partnership, or corporation), or (7) any other event specified in the agreement.\r\n\r\nThus under most statutes\u2019 default position, if a member dies, becomes insane or bankrupt, retires, resigns, or is expelled, the LLC will dissolve <em class=\"im_emphasis\">unless<\/em> within ninety days the rest of the members unanimously agree to continue. And by this means the firm does <em class=\"im_emphasis\">not<\/em> have continuity of life. Some states provide opportunities for even more flexibility regarding the \u201cunanimous\u201d part. In the mid-1990s, the IRS issued revenue rulings (as opposed to regulations) that it would be enough if a \u201cmajority in interest\u201d of remaining partners agreed to continue the business, and the \u201cflexible\u201d statute states adopted this possibility (the ones that did not are called \u201cbulletproof\u201d statutes). \u201cMajority in interests\u201d means a majority of profits and capital.\r\n\r\nIf the firm does dissolve, some states require public filings to that effect. If dissolution leads to winding up, things progress as in a general partnership: the business at hand is finished, accounts are rendered, bills paid, assets liquidated, and remaining assets are distributed to creditors (including member and manager creditors, but not for their shares in profits); to members and past members for unpaid distributions; to members for capital contributions; and to members as agreed or in proportion to contributions made. Upon dissolution, actual authority of members or managers terminates except as needed to wind up; members may have apparent authority, though, unless the third party had notice of the dissolution.\r\n\r\n<\/div>\r\n<div id=\"mayer_1.0-ch42_s02_s06_s01_s02\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Free Transferability of Interest<\/h2>\r\nAgain, the problem here is that if a member\u2019s interest in the LLC is as freely transferable as a shareholder\u2019s interest in a corporation (an owner can transfer all attributes of his interest without the others\u2019 consent), the LLC will probably be said to have a check mark in the \u201ccorporate-like\u201d box: too many of those and the firm will not be allowed pass-through taxation. Thus the trick for the LLC promoters is to limit free transferability enough to pass the test of not being a corporation, but not limit so much as to make it really difficult to divest oneself of the interest (then it\u2019s not a very liquid or desirable investment).\r\n\r\nSome states\u2019 LLC statutes have as the default rule that the remaining members must unanimously consent to allow an assignee or a transferee of a membership interest to participate in managing the LLC. Since this prevents a member from transferring <em class=\"im_emphasis\">all<\/em> attributes of the interest (the right to participate in management isn\u2019t transferred or assigned), the LLC formed under the default provision will not have \u201cfree transferability of interest.\u201d But if the LLC agreement allows <em class=\"im_emphasis\">majority<\/em> consent for the transfer of all attributes, that also would satisfy the requirement that there not be free transferability of interests. Then we get into the question of how to define \u201cmajority\u201d: by number of members or by value of their membership? And what if only the managing partners need to consent? Or if there are two classes of membership and the transfer of interests in one class requires the consent of the other? The point is that people keep pushing the boundaries to see how close their LLC can come to corporation-like status without being called a corporation.\r\n\r\nStatutes for LLCs allow other business entities to convert to this form upon application.\r\n<div id=\"mayer_1.0-ch42_s02_s06_s01_s02_n01\" class=\"im_key_takeaways im_editable im_block textbox\">\r\n<h3 class=\"im_title\">Key Takeaway<\/h3>\r\nThe limited liability company has become the entity of choice for many businesspeople. It is created by state authority that, upon application, issues the \u201ccertificate of organization.\u201d It is controlled either by managers or by members, it affords its members limited liability, and it is taxed like a partnership. But these happy results are obtained only if the firm lacks enough corporate attributes to escape being labeled as a corporation. To avoid too much \u201ccorporateness,\u201d the firm\u2019s certificate usually limits its continuity of life and the free transferability of interest. The ongoing game is to finesse these limits: to make them as nonconstraining as possible, to get right up to the line to preserve continuity, and to make the interest as freely transferable as possible.\r\n\r\n<\/div>\r\n<div class=\"bcc-box bcc-info\">\r\n<h3>Exercises<\/h3>\r\n<section id=\"self-check-questions\">\r\n<ol>\r\n\t<li>What are the six attributes of a corporation? Which are automatically relevant to the LLC? Which two corporate attributes are usually dropped in an LLC?<\/li>\r\n\t<li>Why does the LLC not want to be treated like a corporation?<\/li>\r\n\t<li>Why does the name of the LLC have to include an indication that it is an LLC?<\/li>\r\n\t<li>How did LLCs finesse the requirement that they not allow too-free transferability of the interest?<\/li>\r\n<\/ol>\r\n<\/section><\/div>\r\n<div id=\"mayer_1.0-ch52_s02_s06_n02\" class=\"im_exercises im_editable im_block\"><\/div>\r\n<\/div>\r\n<\/div>\r\n<\/div>","rendered":"<div class=\"bcc-box bcc-highlight\">\n<h3>Learning Objectives<\/h3>\n<p>By the end of this section, you will be able to:<\/p>\n<ul id=\"mayer_1.0-ch52_s02_l01\" class=\"im_orderedlist\">\n<li>Understand the history and law governing limited liability companies (LLCs).<\/li>\n<li>Identify the creation and capitalization of an LLC.<\/li>\n<li>Understand control and compensation of a firm.<\/li>\n<li>Recognize liabilities in the LLC form.<\/li>\n<li>Explain the taxation of an LLC.<\/li>\n<li>Identify how LLCs are terminated.<\/li>\n<\/ul>\n<\/div>\n<div id=\"mayer_1.0-ch42_s02_s01\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">History and Law Governing Limited Liability Companies<\/h2>\n<div id=\"mayer_1.0-ch42_s02_s01_s01\" class=\"im_section\">\n<h3 class=\"im_title im_editable im_block\">History of the Limited Liability Company<\/h3>\n<p>The <span class=\"im_margin_term\"><span class=\"im_glossterm\">limited liability company<\/span><\/span> (LLC) gained sweeping popularity in the late twentieth century because it combines the best aspects of partnership and the best aspects of corporations: it allows all its owners (members) insulation from personal liability and pass-through (conduit) taxation. The first efforts to form LLCs were thwarted by IRS rulings that the business form was too much like a corporation to escape corporate tax complications. Tinkering by promoters of the LLC concept and flexibility by the IRS solved those problems in interesting and creative ways.<\/p>\n<p>Corporations have six characteristics: (1) associates, (2) an objective to carry on a business and divide the gains, (3) continuity of life, (4) centralized management, (5) limited liability, and (6) free transferability of interests. Partnerships also, necessarily, have the first two corporate characteristics; under IRS rulings, if the LLC is <em class=\"im_emphasis\">not<\/em> to be considered a corporation for tax purposes, it must lack at least one-half of the remaining four characteristics of a corporation: the LLC, then, must lack two of these corporate characteristics (otherwise it will be considered a corporation): (1) limited liability, (2) centralized management, (3) continuity of life, or (4) free transferability of interests. But limited liability is essential and centralized management is necessary for passive investors who don\u2019t want to be involved in decision making, so pass-through taxation usually hinges on whether an LLC has continuity of life and free transferability of accounts. Thus it is extremely important that the LLC promoters avoid the corporate characteristics of continuity of life and free transferability of interests.<\/p>\n<p>We will see how the LLC can finesse these issues.<\/p>\n<\/div>\n<\/div>\n<div id=\"mayer_1.0-ch42_s02_s01_s02\" class=\"im_section\">\n<h3 class=\"im_title im_editable im_block\">Governing Law<\/h3>\n<p>All states have statutes allowing the creation of LLCs, and while a Uniform Limited Liability Company Act has been promulgated, only eight states have adopted it as of January 2011. That said, the LLC has become the entity of choice for many businesses.<\/p>\n<\/div>\n<div id=\"mayer_1.0-ch42_s02_s02\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Creation and Capitalization<\/h2>\n<div id=\"mayer_1.0-ch42_s02_s02_s01\" class=\"im_section\">\n<h3 class=\"im_title im_editable im_block\">Creation of the LLC<\/h3>\n<p>An LLC is created according to the statute of the state in which it is formed. It is required that the LLC members file a \u201ccertificate of organization\u201d with the secretary of state, and the name must indicate that it is a limited liability company. Partnerships and limited partnerships may convert to LLCs; the partners\u2019 previous liability under the other organizational forms is not affected, but going forward, limited liability is provided. The members\u2019 operating agreement spells out how the business will be run; it is subordinate to state and federal law. Unless otherwise agreed, the operating agreement can be amended only by unanimous vote. The LLC is an entity. Foreign LLCs must register with the secretary of state before doing business in a \u201cforeign\u201d state, or they cannot sue in state courts.<\/p>\n<p>As compared with corporations, the LLC is not a good form if the owners expect to have multiple investors or to raise money from the public. The typical LLC has relatively few members (six or seven at most), all of whom usually are engaged in running the firm.<\/p>\n<p>Most early LLC statutes, at least, prohibited their use by professionals. That is, practitioners who need professional licenses, such as certified public accountants, lawyers, doctors, architects, chiropractors, and the like, could not use this form because of concern about what would happen to the standards of practice if such people could avoid legitimate malpractice claims. For that reason, the limited liability partnership was invented.<\/p>\n<\/div>\n<div id=\"mayer_1.0-ch42_s02_s02_s02\" class=\"im_section\">\n<h3 class=\"im_title im_editable im_block\">Capitalization<\/h3>\n<p>Capitalization is like a partnership: members contribute capital to the firm according to their agreement. As in a partnership, the LLC property is not specific to any member, but each has a personal property interest in general. Contributions may be in the form of cash, property or services rendered, or a promise to render them in the future.<\/p>\n<\/div>\n<\/div>\n<div id=\"mayer_1.0-ch42_s02_s03\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Control and Compensation<\/h2>\n<div id=\"mayer_1.0-ch42_s02_s03_s01\" class=\"im_section\">\n<h3 class=\"im_title im_editable im_block\">Control<\/h3>\n<p>The LLC operating agreement may provide for either a member-managed LLC or a manager-managed (centralized) LLC. If the former, all members have actual and apparent authority to bind the LLC to contracts on its behalf, as in a partnership, and all members\u2019 votes have equal weight unless otherwise agreed. Member-managers have duty of care and a fiduciary duty, though the parameters of those duties vary from state to state. If the firm is manager managed, only managers have authority to bind the firm; the managers have the duty of care and fiduciary duty, but the nonmanager members usually do not. Some states\u2019 statutes provide that voting is based on the financial interests of the members. Most statutes provide that any extraordinary firm decisions be voted on by all members (e.g., amend the agreement, admit new members, sell all the assets prior to dissolution, merge with another entity). Members can make their own rules without the structural requirements (e.g., voting rights, notice, quorum, approval of major decisions) imposed under state corporate law.<\/p>\n<p>If the firm has a centralized manager system, it gets a check in its \u201ccorporate-like\u201d box, so it will need to make sure there are enough noncorporate-like attributes to make up for this one. If it looks too much like a corporation, it will be taxed like one.<\/p>\n<p>One of the real benefits of the LLC as compared with the corporation is that no annual meetings are required, and no minutes need to be kept. Often, owners of small corporations ignore these formalities to their peril, but with the LLC there are no worries about such record keeping.<\/p>\n<\/div>\n<div id=\"mayer_1.0-ch42_s02_s03_s02\" class=\"im_section\">\n<h3 class=\"im_title im_editable im_block\">Compensation<\/h3>\n<p>Distributions are allocated among members of an LLC according to the operating agreement; managing partners may be paid for their services. Absent an agreement, distributions are allocated among members in proportion to the values of contributions made by them or required to be made by them. Upon a member\u2019s dissociation that does not cause dissolution, a dissociating member has the right to distribution as provided in the agreement, or\u2014if no agreement\u2014the right to receive the fair value of the member\u2019s interest within a reasonable time after dissociation. No distributions are allowed if making them would cause the LLC to become insolvent.<\/p>\n<\/div>\n<\/div>\n<div id=\"mayer_1.0-ch42_s02_s04\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Liability<\/h2>\n<p>The great accomplishment of the LLC is, again, to achieve limited liability for all its members: no general partner hangs out with liability exposure.<\/p>\n<div id=\"mayer_1.0-ch42_s02_s04_s01\" class=\"im_section\">\n<h3 class=\"im_title im_editable im_block\">Liability to Outsiders<\/h3>\n<p>Members are not liable to third parties for contracts made by the firm or for torts committed in the scope of business (but of course a person is always liable for her own torts), regardless of the owner\u2019s level of participation\u2014unlike a limited partnership, where the general partner is liable. Third parties\u2019 only recourse is as against the firm\u2019s property. See <em class=\"im_emphasis\">Puleo v. Topel<\/em>, (see Section 20.4.2 &#8220;Liability Issues in LLCs&#8221;), for an analysis of owner liability in an LLC.<\/p>\n<\/div>\n<div id=\"mayer_1.0-ch42_s02_s04_s02\" class=\"im_section\">\n<h3 class=\"im_title im_editable im_block\">Internal Liabilities<\/h3>\n<p>Unless the operating agreement provides otherwise, members and managers of the LLC are generally not liable to the firm or its members except for acts or omissions constituting gross negligence, intentional misconduct, or knowing violations of the law. Members and managers, though, must account to the firm for any personal profit or benefit derived from activities not consented to by a majority of disinterested members or managers from the conduct of the firm\u2019s business or member\u2019s or managers use of firm property\u2014which is the same as in partnership law.<\/p>\n<\/div>\n<\/div>\n<div id=\"mayer_1.0-ch42_s02_s05\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Taxation<\/h2>\n<p>Assuming the LLC is properly formed so that it is not too much like a corporation, it will\u2014upon its members\u2019 election\u2014be treated like a partnership for tax purposes.<\/p>\n<\/div>\n<div id=\"mayer_1.0-ch42_s02_s06\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Termination<\/h2>\n<p>Termination, loosely speaking, refers either to how the entity\u2019s life as a business ends (continuity of life) or to how a member\u2019s interest in the firm ends\u2014that is, how freely the interest is transferable.<\/p>\n<div id=\"mayer_1.0-ch42_s02_s06_s01\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Continuity of Life<\/h2>\n<p>The first step in the termination of the LLC is dissolution, though dissolution is not necessarily followed by termination.<\/p>\n<div id=\"mayer_1.0-ch42_s02_s06_s01_s01\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Dissolution and Winding Up<\/h2>\n<p>The IRS has determined that continuity of life does <em class=\"im_emphasis\">not<\/em> exist \u201cif the death, insanity, bankruptcy, retirement, resignation, or expulsion of any member will cause a dissolution of the organization,\u201d<span id=\"mayer_1.0-fn42_005\" class=\"im_footnote\">Treasury Regulation, \u00a7 301.7701-2(b)(1).<\/span> and that if one of these events occurs, the entity may continue only with the members\u2019 unanimous consent. Dissolution may occur even if the business is continued by the remaining members.<\/p>\n<p>The typical LLC statute provides that an LLC will dissolve upon (1) expiration of the LLC\u2019s term as per its agreement; (2) events specified in the agreement; (3) written consent of all members; (4) an \u201cevent of dissociation\u201d of a member, unless within ninety days of the event all remaining members agree to continue, or the right to continue is stated in the LLC; (5) the entry of a judicial decree of dissolution; (6) a change in membership that results in there being fewer than two members; or (7) the expiration of two years after the effective date of administrative dissolution.<\/p>\n<p>And an \u201cevent of dissociation\u201d is typically defined as (1) a member\u2019s voluntary withdrawal, (2) her assignment of the entire LLC interest, (3) her expulsion, (4) her bankruptcy, (5) her becoming incompetent, (6) dissolution of an entity member (as an LLC, limited partnership, or corporation), or (7) any other event specified in the agreement.<\/p>\n<p>Thus under most statutes\u2019 default position, if a member dies, becomes insane or bankrupt, retires, resigns, or is expelled, the LLC will dissolve <em class=\"im_emphasis\">unless<\/em> within ninety days the rest of the members unanimously agree to continue. And by this means the firm does <em class=\"im_emphasis\">not<\/em> have continuity of life. Some states provide opportunities for even more flexibility regarding the \u201cunanimous\u201d part. In the mid-1990s, the IRS issued revenue rulings (as opposed to regulations) that it would be enough if a \u201cmajority in interest\u201d of remaining partners agreed to continue the business, and the \u201cflexible\u201d statute states adopted this possibility (the ones that did not are called \u201cbulletproof\u201d statutes). \u201cMajority in interests\u201d means a majority of profits and capital.<\/p>\n<p>If the firm does dissolve, some states require public filings to that effect. If dissolution leads to winding up, things progress as in a general partnership: the business at hand is finished, accounts are rendered, bills paid, assets liquidated, and remaining assets are distributed to creditors (including member and manager creditors, but not for their shares in profits); to members and past members for unpaid distributions; to members for capital contributions; and to members as agreed or in proportion to contributions made. Upon dissolution, actual authority of members or managers terminates except as needed to wind up; members may have apparent authority, though, unless the third party had notice of the dissolution.<\/p>\n<\/div>\n<div id=\"mayer_1.0-ch42_s02_s06_s01_s02\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Free Transferability of Interest<\/h2>\n<p>Again, the problem here is that if a member\u2019s interest in the LLC is as freely transferable as a shareholder\u2019s interest in a corporation (an owner can transfer all attributes of his interest without the others\u2019 consent), the LLC will probably be said to have a check mark in the \u201ccorporate-like\u201d box: too many of those and the firm will not be allowed pass-through taxation. Thus the trick for the LLC promoters is to limit free transferability enough to pass the test of not being a corporation, but not limit so much as to make it really difficult to divest oneself of the interest (then it\u2019s not a very liquid or desirable investment).<\/p>\n<p>Some states\u2019 LLC statutes have as the default rule that the remaining members must unanimously consent to allow an assignee or a transferee of a membership interest to participate in managing the LLC. Since this prevents a member from transferring <em class=\"im_emphasis\">all<\/em> attributes of the interest (the right to participate in management isn\u2019t transferred or assigned), the LLC formed under the default provision will not have \u201cfree transferability of interest.\u201d But if the LLC agreement allows <em class=\"im_emphasis\">majority<\/em> consent for the transfer of all attributes, that also would satisfy the requirement that there not be free transferability of interests. Then we get into the question of how to define \u201cmajority\u201d: by number of members or by value of their membership? And what if only the managing partners need to consent? Or if there are two classes of membership and the transfer of interests in one class requires the consent of the other? The point is that people keep pushing the boundaries to see how close their LLC can come to corporation-like status without being called a corporation.<\/p>\n<p>Statutes for LLCs allow other business entities to convert to this form upon application.<\/p>\n<div id=\"mayer_1.0-ch42_s02_s06_s01_s02_n01\" class=\"im_key_takeaways im_editable im_block textbox\">\n<h3 class=\"im_title\">Key Takeaway<\/h3>\n<p>The limited liability company has become the entity of choice for many businesspeople. It is created by state authority that, upon application, issues the \u201ccertificate of organization.\u201d It is controlled either by managers or by members, it affords its members limited liability, and it is taxed like a partnership. But these happy results are obtained only if the firm lacks enough corporate attributes to escape being labeled as a corporation. To avoid too much \u201ccorporateness,\u201d the firm\u2019s certificate usually limits its continuity of life and the free transferability of interest. The ongoing game is to finesse these limits: to make them as nonconstraining as possible, to get right up to the line to preserve continuity, and to make the interest as freely transferable as possible.<\/p>\n<\/div>\n<div class=\"bcc-box bcc-info\">\n<h3>Exercises<\/h3>\n<section id=\"self-check-questions\">\n<ol>\n<li>What are the six attributes of a corporation? Which are automatically relevant to the LLC? Which two corporate attributes are usually dropped in an LLC?<\/li>\n<li>Why does the LLC not want to be treated like a corporation?<\/li>\n<li>Why does the name of the LLC have to include an indication that it is an LLC?<\/li>\n<li>How did LLCs finesse the requirement that they not allow too-free transferability of the interest?<\/li>\n<\/ol>\n<\/section>\n<\/div>\n<div id=\"mayer_1.0-ch52_s02_s06_n02\" class=\"im_exercises im_editable im_block\"><\/div>\n<\/div>\n<\/div>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-164\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Shared previously<\/div><ul class=\"citation-list\"><li>Business and the Legal Environment. <strong>Authored by<\/strong>: Anonymous. <strong>Provided by<\/strong>: Anonymous. <strong>Located at<\/strong>: <a target=\"_blank\" href=\"http:\/\/2012books.lardbucket.org\/books\/business-and-the-legal-environment\/\">http:\/\/2012books.lardbucket.org\/books\/business-and-the-legal-environment\/<\/a>. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by-nc-sa\/4.0\/\">CC BY-NC-SA: Attribution-NonCommercial-ShareAlike<\/a><\/em><\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section>","protected":false},"author":5,"menu_order":131,"template":"","meta":{"_candela_citation":"[{\"type\":\"cc\",\"description\":\"Business and the Legal Environment\",\"author\":\"Anonymous\",\"organization\":\"Anonymous\",\"url\":\"http:\/\/2012books.lardbucket.org\/books\/business-and-the-legal-environment\/\",\"project\":\"\",\"license\":\"cc-by-nc-sa\",\"license_terms\":\"\"}]","CANDELA_OUTCOMES_GUID":"","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-164","chapter","type-chapter","status-publish","hentry"],"part":764,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/pressbooks\/v2\/chapters\/164","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/wp\/v2\/users\/5"}],"version-history":[{"count":4,"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/pressbooks\/v2\/chapters\/164\/revisions"}],"predecessor-version":[{"id":1005,"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/pressbooks\/v2\/chapters\/164\/revisions\/1005"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/pressbooks\/v2\/parts\/764"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/pressbooks\/v2\/chapters\/164\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/wp\/v2\/media?parent=164"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/pressbooks\/v2\/chapter-type?post=164"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/wp\/v2\/contributor?post=164"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/wp\/v2\/license?post=164"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}