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Consider the Limited Liability Company for Corporate Formation

Barry S. Roberts, Professor of Business Law, University of North Carolina at Chapel Hill
Richard A. Mann, Professor of Business Law, University of North Carolina at Chapel Hill

A business enterprise may be operated as a sole proprietorship, an unincorporated business association (such as a general partnership, a limited partnership, or a limited liability company), or a corporation. The choice of the most appropriate form depends on the particular circumstances of the owners. Below are some highlights outlining the characteristics of a limited liability company, which can be an extremely useful vehicle for entrepreneurs.

A limited liability company (LLC) is a noncorporate business organization that provides limited liability toall of its owners (members) and permits all of its members to participate in management of the business. (The limitation on liability, however, will not affect the liability of a member or manager who committed the wrongful act giving rise to the liability.)

It may elect not to be a separate taxable entity, in which case only the members are taxed. (Publicly traded LLCs, however, are subject to corporate income taxation.) If an LLC has only one member, it will be taxed as a sole proprietorship, unless separate entity tax treatment is elected.

The LLC provides many of the advantages of a general partnership plus limited liability for all its members. Its benefits outweigh those of a limited partnership in that all members of an LLC not only enjoy limited liability but also may participate in management and control of the business. Unlike subchapter S corporations, LLCs are not limited in the number of members they may have. In addition, members of LLCs may be corporations and other types of business entities, and members of LLCs may be nonresident aliens. LLCs have become the most popular and widely used unincorporated business form that provides limited liability for its members.

Formation of a Limited Liability Company

The formation of a limited liability company requires substantial compliance with the state’s limited liability company statute. All states permit an LLC to have only one member. The members of an LLC adopt an operating agreement, which is the basic contract governing the affairs of a limited liability company and stating the various rights and duties of the members and any managers, such as how the partners allocate the profits and losses.

A member has no property interest in property owned by the LLC. On the other hand, a member does have an interest in the LLC, which includes two components:

  • The financial interest, which is the right to distributions.
  • The management interest, which consists of all other rights granted to a member by the LLC operating agreement and the LLC statute.

The management interest typically includes the right to manage, vote, obtain information, and bring enforcement actions. Nearly all LLC statutes provide that, in the absence of a contrary agreement, each member has equal rights in the management of the LLC. All LLC statutes permit LLCs to be managed by one or more managers who may, but need not, be members.

Manager-Managed LLC

In a manager-managed LLC, the managers have actual and apparent authority to bind the LLC, while the members have no actual or apparent authority to bind the manager-managed LLC. The managers of a manager-managed LLC have a duty of care and loyalty. Usually, members of manager-managed LLCs have no duties to the LLC or its members by reason of being a member.

Member-Managed LLC

In a member-managed LLC, the members have actual and apparent authority to bind the LLC. Members of member-managed LLCs have the same duties of care and loyalty that managers have in manager-managed LLCs.

Unless otherwise provided in the LLC’s operating agreement, a member may assign thier financial interest in the LLC. The assignment entitles the assignee to receive, to the extent of the assignment, only the assigning member’s share of distributions.The assignee does not become a member and may not exercise any rights of a member. However, an assignee of a financial interest in an LLC may acquire the other rights by being admitted as a member of the company by all the remaining members.

In determining the most appropriate form of business organization consideration should be given to such factors as taxation, control, external liability, fiduciary duties, and duty of care. A business person should not a priori choose the incorporated form without fully exploring the benefits of alternative forms of business organizations, especially LLCs.

© 2006 Richard A. Mann and Barry S. Roberts. All rights reserved.

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