Limited liability company (LLC)

Question 1

Creation

Answer 1

An LLC is created by filing articles of organization with the state, including the LLC’s name, mailing address, and, if there are no members upon filing, a statement to that effect

1. Operating agreement—the articles of organization only reflect an LLC’s existence, but an LLC may also adopt an operating agreement to govern business; agreement can be oral, in a record, or implied by conduct; statutory default provisions apply when the operating agreement is silent
2. Membership—no limit (but some states require at least two members); to become a new member requires the consent of all other LLC members (a transfer of a membership interest also requires the consent of all members)
   • Transfer of membership—the transferee only acquires the transferor’s right to share in the LLC’s profits and losses, not a right to participate in the LLC’s management
   • Termination of membership—does not automatically trigger a dissolution of the LLC; LLC may elect to liquidate the fair value of that person’s interests
   • Allocation of profits and losses—unless determined by an operating agreement, allocations are made according to each member’s contributions to the LLC
   • Inspection rights—LLC members generally have inspection rights similar to SHs of Cs

Question 2

Management

Answer 2

Can be direct (by members) or centralized (by one or more managers who need not be members)

1. Liabilities
   • Members are generally not liable for the LLC’s obligations; managers are not personally liable for obligations incurred on behalf of the LLC
   • Piercing the veil—members may be liable if the veil is pierced due to undercapitalization, commingling of assets, confusion of business affairs, or deception of creditors
   o Mere instrumentality test—(i) members dominated the entity such that the LLC had no will of its own, (ii) members used that domination to commit a fraud or wrong, and (iii) the control and wrongful action proximately caused an injury
   o Unity of interest and ownership test—the LLC did not have an existence independent of the members because there was such a unity of interest and ownership between the entity and the members that the failure to pierce the veil would be unjust or inequitable
   • Creditors can obtain a charging order (judgment lien) against a member’s LLC interest, requiring the LLC to pay to the judgment debtor distributions that otherwise would be paid to the member; the operating agreement cannot alter this rule to the prejudice of third parties
2. Duties—members owe each other and managers duties of loyalty and care
   • Must account to the LLC for any benefit derived by the member related to the LLC’s business, refrain from dealing with the LLC on behalf of one having an adverse interest, and refrain from competing with the LLC
   • Duty of care to LLC is subject to BJR; members are not liable for simple negligence
   • Fiduciary waivers are recognized in LLCs; may agree to specific activities that do not violate the duty of loyalty, as long as the agreement is not manifestly unreasonable

Question 3

Direct and derivative suits

Answer 3

1. Direct—an action to enforce a member’s rights as a member under the operating agreement and the state LLC statute; there must be an actual or threatened injury that is not just a result of an LLC injury
2. Derivative—an action by a member on behalf of the LLC to enforce the rights of the LLC; must show that a demand was made or that demand would be futile

Question 4

Dissolution

Answer 4

An LLC may merge with another LLC or other business entity; may dissolve upon the occurrence of various events (mutual consent of members, lack of members for 90 consecutive days, court order, or events provided in the operating agreement)

1. Member may seek involuntary dissolution if a controlling member acts in a way that is oppressive and directly harmful to the member seeking the order; action must action violate member’s reasonable expectations
2. Winding up—the LLC must (i) discharge the LLC’s debts, obligations, or other liabilities; and (ii) settle and close the LLC’s activities, and marshal and distribute the LLC’s assets; may perform acts necessary or appropriate to the winding up