Limited Partnerships (LP) and Limited Liability Companies (LLC)

Question 1

What is a Limited Partnership?

Answer 1

A limited partnership (“LP”) is a partnership with at least one general partner and at least one limited partner. The general partner(s) is personally liable for partnership obligations, while the limited partner(s) generally does not have any liability beyond the liability to make agreed-upon contributions.

• A limited partnership differs from a general partnership in that a limited partnership can be created ONLY by filing a certificate of formation with the state.
• Like a modern partnership, a limited partnership is an entity distinct from its partners and has a perpetual duration unless otherwise provided.

Question 2

What is a Limited Liability Partnership?

Answer 2

The RUPA allows the creation of limited liability partnerships (LLPs). Unlike a general or limited partnership, ALL of the partners in a LLP have limited liability. Thus, the partners are NOT personally liable for the LLP’s obligations.

Question 3

What is a Limited Liability Corporation?

Answer 3

A limited liability company (“LLC”) is a hybrid business organization between a corporation and a partnership that:

1. Taxed like a partnership (except for a single-member LLC)
2. Offers its owners the limited liability of shareholders of a corporation
3. It can be run like either a corporation or a partnership

An LLC is treated as a separate legal entity distinct from its owners (called “members”).

Although LLCs are governed by statute, LLC members may adopt operating agreements to control most aspects of the LLC’s business and management.

The Revised Uniform Liability Company Act of 2006 (RULLCA) provides a default set of rules for LLC

Question 4

What Management Rights do General Partners have vs. Limited Partners?

Answer 4

General Partners: The LP is managed by the general partner(s). Each general partner has equal rights in the management and conduct of the LP’s activities. Generally, any matter relating to the limited partnership’s ordinary business activities may be exclusively decided by the general partner or, if there is more than one general partner, by a majority of the general partners.

Limited Partners: Limited partners usually have NO management rights unless the partnership agreement GRANTS them rights. Participation in management DOES NOT cause a limited partner to become personally liable for an obligation of the limited partnership (under older law, it did).

Question 5

When is a vote of all partners (including General and Limited Partners) necessary?

Answer 5

Unless otherwise agreed, the vote of all partners (general and limited) is necessary for certain extraordinary activities, including to:

1. Amend the partnership agreement
2. Convert the partnership to a limited liability limited partnership
3. Dispose of all or substantially all of the limited partnership’s property outside the usual and regular course of the partnership’s activities
4. Admit a new partner
5. Compromise a partner’s obligation to make a contribution or to return an improper distribution.

Question 6

How are Distributions determined in a Limited Partnership?

Answer 6

Unless otherwise agreed, distributions from an LP are made on the basis of the partners’ contributions (in proportion to the value of each partners’ contribution) rather than the RUPA’s default equal split for general partnerships.

• Also, like a corporation, a limited partnership may not make a distribution if after making the distribution the limited partnership would be unable to pay its debts as they become due or the limited partnership’s total assets would be less than the sum of its total liabilities, including sums needed to satisfy superior preferential rights upon dissolution.

Question 7

Do Partners have a right to Distribution in a Limited Partnership?

Answer 7

NO! A partner has NO rights to distributions UNLESS the partner makes a contribution to the partnership.

• A contribution may be in the form of any benefit to the partnership (money, property, services, and promises to make such contributions).

Question 8

What is the Liability of a General Partner for Improper Distributions?

Answer 8

A general partner who consents to an improper distribution is personally liable to the limited partnership for the amount that the distribution exceeds what could properly have been distributed.

Question 9

What is the Liability of General Partners vs. Limited Partners in a Limited Partnership?

Answer 9

General Partners: General partners are jointly and severally liable for all obligations of the LP, just as they are in a general partnership.

• NOTE — A general partner may also be a limited partner and have the rights of a limited partner, but such a dual capacity does not relieve the general partner of his duties as a general partner.

Limited Partners: A limited partner is NOT personally liable for an obligation of the LP solely by reason of being a limited partner. Limited partners have limited liability, meaning that they can only lose the value of their investments.

Question 10

What Fiduciary Duties do General Partners and Limited Partners Owe?

Answer 10

General Partner: A general partner owes the LP and the other partners the same fiduciary duties of loyalty and care that general partners owe in a general partnership. HOWEVER, a general partner DOES NOT automatically violate the duty of loyaltymerely because the GP’s conduct furthers his own interests.

Limited Partner: Generally, a limited partner owes NO fiduciary duty to the partnership or any other partner solely by reason of being a limited partner. Thus, they’re free to compete with the partnership and have adverse interests to the partnership, unless partnership agreement says t otherwise.

Question 11

True or False: Any partner (general or limited) may apply for decree of dissolution of limited partnership?

Answer 11

TRUE! Any partner may apply for a decree of dissolution of the limited partnership whenever it is not reasonably practicable to carry on the business in conformity with the partnership agreement.

Question 12

When can a Partner Bring a Derivative Action?

Answer 12

A partner may maintain a derivative action to enforce a right of a limited partnership if: the partner first makes a demand on the general partners to bring an action to enforce the right and the general partners do not bring the action within a reasonable time; or a demand would be futile.

A derivative action may be maintained only by a person who is:

1) A partner at the time the action is commenced AND

2) One of the 2 below:

• 2a. Who was a partner when the conduct giving rise to the action occurred
• 2b. Whose status as a partner devolved upon him by operation of law or pursuant to the terms of the partnership agreement from a person who was a partner at the time of the conduct

Question 13

What is a General Partner’s Right to Information vs. a Limited Partner’s Right to Information?

Answer 13

General Partner — A general partner’s right to information is similar to that of a partner in a general partnership.

Limited Partner — Each limited partner has the right to inspect and copy any partnership records required to be maintained

Question 14

Does a Limited Partner have a Right to Dissociate Before Termination of a Limited Partnership?

Answer 14

NO! A limited partner has NO right to dissociate before termination of the limited partnership.

Question 15

What is the Effect of Dissociation with Limited Partner vs. General Partner?

Answer 15

Limited Partner — After dissociation, a limited partner is treated as a transferee of the limited partner’s transferable interest

General Partner — The effects of dissociation of a general partner in a limited partnership are similar to the effects of dissociation of a partner in a general partnership

Question 16

When can a Limited Partnership be Dissolved?

Answer 16

1) Application of a partner to dissolve because it is NO LONGER reasonably practicable to carry on the limited partnership in conformity with the LP agreement.

2) Adminstrative Dissolution by the Secretary of State for failure to pay fines or file an annual report.

• The partnership may apply for reinstatement by curing the defect within two years of the dissolution.

Question 17

What events cause Dissolution of a Limited Partnership?

Answer 17

1. The happening of an event specified in the partnership agreement
2. The consent of ALL general partners and limited partners holding a majority of the right to receive distributions (“majority in interest”)
3. After dissociation of a general partner, upon consent of partners owning a majority in interest if another general partner remains; if no general partner remains, after 90 days unless the partners admit a new general partner
4. 90 days after dissociation of the last limited partner, unless a new limited partner is admitted within the 90 days

Question 18

What is the Rule for Winding Up with Limited Partnerships?

Answer 18

A limited partnership continues after dissolution only for the purpose of winding up its activities. In winding up, the partnership MUST discharge liabilities, settle and close partnership activities, and marshal and distribute its assets.

Question 19

Which Partners have Power to Bind Limited Partnership After Dissolution?

Answer 19

A Limited Partnership is bound by acts of a General Partner that are appropriate for winding up the LP

• The partnership can also be bound by acts of a general partner that are not appropriate for winding up if the acts would have bound the partnership before dissolution and the 3rd Party with whom the general partner dealt DID NOT have notice of the dissolution.

Question 20

What is the Distribution Order for Winding Up of Limited Partnerships?

Answer 20

Upon winding up a limited partnership, the assets are distributed in the following order:

1. To creditors (including partners who made loans to the limited partnership)
2. Any surplus MUST be paid in cash as a Distribution

Question 21

What happens when the Limited Partnership’s Assests are Insufficient to Satisfy All Obligations to Creditors?

Answer 21

Each person who was a general partner when the obligation was incurred must contribute to the partnership to satisfy the obligation. The contribution due is in proportion to the right to receive distributions in effect when the obligation was incurred.

• If a person does not contribute the full amount required, the other persons REQUIRED to contribute MUST pay the ADDITIONAL amount necessary to discharge the obligation, in proportion to the right to receive distributions in effect when the obligation was incurred.

Question 22

What are the Formation Requirements for a Limited Liability Partnership?

Answer 22

To become an LLP, a partnership must file a statement of qualification with the secretary of state. The statement must be executed by at least two partners.

The required minimal information includes:

1. The name and address of the partnership
2. A statement that the partnership elects to be an LLP
3. A deferred effective date (if any)

Question 23

What is the Liability of a Partner in a Limited Liability Partnership?

Answer 23

A partner in an LLP is NOT personally liable (directly, indirectly, or by way of contribution) for the obligations of the LLP, whether arising in tort, contract, or otherwise. As always, however, a partner remains personally liable for their own wrongful acts.

Question 24

What Content Must be included in a LLC’s Certificate of Organization?

Answer 24

The information required in the certificate is minimal. It must include the following:

1. The name of the LLC
2. The address of the LLC’s registered office
3. The name and address of its registered agent

Question 25

True or False: An LLC’s Operating Agreement MAY alter the duties owed by members.

Answer 25

TRUE! The operating agreement may alter duties owed by members.

• The agreement MAY ELIMINATE the Duty of Loyalty and ALTER the Duty of Care if doing so is not manifestly unreasonable.
• Similarly, the operating agreement MAY NOT eliminate the contractual obligation of Good Faith and Fair Dealing, but it MAY prescribe standards for measuring the performance of the obligation if doing so is not manifestly unreasonable.

Question 26

How are LLC’s Managed?

Answer 26

Management of the LLC is presumed to be by all members. Other management arrangements can be made (management by outside managers), but they must be specified in the operating agreement.

Each member (or manager, if the LLC is manager-managed) has EQUAL RIGHTS in the LLC’s management.

Question 27

What Financial Rights do LLC members have?

Answer 27

In most states, unless otherwise agreed, profits and losses and distributions are allocated on the basis of contributions. A member or transferee does not have a right to demand or receive a distribution from the LLC in any form other than money.

Question 28

What Liability Does a LLC Member Have?

Answer 28

Members and managers GENERALLY are NOT personally liable for the LLC’s obligations. They have limited liability and can lose only the amount of their investments (members are liable for their own torts).

• However, courts MAY pierce the LLC veil of limited liability to reach the members’ and managers’ personal assets to satisfy LLC obligations under circumstances similar to those under which courts would pierce the veil of a corporation.
• Failure to observe corporate-type formalities (having meetings, recording minutes, etc.) WILL NOT be a ground for piercing the LLC veil.

Question 29

What Fiduciary Duties Do LLC members Have?

Answer 29

1) Duty of Care — Members (or managers if manager-managed) must act with the care that a person in a like position would exercise under similar circumstances, in a manner reasonably believed to be in the best interests of the LLC.

• Business judgment rule protection is provided, which effectively means that members (or managers if manager-managed) CANNOT be held liable for negligent decisions (but can be held liable for decisions tainted by gross negligence or worse).

2) Duty of Loyalty — Pursuant to the duty of loyalty, a member (or manager if manager-managed) must:

• Account to and hold for the LLC any benefit they derive from the LLC’s activities or from the appropriation of an LLC opportunity
• Refrain from dealing with the LLC as, or on behalf of, a person who has an adverse interest to the LLC (unless the transaction is fair to the LLC)
• Refrain from competing with the LLC’s business

NOTE for Duty of Loyalty — However, after disclosure of all material facts, ALL of the members may authorize or ratify a specific act by a member (or manager if manager-managed) that would otherwise violate the duty of loyalty.

Question 30

How are Duties Different in a Member-Managed vs. a Manager-Managed LLC?

Answer 30

In a member-managed LLC, members owe to each other and the LLC Duties of Care and Loyalty.

Both members and managers must discharge their duties and exercise their rights in accordance in Good Faith and Fair Dealing, however:

1. Only the Managers are subject to the duties of loyalty and care
2. Only the Members may authorize or ratify an act by a manager that would otherwise violate the duty of loyalty.

Question 31

What kind of Transfer Rules Apply to LLCs?

Answer 31

Financial rights are unilaterally transferable, but management rights are not.

• An assignment of a member’s interest in an LLC transfers only the member’s right to receive distributions. Management rights are not transferred.
• One can become a member (that is, management rights can be transferred) only with the consent of all members or as provided in the operating agreement.

Question 32

Do LLC members have the Power to Dissociate?

Answer 32

A person has the power to dissociate as a member of an LLC at any time (rightfully or wrongfully) by expressly withdrawing as a member. Generally, the events that cause dissociation of a partner in a partnership will also cause dissociation of a member of an LLC. A wrongfully dissociating member may be liable to the LLC for damages.

Question 33

What Events Cause Dissolution of a LLC?

Answer 33

An LLC will be dissolved when any of the following events occurs:

1. An event or circumstance that the operating agreement states causes dissolution
2. The consent of all the members
3. The passage of 90 consecutive days during which the LLC has no members.

Question 34

When Will a Court Grant Judicial Dissolution of a LLC?

Answer 34

A member may also apply for judicial dissolution of the LLC. A court may grant an application for judicial dissolution if:

1. The conduct of all or substantially all of the LLC’s activities is unlawful
2. It is not reasonably practicable to carry on the company’s activities in conformity with the certificate of organization and the operating agreement
3. The controlling members have acted, are acting, or will act in a manner that is illegal or fraudulent
4. The controlling members have acted or are acting in a manner that is oppressive and was, is, or will be directly harmful to the member applying for dissolution

Question 35

When Will a LLC be Adminstratively Dissolved?

Answer 35

The secretary of state may dissolve an LLC administratively when the LLC fails to submit a required fee or annual report. The LLC may apply for a reinstatement after correcting the problem. If reinstated, the LLC may resume its activities as if the administrative dissolution had never taken place.

Question 36

What is the Effect of Dissolution of a LLC?

Answer 36

An LLC that has been dissolved continues its existence but is not allowed to carry on any businessexcept that which is appropriate to winding up its activities.

Question 37

What are the Rules for Barring Creditors Claims When an LLC Dissolves?

Answer 37

A claim can be asserted against a dissolved LLC, even if the claim does not arise until after dissolution, to the extent of the LLC’s undistributed assets. If the assets have been distributed to the members, a claim can be enforced against each member to the extent of the member’s proportionate share of the claim or to the extent of the assets distributed to him, whichever is less.

• Known Claims — An LLC can cut short the time for bringing known claims by notifying claimants in writing of the dissolution and giving them a deadline of not less than 120 days in which to file their claim.
• Unknown Claims — The time for filing unknown claims can be limited to 5 years by publishing notice of the dissolution in a newspaper in the county where the LLC’s known place of business is located.

Question 38

How are LLCs Taxed?

Answer 38

Partnerships and LLCs are taxed on a pass-through basis. There is no entity-level tax; instead, business income is passed-through to the owners and reported on the owners’ individual tax returns (regardless of whether that business income is actually distributed to the partners).

• Pass-through treatment usually results in LESS taxes paid.

• By contrast, a corporation is subject to “double taxation.” The corporation pays taxes on its income, and the shareholders pay taxes on that income again when and if it is distributed to them.

Question 39

What Rights to Information Do LLC Members Have?

Answer 39

Member-Managed LLC: A member has a right to inspect and copy any record concerning the LLC’s activities, financial condition, and so on, material to the member’s rights and duties.

• An LLC and its members must automatically furnish such information that they know is material to the exercise of a member’s rights and duties, unless they reasonably believe the member already knows the information.
• The LLC and its members must furnish other information on a member’s demand unless the demand is unreasonable or improper.

Manager-Managed LLC
1) The managers have the same right to information and duty to furnish information, as discussed above.

2) The members have a right to inspect and copy any record regarding the LLC’s activities, financial condition, and so on, as is just and reasonable if:

• The member seeks the info for a purpose material to the member’s interest as a member
• The member makes a demand to the LLC describing with reasonable particularity the info sought and the purpose for seeking the info AND
• The info sought is directly connected to the member’s purpose.

Question 40

What Kind of Member Actions Can be Brought Against a LLC?

Answer 40

1) Direct Action Against LLC: A member who has been injured personally by his LLC can bring a direct action against the LLC to recover.

2) Derivative Action:A member may also bring a derivative action on behalf of the LLC if they make a demand on the other members (or managers), unless demand would be futile.

• A derivative action may be maintained only by a person who is a member at the time the action is commenced and who remains a member while the action continues.

Question 41

Can a Judgment Creditor Attach the Transferable Interest of a Member of a LLC?

Answer 41

Yes! A judgment creditor of a member or transferee of a member may charge (attach) the transferable interest of the judgment debtor to satisfy the judgment.