Chapter 14 Limited Liability Partnerships Limited Liability Companies

Chapter Overview • Background and laws related to operation of a limited liability company (LLC) and a limited liability partnership (LLP). • Legal liability of principals in an LLC and LLP. • Use of franchises and business trusts to achieve business objectives. 2

OVERVIEW OF LLC AND LLP • Prior to development of LLC/LLP, principals who wished to avoid double taxation of a corporation, but desired liability protection for their personal assets, had few choices. • LLCs and LLPs are similar in many ways to corporations and partnerships, but the legal terminology is different. 3

Limited Liability Companies (LLCs) • Same liability protection afforded to principals of a corporate form, and • Pass-through tax treatment for its principals without the restrictions on ownership and scope required for other pass-through entities. 4

Formation of LLC • An LLC is formed by filing: • Articles of organization (also called certificates of organization ) with the state public filing official. 5

Operating agreement • Structure of governance and responsibility of members, • Death, incapacity, and dissolution. 6

Liability • Although LLC members are insulated from personal liability for any business debt or liability, creditors often require members of new and/or small LLCs to sign personal guarantees. 7

Taxation • Another attractive advantage of an LLC is the various tax treatment alternatives. • Although many LLCs are typically treated as a pass-through entity, the LLC’s members may also elect to be taxed as a corporation if they consider the corporate tax structure more favorable. 8

Capitalization • LLCs are capitalized primarily through debt via private lenders or commercial lenders, or by selling equity ownership in the LLC itself. 9

Management and Operation • Most states distinguish between: • A member-managed LLC, and • A manager-managed LLC. 10

Dissolution of LLCs and Dissociation of Members • Dissolution of an LLC is a liquidation process triggered by an event that is specified in the operating agreement. • Dissociation occurs when an individual member decides to exercise the right to withdraw from the partnership. • Generally, upon a dissociation the remaining members may either continue the LLC. 11

Lieberman v. Wyoming. com, LLC, 82 P. 3 d 274 (Wyo. 2004) • There was no contractual provision between the members related to a buyout of a dissociating member’s financial interest in the venture. • Nor does the state LLC statute provide for a buyout in the case of a dissociated member. • Therefore, even though Lieberman is a dissociated member, he may not demand a buyout, nor may he be forced to sell his interest. 12

Limited Liability Partnerships (LLPs) • Danger of being a general partner is the potential liability for acts of other general partners, debts, and liabilities of the partnership itself. • LLP statutes provide partnerships with the protective shield ordinarily only afforded to limited partners or corporate shareholders. 13

Formation • Limited liability partnerships are formed when members file a statement of qualification and/or articles of limited partnership with the appropriate public official or state office. 14

Liability • General idea behind being an LLP is that all partners have liability protection for debts and liabilities of the partnership, but there may be conditions on these limits. • In cases where a partner has engaged in misconduct or tortious conduct (such as negligence), the LLP acts to shield the personal of assets of other partners—never the partner who committed the misconduct or negligence. 15

Taxation • LLPs are treated as pass-through entities. They are not subject to tax; any income is taxed only when it is distributed to it’s the LLP’s partners. 16

Capitalization • LLPs are capitalized in the same way as a partnership: through debt via private or commercial lenders or by selling partnership equity for ownership in the LLP itself. 17

Management and Operation • The day-to-day operations and powers of the partners are spelled out in the partnership agreement. • The election procedures, qualifications, compensation, meeting times, and other organizational matters are typically addressed in the partnership agreement. 18

Franchises • A franchise involves the franchisor, a business entity that has a proven track record of success, selling to a franchisee the right to operate the business and the business’s trade secrets, trademarks, products, and so on. • The franchisor assists the franchisee with financing, supplies, training and other aspects of running a successful operation. 19

Franchise Agreements • • (1) the term (time limit) of the agreement; (2) franchise fees, payment terms; (3) territory rights/exclusive geographic area; (4) training, support, and advertising; (5) franchisee operating protocol; (6) royalties/fees that the franchisee must pay; (7) franchisee termination/cancellation 20

Federal Disclosure Requirements • Internal legal data and facts • Financial data • Registration not required 21

Small Business Franchise Act (SBFA) • Anti-termination restriction • Freedom to work • Franchisee options to buy certain products elsewhere 22

Servpro Industries, Inc. v. Pizzillo, 2001 WL 120731 (Ct. App. Tenn. 2001) • Despite the general resistance to enforcing restrictive covenants by courts, this one was reasonable under the circumstances. • The court focused on the fact that Servpro’s franchise depended on such restrictions to add value to the franchise. • Servpro had acted in good faith, trained Pizzillo, and allowed him exclusive territory. 23

Business Trusts • The use of a business trust is rare, • Primarily used in development of very large commercial projects, • Flexibility in terms of management, • Owners have liability protection, • Important tax benefits for companies with significant amounts of passive income. 24

learning outcomes checklist • 14 - 1 Identify the sources and level of laws that govern LLP and LLC entities. • 14 - 2 Explain the function of an operating agreement and fundamental structure of an LLC. • 14 - 3 Distinguish between the formation and management of an LLC and the formation and management of an LLP. 25

learning outcomes checklist • 14 - 4 Determine the rights of principals upon withdrawal from an LLC. • 14 - 5 Articulate the legal protections from personal liability afforded to the principals in an LLC and LLP. • 14 - 6 Identify the tax treatment schemes of an LLC and LLP. 26

learning outcomes checklist • 14 - 7 Provide the primary methods for capitalizing limited liability entities. • 14 - 8 Recognize the utility of other business arrangements including franchise relationships and business trusts. 27