LLCs have become, by a wide margin, the most popular U.S. business entities for start-up businesses, and many non-LLC entities are converting to LLCs to obtain unique LLC statutory benefits such as charging order and pick-your-partner provisions and management flexibility.
However, LLCs are largely ignored in the business organization courses of many law schools. Here, from the current Washington & Lee Law Journal, is an excellent introduction to this problem by Lyman Johnson, a first-rate law professor himself; and his introduction is followed by two detailed law journal articles about the problem.
In this new post in his excellent LLC blawg, Doug Batey provides brief but very useful comments on Minnesota’s new LLC Act.
As Doug notes, the new act will be effective on August 1, 2015.
If you engage in LLC practice long enough, you will eventually be asked to draft an operating agreement that effectively gives continuing control of the LLC to the “dead hand” of the patriarch or matriarch in control of the LLC after his or her death. Some of the issues in this drafting challenge are addressed in the attached post by Peter Mahler in his wonderful blawg called “Business Divorce.”
The drafters of RULLCA are first-rate LLC lawyers, and there are dozens of fine provisions in RULLCA. However, as I indicated in a post earlier today, I think there are several important reasons why RULLCA is not a good LLC act for small LLCs and their lawyers—i.e., for the vast majority of LLCs and their lawyers nationwide. A number of people have asked me to spell out these reasons. Click here for an article that does just that.
To cite but one reason: RULLCA, unlike almost all other LLC acts, doesn’t use the phase “unless the operating agreement provides otherwise” to denote default provisions. Instead, it uses a single very complex statutory provision to do so, which unsophisticated readers could easily be unaware of. This could create a major problem for clients and lawyers who look at the text of a RULLCA-based LLC act online for practical guidance in an LLC crisis. In doing this, they might well focus on a seemingly relevant provision that RULLCA intends to be default but isn’t expressly default; and if they didn’t know that RULLCA doesn’t use the above phrase to denote default provisions, they would, very understandably but erroneously, construe the provision as mandatory and thus in some cases get themselves into big trouble.
I track LLC legislative developments nationwide. I was sorry to learn that on April 8, 2014, Minnesota replaced its former LLC act with the Revised Uniform Limited Liability Company Act (“RULLCA”). This is obviously very big news not only for Minnesota lawyers but for lawyers whose clients do business in Minnesota. For a brief but helpful introduction to the new Minnesota LLC act and for links to further information about it, click here.
In my view, RULLCA has many serious flaws, especially as it affects small LLCs and the lawyers who serve them. We considered adopting RULLCA in New Hampshire, but a clear consensus quickly emerged in our drafting committee that we should not.
This post is further to my March 11, 2014 post about derivative suits, and it expands the discussion in that post.
When LLC members feel they have been wronged by the LLC, by another member or by a manager, they can, in theory, bring either derivative or direct suits against the alleged wrongdoer. If the wrong they allege affects only them individually and not the LLC, they must bring a “direct” suit. If it affects not only them but the LLC itself, many LLC acts require that they bring a “derivative” suit—i.e., a suit on behalf of the LLC. The rules governing direct suits are simple. Those governing derivative suits are complex, and complying with them as a condition for bringing the suit can cost much time and money. Many LLC acts provide, in effect, that if a member brings a claim that affects more than just the member, the member may not bring a direct action but only a derivative action. A number of leading LLC scholars have argued that in the context of small, informal business entities like LLCs, derivative suits, with their many vague and complex rules, make no sense. The New Hampshire Revised Limited Liability Company Act permits members to bring derivative suits but also to bring direct actions even if the alleged wrongs arguably affect not just them but the LLC; but you can’t necessarily get attorneys’ fees if you win a direct suit under the New Hampshire Act.
Obviously, LLC lawyers whose clients want to make claims against their LLCs or against other members or managers of their LLCs must be thoroughly familiar with the rules in the governing LLC act concerning direct and derivative suits. But so, too, must LLC formation lawyers in planning, negotiating and drafting the dispute resolution provisions to be included in the LLC’s operating agreement.
Click here for Doug Batey’s excellent new post about the direct-vs.-derivate issue in LLC litigation. The post concerns an Arkansas case, but its lessons apply in many other states.
LLC operating agreements are primarily tools to define and enforce the rights and duties of LLC members and managers with respect to their LLCs. These agreements should also be effective pre-formation teaching tools that will help prospective members and managers decide whether to join LLCs, and they should be effective post-formation users’ manuals that guide LLC members and managers in operating their LLCs.
In order to accomplish any of these goals, operating agreements must be written in plain English, and they must avoid legalisms. The latest American Bar Association Journal contains an excellent article by Bryan Garner, the leading U.S. expert on legal prose style, in which he lists the 12 legalisms he hates most. In my experience, many LLC lawyers make constant use of these legalisms in drafting operating agreements. They shouldn’t.
To read Bryan’s article, click here.
If you’re drafting an operating agreement to maximize the chance that you can attract a highly competent manager to manage the LLC in question or if you’re drafting or reviewing a draft of an operating agreement on behalf of a prospective manager, you need to know a lot about advancement and indemnification provisions in operating agreements and about the hidden issues in these provisions. If you don’t already possess this knowledge, here is an excellent place to start.
I happened to be reviewing the latest publication of the IRS’s Statistics of Income lately, and I decided to check their statistics about how many S corporations have only one shareholder, how many have two, etc. This is significant for LLC practice for the simple reason that LLCs, like state-law business corporations, are generally small, closely held business entities. So if IRS statistics indicate that 60% of all S corporations have only one shareholder and that 30% have only two, this tells you a lot about LLC formation practice—namely, that over time, 60 percent of the clients who will call you for LLC formations will probably be individuals wanting to form single-member LLCs, 30 percent will probably be forming two-member LLCs, etc.
This, in turn, tells you that you better have very good forms for all of the main types of single-member LLCs owned by individuals, for two-member LLCs (with great deadlock provisions, etc.), and so forth. As I discuss in detail in my Wolters Kluwer LLC book, you need six main forms for single-member LLCs whose members are individuals, four for those with two members, etc.
For a table that summarizes the above IRS S corporation shareholder statistics, click here. Unfortunately, the latest year for which the IRS has published these statistics is 2007, but I doubt they’ve changed much since then.
Stock options can provide a powerful means to attract and retain business talent and business investment. LLCs taxable as partnerships can grant profits interests under Rev. Proc. 93-27 and even LLC economic interests generally similar to “non-qualified stock options,” but they can’t grant qualified stock options under IRC § 422, and partnership tax issues arising from LLC grants of profits interests and non-qualified stock options can be complex.
However, if, under the Check-the-Box Regulations, LLCs elect to be classified as associations taxable as corporations, they can grant either non-qualified stock options or qualified stock options, and they can do so whether (i) they accept the default federal income tax regimen of associations taxable as corporations—i.e., C corporation taxation—or (ii) they elect into Subchapter S.
For an excellent discussion of the tax differences between qualified and nonqualified stock options as relevant not only to state-law business corporations but also to LLCs taxable as corporations, click here.