Articles Posted in Limited Liability Companies

Part I of this series briefly discussed Indiana’s new benefit corporation statute as well as certification of a company as a “B Corp” by B Lab and some of the possible advantages of certification and of incorporation under the new statute.  Part II begins to look more closely at the details of the new law and to consider whether it makes sense for small businesses to incorporate under the new statute.

From a corporate law perspective, benefit corporations are, first and foremost, corporations subject to the Indiana Business Corporation Law, just like any other Indiana for-profit corporation.  In our view, a corporation is not the best choice of the form of entity for most small businesses.  For a number of reasons, including the tax alternatives available to LLCs, the “pick-your-partner” and charging order provisions of the Indiana LLC statute, and the fact that LLCs have fewer corporate formalities that must be observed (which decreases the possibility that the liability shield that protects the assets of owners from the creditors of the business will be disregarded through so-called veil-piercing), we believe that a limited liability company is a better choice than a corporation for most small businesses.

The above advantages of LLCs over corporations are the same – or even greater – for benefit corporations.  For example, partnership taxation is not an option for benefit corporations; if that is important enough, a benefit corporation is not a viable alternative.  In addition, the benefit corporation adds more required corporate formalities on top of those already imposed by the Indiana Business Corporation law, increasing the administrative burden and the possibility of weakening the liability shield protecting the assets of owners from the company’s creditors.  In other words, for most small businesses, a benefit corporation will not be the best choice of entity for most small businesses, unless the advantages of incorporating as a benefit corporation outweigh the advantages of organizing as a limited liability company.

As we discussed in Part I, the advantages of a benefit corporation appear to fall into two categories:

  • The business advantages that may be achieved by demonstrating to customers and investors the company’s commitment to social and environmental responsibility and to creating specific social benefits.
  • Protecting the directors from lawsuits based on allegations of breach of fiduciary duties for basing decisions on social benefits instead of maximizing corporate profits.

As for the first category, we note that being a benefit corporation can help demonstrate a commitment to creating benefits to society but a benefit corporation probably has no more ability to produce those benefits than a regular business corporation or a limited liability company. For example, the Indiana Business Corporation Law already permits directors to take into account the impact of their decisions on constituencies other than their shareholders and concerns other than maximizing profit, and the Indiana Business Flexibility Act permits the organization of LLCs for any business, personal, or non-profit purpose, which seems broad enough to cover anything that might be accomplished by a benefit corporation. We will discuss that topic in more detail in Part III of this series.  The degree to which directors of a benefit corporation are exposed to lawsuits by shareholders for pursuing purposes other than the pecuniary interests of shareholders will be addressed briefly in Part III and more thoroughly by a guest blogger in Part IV.

The issuance or sale of securities is subject to regulation by the United States Securities Exchange Commission and by authorities in every state, including the Securities Division of the Office of the Indiana Secretary of State.   Depending on the situation, a member’s interest in a limited liability company may or may not be within the definition of a “security” and, therefore, may or may not be subject to federal and state securities laws.  If the securities laws apply, the consequences can be signficant because, as my friend and retired securities lawyer Steven Lund says, “There are three types of securities:  registered, exempt, and illegal.”

Contrary to what you may sometimes hear, there is no exemption for securities that are issued or sold to family members or close friends, and there is no sale of securities that is exempt solely because the value is less than a certain amount.  In addition, certain parts of the securities laws, such as those prohibiting securities fraud, apply to every securities transaction, even if it is exempt from registration requirements.  An illegal sale of securities can have serious ramifications, including civil lawsuits and potentially even criminal charges.  And there can be ramifications even if there is never a lawsuit or governmental enforcement action  For example, a debt incurred through a securities violation cannot be discharged in bankruptcy.  Owners of small businesses who set up new LLCs, or bring new members into existing LLCs, without obtaining the advice of a lawyer with experience in corporate and LLC law expose their businesses and themselves to signficant risk.

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I sometimes run across small business owners who have set up their business as a corporation, and I often ask why they chose a corporation rather than a limited liability company (or LLC).  Sometimes the answer is that the business was incorporated before LLCs existed, or when LLCs were new and the lawyer who advised the owner was not familiar with LLCs or was not comfortable with using them, and that makes sense.  Another relatively common answer is that the owner’s lawyer or, more often, accountant advised the owner that there were advantages to being taxed as a Subchapter S corporation rather than being taxed as an LLC, so the business was organized as a corporation rather than a limited liability company.  That doesn’t make as much sense, at least not since 1997.

Although the history of LLCs can be traced back to earlier statutes in Germany and other European countries, there were no LLCs in the United States until 1977 when Wyoming passed the first LLC statute in the country.  For several years after that, the use of LLCs was suppressed by uncertainty surrounding their status for income tax purposes.

The Internal Revenue Code did not (and still does not) include provisions specifically written for taxing LLCs.  The question was whether they would be taxed as partnerships or as corporations, and the answer was not clear.  In 1995, the IRS issued guidance identifying four specific attributes Continue Reading

iStock_000014425910XSmall.jpgOne of the factors for determining when the owners of an LLC (or a corporation) may be held liable for the obligations of the business is whether the required corporate formalites have been observed. A while back, we posted an article about the required corporate formalities for Indiana limited liability companies. One of them is that each Indiana LLC must maintain certain records and must make them available to members for inspection and copying. Notably, that requirement is not a default provision that can be reduced or eliminated by the operating agreement.

Last week the LLC Law Monitor blog by Doug Batey of Stoel Rives commented on a Massacusetts case, Kosanovich v. 80 Worcester Street Associates, LLC, No. 201201 CV 001748, 2014 WL 2565959 (Mass. App. Div. May 28, 2014), that imposed liability on the sole member of a Massachusetts limited liability company primarily because of the LLC’s failure to maintain records. Doug described the case (correctly, in my view) as “an outlier decision on veil-piercing” for piercing the veil based on so little.

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iStock_000007115543Small.jpgLast week I posted an article about apparent authority of a member or manager of an Indiana limited liability companies to bind the LLC, usually by signing a contract on behalf of the company, including a discussion of a 2013 decision of the Indiana Court of Appeals, Cain Family Farms vs. Shrader Real Estate & Auction, addressing the common law doctrine of apparent authority and the provisions of the Indiana Business Flexibility Act that bestow apparent authority on members and managers. Under the facts presented by the record, the court held that apparent authority existed and, in particular, “Whether we consider the question of apparent authority under the common law or the
Indiana Business Flexibility Act, the outcome is the same.”

As discussed in last week’s Indiana Business Law Blog post, one can imagine situations in which the statute would establish apparent authority but the common law analysis would not, and vice versa. It seems clear that a member or manager has authority to bind a limited liability company if the Indiana Business Flexibility Act says so, even if the member or manager would not have apparent authority under the common law analysis. But what if it’s the other way around? Will an Indiana court enforce a contract signed by a member or manager on behalf of the LLC if the member or manager would have apparent authority under the common law but not under the Indiana Business Flexibility Act? Although the Cain Family Farm decision does directly address that question, the Court of Appeals appears to treat the two bases of apparent authority as independently viable, implying that Indiana courts will recognize the apparent authority of a member or manager under the common law even if apparent authority does not exist under the Indiana Business Flexibility Act.

Since I posted the article last week, I’ve corresponded with my friend John Cunningham, a New Hampshire attorney, a recognized expert on LLCs, a blogger, and co-author of Drafting Limited Liability Company Operating Agreements, my go-to reference for LLC law and operating agreements. I asked John about the question, and he pointed me to the official commentary of the Revised Uniform Limited Liability Company Act, which discusses why the RULLCA leaves the issue of apparent authority of members to the common law. See RULLCA Section 301.

After reflecting on my correspondence with John and reading the commentary to the RULLCA, I’ve come to believe that the path on which the Court of Appeals appears to have placed Indiana law is a good one. Note that question of apparent authority is irrelevant if the member or manager has actual authority to bind the company, and it cannot be used by another party to avoid a contract with a limited liability company over the LLCs objection. (If nothing else, the LLC can always ratify the contract.) The question arises only when an LLC tries to avoid a contract signed by a member or manager in the absence of actual authority, and the question is, who suffers the consequences — the LLC or the other party? Although the Indiana Business Flexibility Act creates some areas of relative certainty (which I believe is superior to the intentional silence of the RULLCA), it also denies apparent authority under some circumstances in which the other party to the contract reasonably believes, based on the conduct of the LLC, that the member or manager is acting within his or her authority.

In my personal view, it is better public policy to err on the side of enforcing contracts in those situations by maintaining the common law doctrine as a viable basis for apparent authority, independent of the statutory basis. First, the LLC is in the best position to control the actions of its members or managers, and the operating agreement can provide a remedy when one of them misbehaves. Second, the LLC is also in the best position to control its own actions and to avoid conduct that cloaks its representatives with apparent authority when they lack actual authority. Third, to fail to enforce a contract that the other party entered into in good faith, based on a reasonable belief that the member or manager had authority to bind the company (or to require prospective counterparties to consult the public record before signing a contract with a limited liability company) could cause others to be overly cautious, even leery, of doing business with LLCs.

Whether Indiana courts agree with this analysis remains to be seen.
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iStock_000007115543Small.jpgWhether a particular person has the authority to execute a contract on behalf of another person or entity is a standard question of agency law. If the principal has expressly or impliedly authorized an agent to execute contracts on behalf of the principal, the agent is said to have actual authority. However, a person who does not have actual authority can nonetheless bind the principal if that person has apparent authority.

Common Law Standard for Apparent Authority

The common law analysis of apparent authority is well established. An agent has apparent authority when a third person reasonably believes, based on the conduct of the principal, that the agent has authority. The reason for the belief need not be an actual statement by the prinicipal but can be (and usually is) found in the circumstances in which the prinicipal places the agent, but it is essential that the third party’s belief is based on the conduct of the principal; the statements or actions of the agent cannot create apparent authority. Moreover, if the third person knows that the agent has no actual authority, apparent authority does not exist.

Apparent Authority under the Indiana Business Flexibility Act

The Indiana Business Flexibility Act (Article 23-18 of the Indiana Code) contains different rules for the authority of members and managers of limited liability companies, and the rules are slightly different for LLCs formed on or before June 30, 1999 (Section 23-18-3-1), and LLCs formed after that date (Section 23-18-3-1.1).

If the LLC’s articles of organization do not provide for managers (i.e., a member-managed LLC), each member is an agent of the LLC for the purpose of the LLC’s business and affairs. Accordingly, the act of any member for those purposes, including the execution of a contract, binds the LLC, subject to the following exceptions:

  1. The member does not have actual authority and the person with whom the member is dealing knows that the member does not have actual authority.
  2. The act is not apparently for the purpose of carrying on the LLC’s business and affairs in the usual manner, unless the member has been granted actual authority by the operating agreement or by unanimous consent of the members.
  3. For LLCs formed after June 30, 1999, the articles of organization provide that the member does not have the authority to bind the company.

If the LLC’s articles of organizations provide for managers, a member acting solely in the capacity of a member is not an agent of the LLC and does not have authority to bind the LLC, except to the extent provided by the articles of organization. Instead, each manager is an agent of the company and has authority to bind the LLC, subject to the following exceptions:

  1. The manager does not have actual authority and the person with whom the manager is dealing knows that the manager does not have actual authority.
  2. The act is not apparently for the purpose of carrying on the LLC’s business and affairs in the usual manner, unless the manager has been granted actual authority by the operating agreement or by unanimous consent of the members..
  3. For LLCs formed after June 30, 1999, the articles of organization provide that the manager does not have the authority to bind the company.

Although Sections 3-1 and 3-1.1 of the Indiana Business Flexibility Act speak only of authority and agency, not of apparent authority and apparent agency, it seems clear that those sections deal with apparent authority and that actual authority of managers and members is addressed elsewhere, in Section 23-18-4-1. Indeed, the only Indiana decision to address Section 3-1.1, Cain Family Farm, L.P. vs. Schrader Real Estate & Auction Company, describes that section as a source of apparent authority and not actual authority.

Comparison of Common Law and Statutory Bases for Apparent Authority

The following table summarizes the main differences between the common law basis of apparent authority and the statutory basis.

Common law analysis of apparent authority

Apparent authority of members and managers under Indiana Business Flexibility Act

Applies to any agent of the company.

Applies only to members or managers.

Apparent authority created by conduct of the company.

Apparent authority created by the articles of organization; no other conduct necessary.

The person with whom the member or manager is dealing must have a reasonable belief that the member or manager has authority based on the company’s conduct.

As long as the person with whom the member or manager is dealing does not have actual knowledge that the member or manager lacks authority,
that person’s subjective belief is irrelevant.

No exception for acts outside the usual course of business

No authority for acts outside the apparent usual way the company does business, unless the authority is granted by the operating agreement or by unanimous consent of the members.

When we’re dealing with managers of an LLC or with members in a member-managed LLC, the statute confers authority more broadly than the common law because no other conduct on the part of the LLC is necessary. However, the statutory exceptions are also broader because the common law contains no exception for acts outside the usual way the LLC does business. In addition, the statute denies authority to members of a manager-managed LLC (except to the extent the articles of organization confer authority) but the common law analysis treats the members of a manager-managed LLC no differently than any other agent. In other words, it is possible for a manager or member to have apparent authority under the statute but not under the common law, and vice versa. What happens then?

One possibility is that the statute is now the exclusive source of apparent authority for members and managers of LLCs. That would not appear to cause any problems when the statute confers apparent authority more broadly than the common law standard, but what about situations that fall into one of the broader statutory exceptions, for example when the member of a manager-managed LLC takes an action that a third party would reasonably believe, based on the conduct of the LLC, the member was authorized to take? Does the statute abrogate the common law in that situation?

It appears that it does not. In the Cain Family Farms decision mentioned above, the Court of Appeals considered the apparent authority of a member to bind a member-managed LLC. In doing so, the Court of Appeals analyzed the member’s authority under both the common law and the Indiana Business Flexibility Act. Perhaps because the Court found that apparent authority existed under both analyses, it did not expressly decide which one would control in the event of a conflict. Nonetheless, the implication seems to be that both sources of apparent authority remain viable and that the LLC will be bound by the actions of a member or manager if either the common law or the Indiana Business Flexibilty Act impute that authority to the member or manager.

[For more discussion of this topic, see LLCs and Apparent Authority II.)
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iStock_000017700348Small.jpgOwners of Indiana LLCs (and their lawyers) can learn some lessons from a recent case involving an Alabama LLC. The case is L.B. Whitfield, III Family LLC v. Virginia Ann Whitfield, et al.

The Whitfield Case

L.B. Whitfield, III owned half of the voting stock in a business that had been in his family for generations. The other half had belonged to L.B.’s brother, who died and left the stock to a trust for the benefit of his son.

L.B. had four children, his son Louie, and three daughters. After his brother’s death, L.B. became concerned that the 50/50 voting balance might be disturbed if, after he died, his stock were to be divided among his four children. To prevent that from happening, L.B. created a manager-managed Alabama limited liability company to hold his half of the voting stock. L.B. was the sole member, and he and Louie were the two managers. His will provided that his interest in the LLC would pass to his four children in four equal shares.

After L.B. died, Louie continued as manager, and the four children were treated as members of the LLC, with each of them holding 25% of the interest in the LLC. About 10 years later, a dispute arose between Louie and his sisters, and the dispute escalated into litigation. Ultimately, the litigation was resolved on a theory that was not argued in the original pleadings and apparently did not even occur to the parties’ lawyers until several months into the case.

The Alabama Supreme Court noted that L.B. had been the sole member of the LLC and that, after he died, the LLC had no members. Although L.B.’s will gave his children equal shares of his economic rights in the LLC (his “interest”), economic rights in an LLC and membership are two different things, and the will did not make his children members. The Court further noted that, under the Alabama LLC statute, a limited liability company that has no members is dissolved and its affairs must be wound up, a process which includes payment of its debt and distribution of its remaining assets to the holders of interest in the LLC. Accordingly, the Court held that the assets of the LLC should be distributed in four equal shares to Louie and his sisters.

Interestingly, the Alabama statute provides a way that L.B.’s heirs could have become members and avoided the dissolution of the LLC, but they had to do it by mutual written agreement within 90 days of L.B.’s death, and there was no such written agreement.

How does it work in Indiana?

If the Whitfield case had involved an Indiana LLC, the results might well have been the same. Unless other provisions (discussed below) have been made to avoid the result, when the single member of an LLC dies, that member will be dissociated (i.e., will cease to be a member, Ind. Code 23-18-6-5(a)(4)), the LLC will have no members, and, as a result, it will be dissolved, at least if the LLC was formed after June 30, 1999, (Ind. Code 23-18-9-1.1(c)). As a result, the member’s heirs will not receive an ongoing business; instead, they will receive only the rights to receive distributions from the dissolved LLC after all obligations are satisfied — which may be far less valuable than the business would have been as an ongoing concern.

Note that there are other scenarios that can create a similar result. Under Ind. Code 23-18-6-4.1(e) (which applies only to LLC’s formed after June 30, 1999), a member who assigns her entire interest to another person ceases to be a member. If the person making the assignment is the sole member, the person who receives the interest can become a member under Ind. Code 23-18-6-4.1(b), which provides that the person who receives the interest can become a member “in accordance with the terms of an agreement between the assignor and the assignee.” But what if there are no such terms? What if the agreement simply says, “Seller hereby assigns her interest in the LLC to Buyer,” but doesn’t mention membership? In that case (unless the operating agreement already deals with the situation some other way), the LLC will have no members, and it will be dissolved. In other words, the person who thought he bought an ongoing business may well have bought only the rights to receive distributions from a dissolved LLC.

Now, what if there are multiple members and one of them dies? In that case, the LLC is not dissolved, at least not if it was formed after June 30, 1999, but the member’s heirs may not become members. Although they may inherit the deceased member’s interest (i.e., rights to receive distributions), they will become members (and therefore have the right to participate in the management of the company), only if the operating agreement makes them members or the other members unanimously consent.

What should you do?

If you own an LLC, or if you own part of an LLC, and these possibilities make you uncomfortable, you need a business succession plan that includes two different components. First, it should include appropriate estate planning tools to make sure that your economic interest in the LLC goes to the people you want to taken care of after your death. For example, you may want to designate a transfer-on-death beneficiary to inherit your interest in the LLC. Second, the LLC should have an operating agreement with appropriate provisions to ensure that your heirs benefit not only from the right to receive distributions from the LLC but also receive the other rights of membership, including the right to participate in the management of the business. There are different ways to do that; an attorney with experience in business succession planning, particularly with Indiana LLCs, can help you choose the best one for you.
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iStock_000034659194Small.jpgA primary reason to organize a business as a corporation or a limited liability company (LLC) is to protect the owners from personal liability for the debts of the business. Sometimes, however, a court may “pierce the corporate veil” of a business to hold the owners of the business personally liable for the company’s obligations.

In deciding whether to pierce the corporate veil, Indiana courts examine and weigh several factors, including whether the owners of the business have observed the required formalities for the particular form of organization. One of the reasons we generally favor LLCs for small businesses is that there are fewer required formalities for LLCs than for corporations, which in turn means that there is not only a lower administrative burden associated with LLCs, but also fewer opportunities for business owners to miss something. However, there are a few requirements, discussed below.

1. An Indiana LLC must have written articles of organization, and the articles must be filed with the Indiana Secretary of State .

There’s almost no need to mention this one because an LLC does not even exist until its articles of organization are filed with the Secretary of State, but for the sake of being complete . . .

The articles of organization must state:

  • The name of the LLC, which must include “limited liability company,” “LLC,” or “L.L.C.”
  • The name of the LLC’s registered agent and the address of its registered office (discussed in more detail below).
  • Either that the LLC will last in perpetuity or the events upon which the LLC will be dissolved.
  • Whether the LLC will be managed by its members or by managers. (Technically, the articles can remain silent on this point, in which case the LLC will be managed by its members, but the Secretary of State’s forms call for a statement one way or the other.)

2. An Indiana LLC must have a registered agent and a registered office within the State of Indiana.

The purpose of this requirement is to give people who sue the LLC a way to serve the complaints and summons. The registered office must be located within Indiana, and it must have a street address. A post office box is not sufficient. The registered agent must be an individual, a corporation, an LLC, or a non-profit corporation whose business address is the same as the registered office’s address.

The registered office and registered agent must be identified in the articles of incorporation and in the business entity reports (discussed below) filed every other year with the Indiana Secretary of State, but the requirement to have a registered office and registered agent applies all the time, not just when those filings are made. If the LLC’s registered agent resigns, the LLC must name a new one and file a notice with the Secretary of State within 60 days.

In addition, LLCs formed after July 1, 2014, are required to file the registered agent’s written consent to serve as registered agent or a representation that the registered agent has consented. That new requirement was established by Senate Bill 377, passed by the 2014 General Assembly and signed into law by the governor.

3. An Indiana LLC must keep its registered agent informed of the name, business address, and business telephone number of a natural person who is authorized to receive communications from the registered agent.

This is another new requirement contained in Senate Bill 377. It takes effect on July 1, 2014.

4. An Indiana LLC must maintain certain records at its principal place of business.

The required records are:

• A list of the names and addresses of current and former members and managers of the LCC.
• A copy of the articles of organization and all amendments.
• Copies of the LLC’s tax returns and financial statements for the three most recent years (or, if no tax returns or statements were prepared, copies of the information that was or should have been supplied to the members so they could file their tax returns).
• Copies of any written operating agreements and amendments, including those no longer in effect.
• A statement of all capital contributions made by all members.
• A statement of the events upon which members will be required to make additional capital contributions.
• The events, if any, upon which the LLC would be dissolved.
• Any other records required by the operating agreement.

[Note: Ind. Code 23-18-4-8(e) provides that the failure to keep the above records is NOT grounds for imposing personal liability on members for the obligations of the LLC. It’s more likely to become an issue in the event of a dispute among the members. Thanks to Josh Hollingsworth of Barnes & Thornburg for reminding me. MS:4/7/2014].

5. An Indiana LLC must file a business entity report with the Secretary of State every two years.

The report is due at the end of the month that contains an even-numbered anniversary of the filing of the articles of organization. Failure to file the report within 60 days of the due date is grounds for administrative dissolution of the LLC.
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iStock_000005953904Small.jpgI just read a report by the Small Business Administation that includes a wealth of statistics and other information about small businesses in the United States. As useful as the report is, it contains a mistake that, although commonly made, one would not expect from the SBA. The last item in the report asks the question, “What legal form are small businesses?” That’s a good question, but the SBA didn’t answer it. Instead, it answered another question, “What is the tax status of small business?” Even though the two questions are related, they are nonetheless distinct, and answering the second question does not answer the first.

Legal Form of a Business or Nonprofit

As we’ve discussed before, businesses are commonly organized according to one of a handful of legal forms: sole proprietorships, general partnerships, corporations, and limited liability companies. There are a few others used less frequently, including limited partnerships, limited liability partnerships, and professional corporations. Tax exempt organizations are commonly organized as nonprofit corporations, but they can also be organized as unincorporated associations, charitable trusts, and sometimes limited liability companies.

The legal form of a business or tax exempt organization is primarily related to two fundamental attributes: who controls the organization, and who is liable for the organization’s obligations. For example, if a business is structured as a general partnership, the partners collectively control the business and the partners are individually liable for the obligations of the partnership. In contrast, if a business is structured as a corporation, it is probably controlled by a board of directors, elected by the shareholders and acting through the officers. As long as things are done properly, neither the shareholders, the directors, nor the officers are liable for the corporaton’s obligations.

Tax Categories

Although selecting the legal form of an organization determines the attributes of control and liability, it does not determine how much income tax the organization must pay. That is determined by the particular subchapter of Chapter 1 of Subtitle A of Title 26 of the United States Code (also known as the Internal Revenue Code) that applies to a particular business or nonprofit.  There are four common possibilities: Subchapter C (the default provisions for corporations), Subchapter S (which is an alternative to Subchapter C that can be elected by small business corporations that meet the eligibility criteria), Subchapter K (for partnerships), and Subchapter F (for tax exempt organizations). There is actually a fifth possibility because some types of legal forms that have a single owner, such as sole proprietorships, are diregarded for income tax purposes, with their income reported on the owner’s income tax return. Those businesses or nonprofit organizations are known as, appropriately enough, “disregarded entities.”

A common source of confusion is that there is not a one-to-one correspondence between the type of entity and the tax status, and you may have noticed that there is no tax status called “LLC.”  Depending on the number of members in the LLC and some other factors, LLCs may be taxed as disregarded entities, as partnerships under Subchapter K, as corporations under Subchapter C, or as small business corporations under Subchapter S.  In fact, most forms of organization have more than one choice for tax category, as shown in the chart below.  (We’ve indicated that a sole proprietorship is taxed as a disregarded entity, which is technically not correct because there’s no entity to disregard.  But for practical purposes a sole proprietorship is the treated the same way as a disregarded entity owned by an individual.)  Even nonprofit corporations have more than one possibility; while most nonprofit corporations are organized with the intent of qualifying for Subchapter F (exempt organizations), if a nonprofit corporation fails to meet the criteria for tax exemption, it will be subject to taxation under Subchapter C.

Legal Form Tax Status Table cropped

Now you won’t make the same mistake that the SBA made.

[Note:  The above table was corrected on May 7, 2015 to include all the possibilities for the tax status of partnerships.]

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100_3698.JPGEarlier this year the General Assembly passed HEA 1394 which made several changes to the Indiana Business Flexibility Act, the statute that governs limited liability companies. We have already looked at some changes to the Act that enhance the use of Indiana LLCs for estate planning purposes. This article discusses new alternatives for LLC management structure.

The Indiana Business Flexibility Act already provided for a great deal of flexibility for management structure. One of the key steps in designing the management structure of a limited liability company is to establish who has the apparent authority to bind the company, for example by signing contracts on behalf of the LLC. Prior to the changes there were essentially two choices. In a member-managed LLC, the members have that authority. In a manager-managed LLC, the members appoint managers (who may or may not also be members) who have that authority.

HEA 1394 provides a third choice — officers, who may or may not be members. At first blush, there may seem to be little difference between officers and managers because, like the managers in a manager-managed LLC, officers have the apparent authority to bind the LLC to third party agreements. But there is at least one important difference: In a manager-managed LLC, only the managers, and not the members, have the apparent authority to bind the company. The new revisions allow the members of an LLC to establish officers who have the apparent authority to bind the company, while also retaining that authority themselves. In fact, a manager-managed LLC can also have officers. In that case, both the managers and the officers, but not the members, have apparent authority to bind the LLC.

HEA 1394 includes other changes to the statute that enhance the alternatives for LLC governance. For example, the Act now permits the operating agreement to make certain significant decisions, including mergers, dissolutions, and amendments to the operating agreement, subject to the approval of a third party who need not be a member.

One context in which such provisions may prove useful is in estate planning. Imagine the founder of a business, held by a limited liability company, with multiple heirs, who wants the business to remain in the family. Although the operating agreement may create significant restrictions on transfers of membership interests and admission of new members, the heirs could later agree to amend the operating agreement to remove those restrictions. The Act now allows the operating agreement to name a trusted outside party who must approve any amendments to the operating agreement, thus increasing the likelihood that the founder’s desires will be honored.
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