A limited liability company is a kind of business organization. Other kinds of business organizations are partnerships, limited partnerships, and corporations. All these business organizations allow people to aggregate capital and personal effort for the purposes of doing business for profit. (There are not-for-profit organizations, however.) We have different kinds of business organizations because people need different characteristics of formal organization, capital acquisition (including credit), duration in time, number of participants, and tax status, depending upon the kind and extent of business for which they are organizing. The limited liability company is but the newest of a long line of business organizations created in American law to help people do business.

The least formal of the common business organizations is the general partnership. The most formal is the corporation. Another major way to distinguish business organizations is on the basis of the liability of its members or participants. In a general partnership, every partner is jointly and severally liable for the debts of the partnership to the full extent of his or her personal assets. In a corporation, shareholders are liable for the debts of the corporation only to the extent of their investment in the corporation. Limited liability is a hallmark of the corporation, but is also a characteristic of the limited partnership for its limited partners.

Another major distinction between the forms is the basis for the relationship between participants. In a general partnership, the fundamental basis is the agreement of the partners. In a corporation, it is a question of the charter and the corporate law authorizing the creation of corporations.

The three major forms of business organization can be ranked along a line following from these characteristics. A partnership is the least formal in its organization, a basic creature of agreement, in which every partner is liable fully for all debts of the partnership. A limited partnership requires the filing of a certificate to be formed, but remains largely a creature of the agreement between the partners. Its organization is slightly more formal, therefore, than is the case for a general partnership. Limited partners in a limited partnership have limited liability, but general partners are generally liable. Thus, on the issue of limitation of liability, it is a step from partnership to corporation. The last is the corporation, which is formed by filing a charter or certificate, which has a formal organization prescribed by law, and which offers limited liability to all of its shareholders.

Where does a limited liability company fit into this ranking? It fits between a limited partnership and a corporation. As conceived under the Uniform Limited Liability Company Act, promulgated in 1994, it is formed like a limited partnership by filing Articles of Organization with the applicable state office. The relationship of the members is governed primarily by the operating agreement that the members make with each other, again resembling both general and limited partnerships. Its organization may be more formal or less formal, depending upon the form of limited liability company that its promoters choose. On the issue of limited liability, however, it takes on the characteristics of a corporation. Every member of a limited liability company has limited liability.

What is the reason for creating this newer hybrid business organization at this time? The major driving force in the law of business organizations in the United States is federal tax law. A corporation pays tax on its income (but not the same rate) as individuals do. Shareholders also pay tax on the dividends they are paid. Partnerships, on the other hand, pay no tax on their income. Partners pay tax on their distributions from the partnership. A partnership is often called a pass through organization for that reason.

The development of the law of business organizations is the development of organizations that offer the large benefit of limited liability to its members coupled with the pass through tax status of partnerships. The limited liability company has become popular because the Internal Revenue Service has given partnership status to certain limited liability companies, thereby offering in some instances the major advantage of the corporation with a major advantage of a partnership. It does this more completely than the limited partnership does.

THE UNIFORM LIMITED LIABILITY COMPANY ACT

1. Formation

Under the Uniform Limited Liability Company Act promulgated by the Uniform Law Commissioners in 1994, a limited liability company is formed when the prescribed Articles of Organization are filed and accepted in the appropriate state office, usually the Office of the Secretary of State.

Three things should be noted about forming a limited liability company under the Uniform Act. Unlike a partnership, but like a corporation, one person can organize a limited liability company. It is possible to organize a not-for-profit limited liability company under the Uniform Act. There is no limitation to businesses for profit. The Uniform Act also does not restrict the types of business or profession that may organize limited liability companies. Thus, doctors and lawyers may organize limited liability companies. Professionals, generally, have not been able to form business corporations, and have historically organized as partnerships.

The Articles of Organization must specify some characteristics of the limited liability company. It must indicate whether the company is for a term, and if for a term, exactly how long the term is to run. Otherwise, the limited liability company will be considered an "at will" company. The articles must also indicate whether the company will be member managed or manager managed. These designations have significant outcomes.

The notion of a specific term as opposed to "at will" existence is derived from partnership law. These are characteristics of specific kinds of partnerships. Which kind of company, "term" or "at will" makes a big difference in the dissolution of the entity. To choose from member management versus manager management is to choose between partnership character and corporate character, with significant tax implications. A member managed company lacks the characteristic of centralized management, a corporate characteristic under federal tax law, while a manager managed company has that characteristic.

The Articles of Organization establish the time of formation for a limited liability company, but the operating agreement is the true foundation of a limited liability company. It governs the relationship between members, and members and managers in a manager managed company. The Uniform Act is called a default act. Its rules of law govern a company "To the extent the operating agreement does not otherwise provide." However, the agreement may not seriously impair the fiduciary responsibilities of its members, eliminate the obligation of good faith and fair dealing, or vary rights relating to expulsion of members, or the winding up of the company's business. The agreement may not restrict the rights of third parties. But other than these specific prohibitions, the operating agreement can govern everything else. In this sense, a limited liability company resembles a partnership under the Uniform Partnership Act (1994) and the Uniform Limited Partnership Act (1976) with 1985 Amendments.

2. Doing Business

When a limited liability company is formed under the Uniform Act, it either does business through its members or through the designated managers, depending upon the kind of limited liability company that is formed. A limited liability company is an entity, regarded as an undivided whole. Business is done in the name of the company, not in the name of members individually. Therefore, it is important to establish the legitimate agents for the entity - doing business in the name of the entity. In a member-managed company, every member is able to do business in the name of the company and is able to bind the company to obligations with third parties. In a manager-managed company, the designated manager or managers are the agents for the company (members may be designated managers). The agency power includes the power to convey real estate, unless the Articles of Organization expressly limit that power.

Since one function of a limited liability company is to aggregate capital for the purpose of doing business, the Uniform Act has rules governing contributions, generally the value the member gives to become a member, and distributions, generally the value that the member receives for making his or her contribution - the return on investment. Contributions may be in kind, of services - just about anything of value that the entity will accept in exchange for membership. However, no member can be forced to take distributions in kind.

An obligation to contribute is enforceable by the company, and even by creditors of the company. No member is entitled to a distribution that would bankrupt the company. The default rule entitles members to equal distributions. These are enforceable rights, but creditors to the company take priority over members in satisfaction of their obligations (Members may be creditors). The rules pertaining to agency, contributions, and distributions generally mimic the rules for partnerships in the Uniform Partnership Act (1994) and the Uniform Limited Partnership Act (1976) with the 1985 Amendments, emphasizing the relationship between limited liability companies and partnerships, once again. Agency in a manager managed limited liability company is more like the agency of the hired officers and employees of a corporation. It should be remembered, as well, that all these rules are subject to variation by the operating agreement.

The Uniform Act also prescribes some rules of conduct for members of limited liability companies. These are fundamental obligations and are not waivable or subject to variation in the operating agreement. Members enjoy a right of access to the books and records of the company. A member owes a duty of loyalty to other members, consisting of an obligation to account to and hold as a trustee for any property or profit acquired in the business of the company, a duty to refrain from dealing with or on behalf of a party with an adverse interest to the company, and an obligation to refrain from competing with the company before its dissolution.

A member's duty of care in a member managed company is to refrain from grossly negligent conduct, reckless conduct, intentional misconduct, or violation of the law. There is an obligation of good faith and fair dealing. These same obligations belong to a manager in a manager managed company. These obligations parallel those prescribed for a partnership in the Uniform Partnership Act (1994).

Since a limited liability company is an entity under the Uniform Limited Liability Company Act, its property is held in its own name, not in the name of its members. The members have a statutory property interest in the company that is a personal property interest.

Generally that interest may be transferred by a member to another person. A bare transfer does not make the transferee a member. A transferee becomes a member, if the operating agreement does not otherwise provide, only upon consent of all other members. However, the operating agreement for the company can provide for certificates representing members' interests, and for transferring those interests by transferring the certificates. The default transfer rules, therefore, which are rules that mimic partnership rules under the Uniform Partnership Act (1994), can be transformed by the operating agreement into transfer rules consistent with the transfer of corporate shares. Once again, the hybrid quality of the Uniform Act becomes apparent.

A member's property interest is the only interest that can be reached by that member's creditors, as well. There is a procedure for charging a member's interest to satisfy a debt. The charging order becomes a lien upon that interest, and the interest may be placed by the court with a receiver to take distributions on behalf of the creditor. The lien is foreclosable. These provisions for the property interest of a member are very similar to the interest in a partnership under the Uniform Partnership Act (1994).

3. Dissociation of Members and Dissolution

A member can transfer at least the fruits of his or her interest without dissociating with the company. When a dissociation does occur, however, unless the operating agreement specifies otherwise or a majority in interest of the members vote to continue, dissociation can mean dissolution of the company. Every at-will company will dissolve, and every term company will dissolve if the dissociation is of a certain category of involuntary dissociation. It is important to note that the operating agreement may specify the events that constitute dissolution, and there is provision for buying out a voluntarily dissociating member's interest upon dissociation without precipitating dissolution. Few limited liability companies are likely to rely upon the bare default rules of the Uniform Act, precipitating unwanted dissolutions.

Dissociations can be proper or wrongful. A wrongful dissociation is still a dissociation, but the dissociating member will likely be liable to the company for that dissociation.

When dissolution does occur, the company is put through the winding up of the business. Generally, creditors are satisfied, contributions are returned, and distributions made in this phase. A court can, upon a show of good cause, take over the winding up of a limited liability company. The rules for dissociation and dissolution with winding up are taken largely from partnership law as expressed in the Uniform Partnership Act (1994), and provide these essentially partnership qualities to limited liability companies.

4. Conversion and Merger

A limited liability company, like any business organization, is formed, does business, and then dissolves. The statute provides the default rules governing each of these phases of the entity. There is only one more kind of thing that can be provided. The Uniform Act provides for the conversion of partnerships and limited partnerships to limited liability companies, and the merger of limited liability companies with virtually any other kind of business organization. Partnerships and limited partnerships have the ability to convert anyway, but only upon the consent of all partners. Under the conversion provisions of the Uniform Act, the partnership agreement can control the requirements for consent to convert. The same arrangement is provided for merger of a limited liability company. Its agreement can control the consent requirements.

5. Foreign Limited Liability Companies

The Uniform Act also provides for the registration of foreign limited liability companies and for derivative actions by members on behalf of a limited liability company. These are aspects of corporate law that are shared with limited partnerships.

6. Derivative Actions

A member has the power to bring a derivative legal action on the part of a limited liability company if the those with authority to bring such an action do not take the action in the right of the company. The member must have been a member when the transactions upon which the action are based took place. A pleading must specify the nature of the action with particularity, and proceeds are the company's not the member's. A prevailing member can recover expenses and attorney's fees, however. Derivative actions come both from limited partnership and corporation law.

CONCLUSION

The result of the Uniform Act is a very flexible form of business organization that allows the promoters of a limited liability company to establish exactly the kind of company that suits the business at hand. It very much allows organizing the company so that it is a pass through organization for the purposes of federal taxes. A great many states have adopted first generation limited liability company legislation in 1994, the year the Uniform Act is promulgated, but the Uniform Act is the comprehensive, second generation act that should supplant these first generation acts. It also will promote uniformity between the states, a characteristic of business organization law, particularly in the partnership and limited partnership area. The Uniform Law Commissioners have been responsible for the law of partnerships and limited partnerships in the United States since 1914 and 1918, respectively. The resultant existing uniformity can now be duplicated, to the advantage of all the states, by the adoption of the Uniform Limited Liability Company Act.