LA BAR EXAM NON-CODE TOPIC 1 BUSINESS ENTITIES (LLCs)

Question 1

I. Introduction - Defintion

Answer 1

A limited liability company (“LLC) is a type of business form combining attributes of both corporations and partnerships. It has two primary attributes: (i) the limited liability that shareholders of a corporation enjoy and (i) the tax treatment of a partnership. An LLC is a legal “entity,” capable of suing and being sued, owning property, etc.

Question 2

I. Introduction - No Personal Liability for Debts

Answer 2

By law neither the owners (called “members”) nor the managers of an LLC are personally liable for any of its debts-the major advantage of the corporate form.

Question 3

I. Introduction - Tax Benefits

Answer 3

The income of an LLC will not be subject to federal or Louisiana income tax at the entity level-the major advantage of the partnership form.

Question 4

I. Introduction - Compare S Corporations

Answer 4

Subchapter S corporations largely combine the two above mentioned attributes as well, but there are limits on which corporations can qualify for S tax status (e.g., S corporations are limited to 100 or fewer shareholders).

Question 5

I. Introduction - Compare Limited Partnerships

Answer 5

Commendam (or limited) partnerships largely combine these two attributes as well, but in a commendam partnership the general partner is still personally liable for the entity’s debts and there are limitations on the authority of the commendam partners to be involved in the management of the business.

Question 6

II. Formation - Commencement

Answer 6

An LLC may be formed and operated by any one or more persons capable of contracting. This includes natural persons, corporations, partnerships, limited partnerships, domestic or foreign LLCs, joint ventures, trusts, etc. To form an LLC, articles of organization, along with an initial report, must be filed with the secretary of state. No parish filing is required. Typically the LLC’s legal existence begins upon the issuance of a certificate of organization by the secretary of state.

The LLC statute is silent as to the liability of LLC promoters who engage in transactions prior to the date on which the LLC comes into existence. Most like-ly, courts will adopt the same rules in the LLC context that apply to the pre-incorporation activities of corporate promoters.

Question 7

II. Formation - Articles of Incorporation

Answer 7

The articles must be written in English, and must be signed by at least one person, who need not be a member or manager.

It is mandatory that the articles state: (i) the name of the LLC; (ii) the purposes for which the LLC is formed or that its purpose is to engage in any lawful activity for which LLCs may be formed; and (i) whether the company is a low-profit limited liability company.

a. Name
The name usually must contain the words “limited liability company” or the abbreviation “L. L.C.” or “L.C.” A name may be reserved by filing with the secretary of state.

b. Purpose and Powers
An LLC may conduct business for any lawful purpose, for profit or not for profit, except insurance underwriting. An LLC has the same powers as a cor-poration or a partnership.

The articles may also include any other provision not inconsistent with law.

Question 8

II. Formation - Initial Report

Answer 8

The initial report must be signed by each person (or his agent) who signed the articles and must state the name, location, and municipal address (not a PO Box) of the LLC itself, each of its registered agents, and the persons vested with the power to manage the LLC (either the managers or members). In addi-tion, the initial report must contain a notarized affidavit of acknowledqment and acceptance signed by each of the registered agents.

The requirements for forming an LLC (filing of the articles of organization and the initial report and their contents) is a commonly tested issue.

Question 9

II. Formation - Operating Agreement

Answer 9

An operating agreement is any agreement, written or oral, of the members of an LLC as to the affairs of the LLC and the conduct of its business. It is analogous to corporate bylaws.

Question 10

II. Formation - Conversions

Answer 10

Any type of already formed Louisiana business (e.g., a corporation) can convert to an LLC by submitting a conversion application to the secretary of state. LLCs may also be merged into or consolidated with other businesses by filing a merger or consolidation agreement with the secretary of state and the conveyance records office of each parish in which any party has immovable property for which title will be transferred.

Question 11

III. Management and Operation - Operational Requirements

Answer 11

There are virtually no operational “formalities” required, e.g., no member meeting requirements. The LLC need only continuously maintain a registered office and at least one registered agent in the state.

Question 12

III. Management and Operation - Members

Answer 12

Members are the equity owners of the LLC. There are no restrictions on who can be a member. Foreigners or non-human entities are permitted.

1. Member-Managed Classification

Unless the management of the LLC is delegated to managers, all the members will manage the business, subject to any provision in the articles or a written operating agreement restricting or enlarging the rights and duties of any member or class of members. Such an LLC will be deemed to be member-managed.

2. Risk of Members Who Manage

There is no risk to the limited liabilit of members if they participate in the management and control of the LLC (unlike for limited partners in a commendam partnership). (See D.4., infra.)

Question 13

III. Management and Operation - Managers

Answer 13

1. Manager-Managed Classification

If the members want the option of having one or more of the board of persons who manage the LLC to be nonmembers, the articles must specifically state that the business of the LLC will be managed by a group of managers, one or more of whom may, but need not, be members. Once it is specified that the LLC will be managed by a board of managers, it is thereafter deemed to be a manager-managed LLC even if at any given time the only managers elected happen to be members.

The differences between a member-managed LLC and a manager-managed LLC are commonly tested.

2. Method of Selection and Removal

Unless otherwise provided in the articles, each manager position will be filled by plurality vote of the members (which is called “straight voting”); and a manager may be removed, with or without cause, by a majority vote of the members.

Question 14

III. Management and Operation - Manager/Member Duties and Liabilities

Answer 14

Any member or manager entrusted with managing the business stands in a fiduciary relationship to the LLC and must act “in good faith, with the diligence, care, judgment, and skill which an ordinary prudent person in a like position would exercise” and “in the manner he reasonably believes to be in the best interests of” the LLC. Reliance in good faith on advisors and experts meets this standard.
Note: In effect, this statutory language, which tracks the Louisiana Business Corporation Law, creates a duty of care and a duty of loyalty that are probably identical to those duties for corporate officers and directors.

Any manager/member who fulfills these duties in good faith will not be liable for her actions taken on behalf of the LLC.

The articles or a written operating agreement may:
(i)
Eliminate or limit a manager/member’s monetary liability to the LLC for breach of the duties described above, although liability for receipt of an improper benefit or intentional violation of criminal law cannot be eliminated; and
(ii) Provide for indemnification and/or insurance for a manager/member for any “judgments, settlements, penalties, fines, or expenses” incurred as a
manager/member.
Note: Unlike for corporations, there is no provision in the LLC statute that provides for automatic reimbursement of costs and attorneys’ fees for members/managers who successfully defend a suit brought against them for conduct undertaken in their official capacity.

As already mentioned, a member will not lose limited liability because of participation in the management of the LLC. Also, because there are almost no required formalities (e.g., meetings, elections, minutes), courts will not “pierce the LLC veil” because formalities are not followed. However, as for corpora-tions, courts probably will “pierce the veil and find member liability for other factors like commingling member and LLC funds, inadequate capitaliza-tion, or failure to maintain a separate entity identity. By statute,
courts can pierce the veil of a Louisiana LLC based on fraud, breach of professional duty, or other negligent or wrongful conduct.

Question 15

III. Management and Operation - Manager/Member Agency Authority

Answer 15

Each manager/member is a mandatary of the LLC for all matters in the ordinary course of its business except the alienation, lease, or encumbrance of the LLCs immovable property.

The mandatary authority of a manager/member may be taken away (i) in the articles, (ii) in an operating agreement, or (iii) by majority vote of the members/managers, provided that the third party with whom the manager/member deals has knowledge of the fact that she (the mandatary) lacks such authority.

A member who is not a manager (in a manager-managed LLC) does not have such agency authority, nor does he have the duties of care and loyalty. Such a member is purely an equity owner (like a corporate shareholder) with no authority or fiduciary duties.

Question 16

III. Management and Operation - Voting Requirements for Management Decisions

Answer 16

Unless the articles or operating agreement provides otherwise, each manager/member is entitled to a single vote, and all decisions shall be made by majority vote.

Question 17

III. Management and Operation - Voting By Members

Answer 17

Unless the articles or a written operating agreement provides otherwise, a majority vote of the members is required to approve the following matters, even if management is vested in managers or less than all of the members:
Dissolution and winding up of the LLC;
(ii) Disposal or encumbrance of all or substantially all of the LLC’s assets;
(iii) A merger or consolidation;
(iv) Incurrence of debt other than in the ordinary course of business;
(V) Alienation, lease, or encumbrance of any immovables; and
(vi) An amendment to the articles or operating agreement.

Voting requirements for the alienation of immovables is commonly tested.

A member may cast her vote either in person or by use of a proxy. A proxy must be written and signed by the member or her agent and filed in the registered office of the LLC. The holder of the proxy is then entitled to vote on the member’s behalf. Proxies will automatically expire 11 months after the date of execution, unless some other period is expressly provided, but in no case will a proxy be valid for longer than three years.

Question 18

III. Management and Operation - Conflict of Interest Transactions

Answer 18

A transaction voted on by a manager/member having a financial interest in the transaction is not void or voidable solely because she participated in the meeting or created a quorum, provided either:
1. The interested manager/member’s interest was disclosed to the other voters and a disinterested majority approved the transaction; or
2. The transaction was fair to the LLC at the time it was approved.

Question 19

IV. Financial Structure - Profits and Losses

Answer 19

Profits and losses in an LLC are allocated equally among the members, unless the articles or a written operating agreement provides otherwise.

Question 20

IV. Financial Structure - Contributions

Answer 20

Contributions may be in the form of “cash, property, services rendered, or a promissory note or other binding obligation to contribute cash or property or to perform services.”

Remember that for LLCs, a promise to contribute must be in a signed writing to be enforceable. This is different from a part-nership. A partner owes the partnership all that she has agreed to contribute whether orally or in writing.

Question 21

IV. Financial Structure - Distributions

Answer 21

No distribution to a member is allowed if:
1. The LLC would be rendered unable to pay its debts as they come due;
2. The LLC’s total assets would become less than its total liabilities; or
3. The distribution would violate a provision in the articles or a written operating agreement.

Question 22

V. Assignment of Membership Interests

Answer 22

A membership interest is an “incorporeal movable.” A member has no interest in the LLC’s property. Unless the articles or an operating agreement provides other-wise, a membership interest is assignable in whole or part, but the assignment entitles the assignee only to receive the distributions the assignor would have been entitled to receive. Assignment does not entitle the assignee to exercise any rights or powers of a member in the LLC until such time as all of the other members approve her for such in writing.

Question 23

VI. Withdrawal - LLC Constituted for a Term

Answer 23

If the LLC has been constituted for a certain term, a member may withdraw only if either (i) she gets the unanimous consent of the other members, or (ii) there is “just cause” for withdrawal “arising out of another member’s failure to perform [a materiall obligation.”

Question 24

VI. Withdrawal - LLC Not Constituted for a Term

Answer 24

If the LLC is not constituted for a set term, a member may withdraw either (i) immediately upon the occurrence of an event specified in a written operating agreement, or (ii) for any reason if the withdrawing member gives the LLC and the other members 30 days’ written notice.
Note: This distinction between an entity constituted for a term and without a term is ver similar to the distinction in a partnership. The only difference is that to withdraw for any reason from an LLC not having a set term requires a 30-day notice, whereas withdrawal from such a partnership requires notice in good faith but no set number of davs.

Question 25

VI. Withdrawal - Entitlement Upon Withdrawal

Answer 25

A member who withdraws is entitled to continue to receive her share of the profits (but the law is unclear about whether she shares the losses) until the LLC pays her the fair market value of her membership interest as of the date of withdrawal, which is required to be done “within a reasonable time.”

Question 26

VI. Withdrawal - Removal of a Member

Answer 26

Unlike in partnership law, the LLC statute provides no procedure for the expulsion of a member.

Question 27

VII. Dissolution - Generally

Answer 27

Unless the articles or a written operating agreement provides otherwise, an LLC is dissolved and its affairs wound up upon any of the following:
1. An event specified in the articles or an operating agreement;
2. The consent of a majority of the membership; or
3. Entry of a iudicial decree of dissolution upon application of a member when it is no longer reasonablv practicable to carrv on the business of the LLC.

Question 28

VII. Dissolution - Winding Up

Answer 28

Upon giving notice of the authorization of dissolution and filing the articles of dissolution with the secretary of state, the LLC will then wind up its business affairs unless the articles or a written operating agreement provides otherwise.

Question 29

VII. Dissolution - Distribution of Assets Upon Dissolution

Answer 29

The assets of a dissolved LLC will be distributed first to creditors, then, unless the articles or a written operating agreement provides otherwise, members owed already approved distributions will be paid next. Then members will receive return of their capital contributions. Finally, members will divide the remaining assets in the proportion they share in the distributions.