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LIMITED LIABILITY COMPANIES
TABLE OF CONTENTS
INTRODUCTION ................................................................................... 1
1. COMMON QUESTIONS REGARDING LIMITED LIABILITY
COMPANIES (LLC's) .............................................................................. 4
2. THE LLC ..............................................................................................32
3. STEPS IN FORMING AN LLC ...........................................................56
4. TAX CONSIDERATIONS ...................................................................65
5. LIMITED LIABILITY FOR MEMBERS ...............................................93
6. CAPITAL CONTRIBUTIONS AND DISTRIBUTIONS ....................101
7. DOING BUSINESS IN OTHER STATES........................................... 108
8. BULK SALE ........................................................................................114
9. SECURITY LAWS AND COMPLIANCES ........................................120
10. ARTICLES OF ORGANIZATION.....................................................160
11. OPERATING AGREEMENT .............................................................275
12. AFTERWARDS: POST FORMATION ACTS ..................................308
13. MEMBER AGREEMENTS ................................................................317
14. TERMINATION OF AN LLC ...........................................................341
APPENDIX ..............................................................................................351
INTRODUCTION
In the recent past, when two or more people wished to conduct business together there were only two options available in structuring the business, either incorporate and operate as a corporation or operate as a partnership. Much of that has changed, a new form of business entity has been in development in recent years. This is the limited liability company which shares the best characteristics of both corporations and partnerships.
Wyoming was the first state to create a limited liability company. The first liability company was created specifically to assist in the development of oil and gas resources. The expansion into other states and use by other industries was slow until the Internal Service in 1988 finally ruled that a limited liability company could be taxed as a partnership rather than as a corporation. As a result of this monumental tax decision, there has been an explosion in the number of states which now permit limited liability companies to be formed under their laws. To date, there are forty eight states which permit limited liability companies to be formed under their state law. Only Hawaii and Vermont had not, as of January 1996, enacted a Limited Liability Company Act.
It is very important that anyone considering the possibility of forming a limited liability company, possess a good understanding of the rights and obligations that arise from the liability company arrangement. The book strives to explain the various features of limited liability companies along with their drawbacks. This book is very easy to use. It contains the basic Articles of Organization needed to be filed in order to form the company. It also contains a basic operating agreement to cover the management of the company for its daily operations.
Limited liability companies permit persons to operate a business in a manner virtually identical to a general partnership yet with the full corporate protection against personal liability for the debts of the company. In addition, it is often cheaper to form a limited liability than a corporation because most states charge less for the filing of their Articles of Organization than a corporation's Articles of Incorporation.
This book discusses what requirements must be met to have the company taxed as a partnership. This is often the major consideration in forming such a limited liability company. As a rule, if the parties want the company to be taxed as a corporation, then it should be incorporated. Generally, only if the members actually want the company taxed as partnership should a limited liability company be formed. There is no real benefit derived from forming liability company over that of corporation, if it is going to be taxed as if it were a corporation anyway. The discussion of the respective benefits of being treated as a corporation or partnership are discussed in great detail.
This book is one in a series that have been written to help the reader cut through legal jargon and understand his or her rights. Other books of this series are:
These books are different from other legal self-help books. While they explain the pertinent law, they move beyond the basics. This series is written in a very practical mode, explaining to the user how to accomplish the desired results while providing detailed forms, examples and instructions. This series offers the most user-friendly and complete books of their type on the market.
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CHAPTER ONE
COMMON QUESTIONS REGARDING LIMITED LIABILITY COMPANIES
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INTRODUCTION
This chapter is written in a question and answer format. It covers many of the most commonly asked questions regarding limited liability companies. The questions covered are answered throughout the book in greater detail. The main reason for having such a chapter is to give the user of this book a basic understanding of limited liability companies before reading the more substantive chapters.
It has been shown that when legal self-help books are presented in this format, even though it requires more work and effort to do so, the reader is able to understand and assimilate the material in a better and faster manner.
1. WHAT IS A LIMITED LIABILITY COMPANY?
The newest development in business law is the creation of the limited liability company. In operation, a limited liability company is a cross between a corporation and a partnership, both general and limited, and shares some of the characteristics of all three entities. Unlike a corporation which can have perpetual existence, some states limit the life a limited liability company to a maximum term, usually thirty years. Unlike the general partners of a partnership, the members of a limited liability company are not personally liable for the debts of the company which is the basic treatment for shareholders of a corporation or the limited partners of a limited partnership. Members of a limited liability company may agree in the operating agreement to allocate profit and losses other than in accordance with the percent of their ownership interests which is something a corporation can not do. In addition, a limited liability company may give full management and control to just a few managing members which is the same treatment that is available in a partnership.
As of January 1996, forty eight states and the District of of Columbia have adopted a limited liability company act. Only Hawaii and Vermont have yet to adopt a LLC Act. It is believed that these states will soon adopt an LLC Act so as to give their citizens the advantages of doing business in the LLC form.
A limited liability company is considered to be a legal entity which is separate and apart from all of the people who own, control or operate it. A liability company holds most of the rights of a legal person, As such, a limited liability company is capable of validly executing contracts, incurring debts, holding title to both real and personal property and also paying taxes. The attractiveness of limited liability companies stems from the very fact that they are held to be separate legal entities apart from their owners, the members, which gives LLCs unique advantages over both corporations and partnerships,
2. HOW IS A LIMITED LIABILITY COMPANY FORMED?
The steps for forming a business as a limited liability company are simple. They can be summed up as follows:
Once the above steps have been accomplished, the limited liability company is formed and can commence operations in its home state. If the company wishes to do business in other states, it is usually required to filed a copy of its Articles with the Secretary of State along with a form stating that it is a foreign limited liability company.
3. WHAT MUST BE INCLUDED IN THE COMPANY NAME?
A limited liability companies must have a name that denotes that it is a limited liability company. The name usually must contain the words, "Limited Liability Company" or the symbols "LLC", "L.L.C." or "L.C.". The name selected for the company must not mislead the public into believing that it is an agent of the Federal or State government. The name of the limited liability company also must not mention or suggest involvement in a regulated or licensed field unless the limited liability company actually has that license.
The main concern is whether the proposed name is so similar to that of an existing business's name so as to mislead the public into believing that it is that other company. No state will permit two businesses to have the names so similar in nature that they are confusing. To avoid the possibility of having the Articles rejected because of similarity to the name of an existing business, the persons forming the limited liability company, the organizers, should conduct a name search with the Secretary of State's Office. If the name has not taken by another company, then it can be reserved, for a fee set by the Secretary of State, for a period of time which is usually sixty (60) days.
4. WHAT IS A REGISTERED OFFICE AND AGENT?
All of the states which permit limited liability companies require that the company, in its Articles of Organization:
1. List the address of its principal place of business in the state; and
2. List both the name and address of a resident agent for the company who is located in the state.
These requirements for the listing of a resident agent and registered office are also imposed upon a business which is incorporating. The purpose behind the listing of registered is that this person is thereby authorized to receive legal process (lawsuits and official notices) against the company. This means that the resident agent is the person who is served any legal notices along with any summons and complaints filed against the company. Under most state laws, a company must have a resident agent in the state or, by default, it is agreed that the Secretary of State will serve as the resident agent. The reasons behind the requirement for listing a registered office are self-evident. The registered office is the location where the company's records are to be kept in the state. Another reason for the listing is to give notice to the world, at large, where any complaint against the can be served.
5. WHAT ARE ARTICLES OF ORGANIZATION?
In the basic sense, the Articles of Organization is an application by a group of individuals or entities for a licenseto do business as a limited liability company in the state, If the Articles are accepted and filed, in accordance with state law, the limited liability company is thereafter formed. This book contains a detailed chapter for preparing the Articles of Organization. Each state has it own minimum requirements for the contents of the Articles. This book has attempted to provide a general set of Articles that are sufficient for most states and more specific Articles when necessary. The reader should, nevertheless, familiarize himself with the limited liability law of the state where the limited liability company will be formed so as to assure compliance with the latest version of the law.
6. WHAT IS A MEETING OF MEMBERS?
Before the Articles were filed, they had to be approved and adopted. To do that, the person or persons who were to file the Articles, the incorporators, often call a meeting of potential members. At this meeting, the provisions to be contained in the Articles are decided upon. Also decided, at the meeting, is the important detail as to whether as to whether all of the members will manage the business or if the management will be through a centralized panel of selected managers. Once the Articles are adopted, they must be signed either by all of the potential members, if no managing members are selected, or all of the managing members if management is to be by selected managing members. Usually, at this meeting, the operating agreement for the company is also created and adopted.
After filing the Articles, the limited liability company exists on paper but it is not until membership certificates are actually issued will it exist at law, de jure. It is the fact that the company has outstanding membership certificates in the hands of members that is the defining characteristic behind the existence of a limited liability company, Following the filing of the Articles, the potential members of the limited liability company meet to purchase their membership certificates in the company and adopt the operation agreement. After the membership certificates have been issued, the company is then truly and fully formed.
8. WHO ARE MEMBERS?
Members are the owners of the limited liability company. Members own the membership certificates of the limited liability company and thus have the right to vote in the election of managing members or on other company business. Members are not personally liable for the debts of the limited liability company beyond the extent of their investment in the membership certificates. Members may agree to manage the company themselves or to turn the management over to a few elected members who are referred to as managing members.
In addition to electing any managing members, the members are required to vote for the following acts:
Most operating agreements for limited liability companies require that an annual member's meeting be held each year to review the business affairs and conduct of the company. The members will also, at the meeting, re-elect or replace the managing members for another year. Members are usually given just one vote equal to their percentage of ownership in the company as evidenced by membership certificates. A majority of those membership interestsvoting is needed to carry a resolution, the matter be voted upon.
9. WHO ARE MANAGING MEMBERS?
Managing members are those persons elected by the members of a limited liability company to manage the company's affairs within the scope of authority set forth in the operating agreement. The term managing members refers to all of the managing members. Managing members must be elected if the articles or operating agreement does not reserve management to all of the members themselves.
If managing members are elected, then they alone are responsible for running the day to day business affairs of the limited liability company. When the limited liability company is taxed as a corporation, the managing members are permitted reasonable compensation for their services. In small limited liability companies, the managing members often serve for free since they are primarily are there to protect their investments.
The decision to have the limited liability company managed by elected managing members is an element of corporate existence. As such, if the company also has either of the following characteristics: free transferability of its membership interests or continuity of life and then it will be taxed as a corporation and not a partnership.
10. WHAT DUTIES ARE OWED BY A MEMBER TO A LIMITED LIABILITYCOMPANY OR TO THE OTHER MEMBERS?
A member owes to a limited liability company a duty of loyalty, A member can not usurp a company benefit, that is take for himself a benefit that could go to the limited liability company. In short, a member owes to the limited liability company the right of first refusal on any business opportunities that the member becomes aware that could affect the limited liability company. For example, if the limited liability company is in the paving business, a member could not form a competing paving business and solicit business from the limited liability company's existing clients. When a member has a personal interest on a matter before the board, the member is only allowed to vote on it if:
A member is not personally liable for the debts of the limited liability company. A member can not be sued, by members, for losses incurred as a result of the member's actions or decisions provided that they were undertaken in a reasonable and prudent manner. As agents of the limited liability company, members have the authority to bind the limited liability company by their actions. As such, members can execute contracts for the limited liability company and likewise can subject the limited liability company to liability for damages arising from their negligent or intentional acts committed on the limited liability company's behalf.
11. WHAT ARE MEMBERSHIP CERTIFICATES?
Membership certificates can be thought of as the ownership interests in a limited liability company. Every limited liability company is authorized to sell only a certain amount of membership certificates in accordance with the security law of the state where the company is formed. The purchasers of the membership certificates acquire an ownership interest in the company equal to their percentage of membership certificates to the total amount of membership certificates outstanding. Membership interest can be sold as shares in the company such as is done in a corporation or as fixed percentages such as is done in a partnership. The membership certificates used in this book are based upon the partnership format because that is the easiest form for most people to understand and to evaluate. Membership certificates may be sold by a limited liability company for money , labor , services canceled debts or for property contributed to the limited liability company. Membership certificates also be purchased with a promissory notes although, in such cases, the membership certificates is secured by tangible property.
Membership certificates can be voting or non-voting in nature. Non-voting membership certificates is usually issued by a limited liability company to raise money without giving the owner the right to participate in the business. To attract purchasers for its non-voting membership certificates, a limited liability company usually guarantees a fixed dividend payment or the right to later convert the non-voting shares into voting shares on a fixed formula.
12. WHAT IS MEANT BY LIMITED LIABILITY?
The main advantage of a limited liability company is the limited liability that it provides the owners which are called members. As a limited liability company, the most that its members can lose in a lawsuit against the company is the assets that they contributed to the limited liability company, This limited liability for members is vastly different from that of a partnership or sole proprietorship where the owners are totally liable for all debts of the business. In such an instance, the creditors of the business can seek and attach every dollar and piece of property that a partner or sole proprietor owns in order to settle a judgment against the partnership or sole proprietorship. Such personal attachment to satisfy company debts can not be done against the assets of a member.
It is to cut off this unlimited liability for the debts of the business that people either incorporate or form a limited liability company. Few people would ever invest in a business, if by doing so, they risked losing everything that they have earned or will earn in the future,
13, WHAT IS THE COST OF FORMING A LIMITED LIABILITY COMPANY?
Costs for forming a limited liability company varies somewhat from state to state. The filing fees tend to run from a low of $50.00 to a high of $500.00. As such, the cost of forming a limited liability company is no more expensive, and in many cases, it is much cheaper than forming a corporation . If an attorney is used to prepare the Articles of Organization and Operating Agreement, then the attorney would tend to charge between $500 to $1,000. This amount avoided by using the basic forms in this book which can be augmented with whatever additional clauses the parties want to include.
The cost of forming a limited liability company should be looked upon as a one time insurance premium. Once the business is formed as a limited liability company, the members are protected from individual liability from then forward for the actions of limited liability company or its employees. After forming the limited liability company, its members no longer have everything they own at risk. Peace of mind is an important consideration in addition to cost when deciding whether to form a limited liability company.
**** end of sample view of chapter ****
CHAPTER 2
THE LIMITED LIABILITY COMPANY
I. DEFINITION
The most recent development in business law is the creation of the Limited Liability Company (LLC). The first LLC was created in the 1970's. For many years LLC's were not popular because the tax laws subjected them to more taxation than either a corporation or a limited partnership. In 1977, the first LLC was created in Wyoming for an oil company. The company was granted a private tax ruling stating that it would be treated as a partnership. In 1980, the U. S. Treasury issued proposed regulations that stated an LLC would be taxed as a corporation because its members did not have a partner's liability for the company's debts. In 1988, the Internal Revenue Service finally issued Revenue Ruling 88-76, 19882 CB 360, stating that an LLC could be taxed as a partnership. This revenue ruling calmed concerns about forming LLC's. As a result, the number of states permitting LLC's has increased dramatically.
An LLC is a cross between a corporation and a partnership. The characteristics that are shared with a corporation or a partnership are:
In addition, an LLC may give full management and control to just a few managing members, which is the same treatment that is available in a partnership and similar to that of the board of directors of a corporation.
The following, however, are the major differences between LLC's and corporations or partnerships:
These characteristics are important. If an LLC has any three of them (as discussed below), it will be taxed as a corporation. Such taxation would be detrimental to members so care must be taken in deciding which common characteristics the company should share with a corporation.
The main advantage of an LLC is the limited liability that it provides its owners, who are called members. In an LLC, the most that its members can lose in a lawsuit against the company are the assets they contributed to the LLC. The limitation of liability would naturally not extend to any personal guarantees of company debts by a member. If a member personally guarantees a company loan of $100,000, the member is personally liable for the repayment. The member's liability arises not because the person is a member of the company but because the member guaranteed that he personally would repay the loan. It is immaterial that the money may have gone directly to the company. The limited liability for members is quite different from that of a general partnership where the partners are totally liable for all debts of the business. The creditors of a general partnership can seek and attach every dollar and piece of property that a partner owns in order to settle a judgement against the partnership. Such personal attachment to satisfy company debts cannot be taken against the assets of a member. People either incorporate or form an LLC to eliminate this unlimited business liability exposure. Few people will invest in a business that risks everything they have or will earn.
LLC's are relatively new and has taken time for them to catch. Even so, 48 states and the District of Columbia now permit them to be formed or recognize them. Only Hawaii and Vermont have yet to join the majority. It is expected that soon these states will also enact a LLC Act.
The fact that two states have yet not decided to permit the existence of LLC's causes a degree of concern for any foreign LLC that wishes to do business in a state that does not permit the formation of LLC's. Such a state could treat a foreign LLC in one of two ways:
It is commonly felt among corporate and tax attorneys that most of the four states that do not permit their citizens to do business as an LLC will permit foreign citizens to do so. An LLC that is considering doing business in one of these three states should consult with both a corporate and a tax attorney to determine how that state would treat the company. It may well be that by the time the company wishes to do business in Hawaii or Vermont, the state may have, by then, adopted a LLC Act which settles the issue.
An LLC is considered to be separate and apart from all of the people who own, control and operate it. An LLC holds most of the rights of a legal person. An LLC is able to validly execute contracts, incur debts, hold title to both real and personal property and pay taxes. The attractiveness of LLC's is that they are held to be separate legal entities from owners, the members, which gives them unique advantages over both corporations and partnerships.
II. FORMATION
A. General
An LLC is a statutory creation. It can only be formed by strict compliance with the state law under which it is being created. An LLC just as with a corporation or a limited partnership requires a public filing of its formation documents. The filing of the Articles of Organization is required:
Most states require a LLC to have more than one owner. This is a different requirement than imposed on corporations which are permitted to have only one shareholder. Several states which include Arizona, Colorado, Delaware, Illinois, Iowa, Kansas, Louisiana, Maryland, Minnesota, and Virginia permit only one person to form an LLC, but the company is not given legal effect until it has more than one member. States that require a company to have two or more members usually also require two or more persons to sign the Articles of Organization or a subscription agreement prior to filing the Articles. If a company falls below the minimum number of members for an LLC, it will not only be dissolved but it will lose the limited liability shield for its members to the extent necessary to dissolve the company. A company will be treated harshly if it continues to do business for an undue period after ceasing to have the minimum number of members. Those states that have the two member requirement use it to insure the availability of the partnership classification for tax purposes. A partnership requires, by definition, two or more persons engaged in business.
B. ARTICLES OF ORGANIZATION
Articles of Organization is an application by a group of individuals or entities for a license to do business as an LLC. Once the Articles are accepted and filed, the LLC is thereafter formed. Each state sets its own requirements for the contents of the Articles, however, they all require:
The requirement for listing both the resident agent and the registered office is also imposed upon a company which is incorporating. Listing of registered agent ensures that someone is authorized to receive legal process against the company. The resident agent is the person who is served any legal notices or summons and complaint on behalf of the company. A company maintains a resident agent in the state, or by default agrees to let the secretary of state serve as the resident agent. The registered office is the location where the company's authority is kept in the state. The registered office listed address gives notice to the world where any complaint against the company can be served.
Several states also require additional provisions to be included in the Articles, such as:
Some states such as Colorado, Florida, Minnesota, Nevada, West Virginia and Wyoming require the Articles to state if the company will continue in effect upon the death, bankruptcy or withdrawal of a member. This is a good provision, recommended to be in every operating agreement, especially if partnership taxation is sought because continuity of life is a determining factor.
This book attempts to provide a general set of Articles sufficient for most states and has provided specific Articles when necessary. The reader should, nonetheless, familiarize himself with the particular LLC law of the state where the LLC will be formed. There are possibly current changes not reflected in this text. The provisions contained in the Articles of Organization for an LLC can only be altered or changed by the filing of an amendment to the Articles. Members frequently place important management provisions in the Articles because it is difficult to amend them. The Articles contained in this book are all that are needed to meet minimum requirements under state law. In practice, the entire operating agreement or any of its provisions can be included in the Articles. Remember, once something is listed in the Articles, it can only be changed by filing an amendment.
Before the Articles are filed they must be approved and adopted. The person who will file the Articles calls a meeting of potential members where they decide what provisions will be contained in the Articles. They also decide another important detail: whether all the members or a centralized panel of selected managers will manage the business. Once the Articles are adopted, they must be signed either by all the selected managing members, or by all of the members (if no managing members are selected. Usually, the operating agreement for the company is also created and adopted at this meeting.
C. OPERATING AGREEMENTS
After the LLC files its Articles, it exists on paper; it does not exist at law (de jure) until membership certificates are actually issued. It is the fact that the company has outstanding membership certificates in the hands of members that is the defining characteristic behind the existence of an LLC. Similarly, a corporation is not deemed to be in effect until it has sold and issued stock. Following the filing of the Articles, the potential members of the LLC meet to purchase their membership certificates and adopt the operating agreement for the business. After the membership certificates have been issued, the company is fully formed.
Operating agreements are the rules for the general day-to-day management and operation of the LLC. Contained in the operating agreement are the terms of the company concerning:
The operating agreement is adopted by the members and thereafter can be amended only by a majority vote of the members. An operating agreement is an attempt to resolve the many areas of potential conflict within an LLC and to delegate duties and assign responsibilities. A proposed form for a basic operating agreement for use in the 48 entities that permit LLC's follows in the Operating Agreement chapter
Operating agreements can be general in nature or tailored to the needs and desires of the members. Most operating agreements contain or mention most of the issues covered in the Operating Agreements chapter. A few states do not require the operating agreement to be in writing. Only if the agreement is in writing can the actual intent of the members be ascertained with confidence.
Operating agreements are not set in concrete and, in fact, quite flexible. Members can change the operating agreements by simple amendments. The purpose of operating agreements is to establish procedures for daily administration and management of the company. As the company develops the operating agreement must be amended to meet new requirements.
As can be seen from the foregoing discussions, the steps for forming a business as an LLC are simple:
Once these steps have been accomplished the LLC is formed and can commence operations. An LLC is easier and less expensive to create than a corporation or a limited partnership provided ordinary caution and care are undertaken.
D. MEMBERS
Members are the owners of the LLC. Usually an LLC must have two or more members. Texas, however, permits a company to have only one member. Members own the membership certificates of the LLC and have the right to vote in the election of managing members. The extent of ownership interest a member has in the company is usually based either:
Members are not personally liable for the debts of the LLC beyond the extent of their investment in the LLC. Exception: A member is personally liable for a company debt or obligation if he personally guarantees repayment.
Members may agree for all members to manage the company or agree to elect a few members to manage, who will be called "managing members." In addition to electing any managing members, the members are required to vote on the following:
The term "managing member" refers to all of the managing members. Managing members must be elected if the operating agreement does not reserve the management to all of the members. If managing members are elected, they alone are responsible for running the day-to-day business of the LLC. When the LLC is taxed as a corporation, the managing members are permitted reasonable compensation for their services. In small LLC's, the managing members usually serve for free to protect their investments. Caveat: The decision to have the LLC managed by elected managing members is an element of corporate existence. If the company also has free transferability of its shares or continuity of life, it will be taxed as a corporation and not as a partnership.
Most operating agreements for an LLC require an annual members' meeting to review business affairs and conduct. The members also will elect or re-elect the managing members for another year. Members are usually given votes proportional to their percentage of ownership in the company. A majority of those membership interests voting is needed to carry a resolution or any other matter brought to the floor.
A member has a duty of loyalty to the LLC. A member cannot usurp a company benefit that could go to the LLC. A member owes the LLC the right of first refusal on any business opportunity he discovers that could affect the company. For example, if the company is in the paving business, a member could not form a competing paving business and solicit business from the LLC's existing clients. When a member has a personal interest on a matter before the board, the member is only allowed to vote on it when:
A member cannot be sued by other members for losses incurred as a result of the member's actions or decisions provided they were reasonable and prudent. As agents of the LLC, members have the authority to bind the company by their actions. Members can execute contracts for the company and can subject the company to liability for damages arising from negligent or intentional acts they may commit on behalf of the company.
All of the states which permit LLC's hold that an assignment of a member's interest only passes financial right unless the operating agreement states otherwise. The assignee (person who acquired a member's interest in the company) only acquires the right to participate in the management of the company through a majority vote of the other members. Usually, a consensus is required.
This is important enough to repeat. The non-assigning members must agree to let the new member participate in the management unless the operating agreement states otherwise. This lack of full transferability of interest means interests do not have "free transferability." As a result, the value of the company is lessened and the company is assisted in obtaining tax treatment as a partnership.
***** end of sample view of chapter *****
CHAPTER 3
STEPS IN FORMING AN LLC
I. INTRODUCTION
There is no mystery or difficulty in forming an LLC. Simply speaking, an LLC is merely a license to do business in a particular manner. The articles of organization is the application for a license, and is turned into a license when accepted for filing by the secretary of state. In fact, in legal parlance an LLC is said to be "licensed to do business" once the articles are filed.
The act of forming an LLC to engage in a business is quite simple in that all that it entails is the filing of the articles of organization and issue membership certificates. The actual act of forming an LLC is no more than standing before a clerk in the secretary of state's office and having the articles stamped (it can also be accomplished by mail). The articles contained in this book are a starting point for formation of any LLC. Before filing any articles, the reader should decide any additional provisions he may want in the articles. In addition, the reader should read those provisions in the state's LLC code (available in most public libraries and state law libraries) to ensure the content of the state law has not changed.
This book provides the user with a detailed analysis of the problems, issues and procedures to be faced in the formation of an LLC. The choices required during formation of an LLC are not difficult, but they can be complex because of the myriad of options available and the particular concerns attendant to each business. A major initial decision is whether all members agree (consensus) to have the business managed by a central committee of selected members or by all the members collectively. Equally important is whether or not the company will continue in existence after the death or resignation of a member, and will an interest in the company be transferable. The answers to these three questions will determine if the company will be treated as a partnership or a corporation for tax purposes.
This book is intended for use by small businesses which ideally have ten or less members. The reason for this is that a membership certificate in an LLC is a security under both state and federal law. It cannot be issued or sold before registration with both federal and state security agencies unless it is exempt. The main exemption from registration available to most LLC's is the one involving sales to 35 persons or less who all live in the same state. All states permit LLC's an exemption from registration if its membership certificates are sold only in that state and only to less than a fixed number of persons. Example: In Delaware, membership certificates can be sold to no more than 30 persons, while in Ohio they can be sold to no more than 10. This book deals with LLC's that will not be required to register with the SEC (Securities and Exchange Commission) and have never had a public offering of securities. The requirements for security registration or security exemptions are discussed in great detail in the Security Laws chapter.
This book was written for use primarily by those individuals who seek to form an LLC to conduct an existing business or a new business involving a few close friends or family. This book must not be used if the LLC intends to raise money by selling its stock to more shareholders than permitted by state law for exemption status.
II. PROCEDURE
The steps for forming a business as an LLC are simple. They can be summed up as simply filing the Articles of Organization and issuing the membership certificates. In arriving at this result, the LLC will go through the following steps:
A. CHOOSE A COMPANY NAME
Every LLC must have a name that denotes it is an LLC and not a corporation, partnership or sole-proprietorship. As such, the name usually must contain the words "limited liability company" or the initials "LLC" or "LC." The name selected must not mislead the public into believing it is an agent of the federal or state government. The name must not mention nor suggest involvement in a regulated or licensed field unless the LLC has that license. Example: Dr. Peter Jones Medical Limited Liability Company would not be valid unless Peter Jones actually has a medical license.
In practice, the main concern is to ensure the proposed name is dissimilar to that of an existing business's name and does not mislead the public. No state will permit two businesses to have the same name or names so similar that they are confusing. To avoid the possibility of having the articles rejected because of similarity of name, conduct a name search with the secretary of state's office. If the name is available, it can be reserved for a fee for 60 days or longer. The search can be done by mail by sending a request with the name and a check for the search to the Secretary of State. The amount of fee and the mailing address can be obtained from the secretary of state's office. A name search through the secretary of state's office can require 30 days for reply. There are attorney service firms in the phone book for the state capitol that will conduct name searches and reserve names within two days for a price of $30 to $50.
If the LLC expects to be doing business in other states, it must be aware that it may have to operate under a fictitious name in those states if its name is substantially similar to an existing business.
B. REGISTER AN OFFICE AND AGENT
As with a corporation, all states that permit LLC's require the company's Articles of Organization to:
These requirements to list the resident agent and the registered office is also imposed upon each corporation. The registered agent is authorized to receive legal process against the company and is served any legal notices or summons or complaints on behalf of the company. Like a corporation, a company maintains a resident agent in the state, or by default the secretary of state serves as the resident agent. Defaulting to the secretary of state to serve as resident agent is a poor idea because service on the secretary of state usually is not relayed to the company before the time to answer has run. A judgement can be taken against the LLC before any of the members have knowledge of the suit.
The reasons for listing the registered office are self-evident. The registered office is the location of the company's books, records and key personnel. In addition, the registered office gives notice to the world at large where any complaint against the company can be served.
C. PREPARE AND FILE ARTICLES
After the proposed LLC name has been reserved, the prospective members meet to prepare and file the articles of organization. This book contains a detailed chapter for preparing the articles. Each state has its own requirements for articles content. The articles herein are a general set acceptable in most states. There are specific articles and also articles for use when necessary. The reader should, nonetheless, familiarize himself with the particular LLC law of the state where the LLC will be formed in order to assure that the law has not recently changed. The articles contained in this book are the basic ones required. They may be retyped with additional provisions. Moreover, a particular state may require additional provisions in the articles to conform to recent changes in its law.
Once prepared, the Articles are filed with the secretary of state's office. Most states require articles to be filed in duplicate and signed by all the managing members (or all the members if managing members are not selected). Therefore, three or more copies should be filed, and the LLC should receive a conformed, file-stamped copy. The filing can be made in person or by mail. Mail filing will require 30 to 60 days for return. The alternative is to use an attorney service firm. Such firms usually take about a week to get the articles returned and will charge about $50.00 for the service. If there are problems, the attorney service firm can correct them quickly.
D. PAY FILING FEES
When the articles are filed, the members must pay the state fee. Fees vary from state to state but tend to be between $50 and $500. For example, in January 1994, the fees for the following states that permit LLC's were:
Arizona$50.00
Delaware$50.00
Florida$50.00 for the first $100,000 of capital which increases up to $250 for capital over $1,000,000
Illinois$500.00
Iowa $50.00
Kansas$150.00
Louisiana $60.00
Minnesota $135.00
Oklahoma$100.00
Rhode Island $150.00
Texas $200.00
Virginia$100.00
Wyoming$50.00 for the first $50,000 of capital, $1010 for capital up to $100,000 and $0.50 for each $1,000 over $100,000
The fees for states not listed can be obtained by calling the secretary of state's office. Some states list the filing fee in their LLC Act, if so, the amount is listed in the chapter for state laws. States not listed do not publish a schedule of fees, but should be within the limits mentioned. If articles are filed by mail, a blank check made payable to the secretary of state can be sent. The secretary of state will fill in the appropriate amount.
E. ISSUE MEMBERSHIP CERTIFICATES
Before the articles are filed they have to be approved and adopted. The person who will file the articles calls a meeting of potential members who decide on the provisions to be contained in the articles. They also vote whether or not to manage as a collective group of all members or to select a centralized panel of managers. Once adopted, the articles are signed by all the managing members (or by all members if management is to be by all collectively).
Once adopted and signed, the articles can be filed. Once filed, the LLC exists on paper only (de facto). Until membership certificates are actually issued, it does not exist at law (de jure). Outstanding membership certificates in the hands of members is the defining characteristic behind the existence of an LLC.
After filing the articles, the next step is for the potential members of the LLC to meet and purchase their membership certificates and the adoption of the operating agreement for the business. The adoption of the operating agreement could have occurred at the first meeting. The membership certificates, however, should be issued only after the articles are filed when it has become a de facto LLC. Until the business actually exists (has its articles filed), it does not have the legal right to sell its membership certificates. If a business's articles are denied at filing, the business must return any money that it received from the premature sale of membership certificates. If the money cannot be returned, the person who received the money for the business can face serious criminal charges. Again, no money should be taken for membership certificates until after the articles are filed.
The members must adopt an operating agreement which governs the day-to-day management of the business and the rights and obligations of the members. It is similar to the by-laws of a corporation or the partnership agreement of a general or limited partnership. The law regarding operating agreements is specifically discussed in the Operating Agreements chapter.
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CHAPTER 4
TAX CONSIDERATIONS
This chapter is intended to help explain the tax consequences that will be faced in creating a limited liability company. These consequences are, in themselves, neither good nor bad, they merely exist. This chapter is definitely not intended to replace a tax professional. An entire book can be written on limited liability tax law. Given these limitations, this chapter gives the reader a basic overview of the most important aspects of the limited liability company tax law. THE IMPORTANT POINT TO BEAR IN MIND IS THAT A LLC WILL BE TREATED FOR FEDERAL TAX PURPOSES AS EITHER A CORPORATION OR A PARTNERSHIP DEPENDING ON THE OPERATING SELECTIONS MADE BY THE MEMBERS IN THE OPERATING AGREEMENT.
Armed with this knowledge, a member will be better able to effectively participate in planning the LLC's operations. The recommendation that a limited liability company consult a tax professional is both rational and reasonable. Limited Liability Company tax law, when treated as a partnership, is, in many instances, the same as individual and partnership tax law. There are, however, areas of particular concern for which members should be aware. It is towards those areas, that this chapter is addressed.
I. TAX TREATMENT AS EITHER A CORPORATION OR A PARTNERSHIP
A. INTRODUCTION
The main reason that people form an LLC is to avoid personal liability for the debts the business may incur. In a general partnership or joint venture, all of the partners and joint venturers are jointly and severally liable for the debts if the partnership. Each of the partners is totally liable and responsible for paying all the debts of the partnership or joint venture even though the partner may own only a fraction of the entity.
By contrast, in a corporation, shareholders are not responsible for the payment of a corporation's debts. Limited partners are not responsible for the payment of the limited partnership's debts. The major differences between a corporation and a limited partnership are:
A third difference between partnerships, both general and limited, and a corporation is how they are taxed. Partnerships are not taxed on their income. Partnership income is divided among partners according to their ownership interest in the partnership. Partnership income is allocated to each partner, and each partner reports this income on his personal income tax return. The tax arrangement is different for a regular corporation (called a C corporation). A tax is placed on all of the C corporation's net income. Distributions which are made to the shareholders are treated as dividends and are included on the shareholder's tax return. The income of a C corporation is taxed twice: once at corporate level and again when distributed to the shareholders.
The double taxation of the income of a C corporation is imposing on small businesses. A small business that operates as a C corporation has its income taxed twice, resulting in shareholders receiving reduced amounts of net income. The corporation does, however, protect shareholders from liability. On the other hand, if the business is a general partnership, income is passed to the partners where it is taxed only once, as personal income. There is no limited liability for the general partners for business debts.
In contrast, if the business is operated as a limited partnership, partnership income to partners is still taxed only once, and limited partners have limited liability for business debts. They are, however, precluded from working in the business.
To help small business, Congress enacted a special provision (subchapter S) in the tax code, creating a subchapter S corporation or simply, an S corporation. Congress permits a small corporation having only one class of stock and having 35 or less shareholders who are Americans or legal residents (corporations, partnerships and non-resident aliens can not be shareholders) to elect to become an S corporation. The S corporation is treated for tax purposes as a partnership. The S corporation has the protection of a corporate form plus the right of the shareholders to participate in the business and have its income taxed as a partnership.
The favorable tax treatment of an S corporation when combined with the right of the shareholders to participate in the business's management without losing their protection for corporate liability are cogent reasons for choosing an S corporation entity over a partnership or a C corporation.
B. LIMITED LIABILITY TAX TREATMENT
A LLC is a cross between a corporation and a partnership because it has operative elements of both. An LLC offers protection from liability of the business's debts to all of its members like a corporation does for it shareholders. The management and operations of the LLC are governed by the terms of the operating agreement, which is similar to a partnership agreement. Because of this cross nature, not all states recognize LLC's. In fact, January 1994 data reflects that only 46 entities permit businesses to operate as an LLC.
For federal tax purposes, an LLC poses unique concerns. Because it has elements of both a C corporation and a partnership, the IRS has struggled over how to tax it: partnership or corporation. If the LLC is taxed as a partnership, its income is passed to its members and double taxation is avoided. On the other hand, if the LLC is taxed as a corporation, its income is taxed twice: first when earned and second when received by members. Clearly, it is better for an LLC to be taxed as a partnership.
Whether taxed as a corporation or a partnership, the members of a limited liability company will still be protected from liability for the company's debts.
C. THE INTERNAL REVENUE SERVICE'S DETERMINATION TEST
A LLC offers some distinct advantages over an S corporation. Like an S corporation, an LLC may, under appropriate circumstances, be treated as a partnership for tax purposes. In addition, an LLC, unlike an S corporation, may have:
The above advantages that are available to LLC's are some of the reasons for the growing demand for LLC's in the United States and abroad (even Mexico recognizes them as well as ordinary corporations).
To determine whether an LLC will be taxed as a corporation or a partnership, the IRS has developed a four-prong test. If an LLC possesses any three of the four following corporate characteristics, it will be taxed as a corporation and not as a partnership:
In determining whether an LLC is treated as a corporation or partnership for tax purposes, the United States Tax Court in Larson vs. Commissioner 66 T.C. 159, required the IRS to give equal weight to each of the above characteristics. The IRS acquiesced (agreed to comply with the Tax Court's directive). This is the test to be applied to determine if an LLC will be treated as a partnership or as a corporation for tax purposes.
Under the regulation promulgated by the IRS, if the operating agreement states that the business will dissolve upon the death, insanity, bankruptcy, retirement, resignation or expulsion of a member, the continuity-of-life characteristic will not exist. If the operating agreement provides for the continuation of the business after the occurrence of any of the foregoing events, the continuity-of-life characteristic will be met. Where all of the members must consent to the continuation of the business upon the happening of any of the foregoing events, the continuity-of-life characteristic is not met because of the uncertainty of remaining members approving the continuation.
The IRS regulations state there is no centralized management of an LLC unless the managing members are vested with sole authority to make decisions. When the managing members are elected by the members, the corporate characteristic of centralized management exists. The corporate characteristic of limited liability exists if, under state law, the members are not liable for the debts of the company. Twenty-four states recognize that members of LLC's are not liable for the company debts. A limited liability company formed in these states will have the corporate characteristic of limited liability for its members.
The corporate characteristic of free transferability of interest is the characteristic most likely to cause concern. The IRS regulation holds the test is whether or not a member can substitute another person into the company for himself without the consent of the other members. For free transferability to exist the person acquiring the interest in the business must be able to assume all of the rights, powers and duties of a member. The characteristic of free transferability will not exist if a member is limited to assigning only the right to participate in the business' profits but cannot automatically participate in the business' management.
In a series of Revenue Rulings to determine whether an LLC should be treated as a corporation or as a partnership for tax purposes, the IRS has applied the following tests:
IMPORTANT NOTE: EVEN THOUGH SOME STATES PERMIT A LIMITED LIABILITY COMPANY TO HAVE ONLY ONE MEMBER, THE INTERNAL REVENUE SERVICE HAS STATED THAT IN REV. PROC. 95-10, THAT IN ORDER FOR A LIMITED LIABILITY COMPANY TO BE TREATED AS A PARTNERSHIP FOR TAX PURPOSES IT MUST HAVE AT LEAST TWO MEMBERS. AS A RESULT OF THE IRS'S REV. PROC. 95010, IF A SOLE INDIVIDUAL WISHES TO FORM A SOLELY-OWNED BUSINESS ENTITY AND HAVE IT TREATED AS A PARTNERSHIP, THE INDIVIDUAL SHOULD CONSIDER FORMING A SUBCHAPTER S CORPORATION BECAUSE ANY LIMITED LIABILITY COMPANY THAT A LONE INDIVIDUAL FORMS WOULD BE TREATED TAXWISE AS IF IT WERE A CORPORATION. IF, HOWEVER, SUCH A LIMITED LIABILITY COMPANY SUBSEQUENTLY WERE TO ADD ANOTHER MEMBER THEN UNDER REV. PROC. 95-10, IT COULD QUALIFY FOR PARTNERSHIP TAX TREATMENT PROVIDED THE OTHER REQUIRED ELEMENTS WERE MET. REV. PROC 95-10 SHOULD BE REVIEWED BEFORE FORMING A LIMITED LIABILITY COMPANY TO ASSURE THAT THE COMPANY MEETS THE TESTS FOR PARTNERSHIP OR CORPORATION TAXATION AS SET FORTH ABOVE.
Generally, it just does not make good sense to do business as an LLC unless the company will be treated as a partnership for tax purposes. If the company is going to be taxed as though it were a corporation, it should be a corporation in fact. As a corporation, a subchapter S election can be made to have the corporation treated as a partnership anyway. The items that must be relinquished to ensure an LLC is not a corporation for tax purposes are important; the members must agree that:
These requirements all have an impact on the value of the company. A corporation that will terminate on the death or resignation of a member has very little cash value beyond its assets. Moreover, if a purchaser cannot participate in the company's management, there will be no way that the assignee can protect his interest. The market for the membership interest in an LLC that is treated as a corporation for tax purposes is severely limited.
The operating agreement in this book contains provisions for the members to elect to have the company treated as either a corporation or a partnership. Unless the company will be treated for tax purposes as a partnership, an LLC should not be created. A subchapter S corporation should be created instead.
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CHAPTER 5
LIMITED LIABILITY OF MEMBERS
I. INTRODUCTION
It is the hallmark of an LLC that neither its members nor its managers are personally liable for the debts of the company. In this respect, a LLC is similar to that of a corporation. A limited partnership bestows limited liability on the limited partners, but the general partners remain personally liable for payments of all the partnership debts. It is the limited liability of its members that is the most important elements of an LLC. Each of the 48 entities that permit LLC's have laws that specifically state that the members of LLC's are not liable for the payment of the company's debts, liabilities or obligations except under certain circumstances. The American Bar Association's (ABA) Working Group on the Prototype Limited liability Company Act of November 1992 proposed in section 305 the following uniform provision:
"A member of a limited liability company is not a proper party to a proceeding by or against a limited liability company solely by reason of being a member of the limited liability company, except where the object of the proceeding is to enforce a member's right against or liability to the limited liability company or as otherwise provided in the operating agreement."
This provision is very similar to that contained in the laws of those states that permit LLC's. The ABA hopes to create a Uniform Limited Liability Company Act that will be adopted by all of the states.
This chapter explains the unique facts and circumstances under which members of an LLC can be found liable for the debts of the company. Such situations are few, but they can arise often enough that the specter of loss of limited liability protection is a real concern for the company.
II. LIABILITY IMPOSED BY LAW
As stated above, the general rule is that members of an LLC are not liable for the debts, liabilities and obligations of the company; hence the name LLC. As with any rule, there are exceptions. First, the law simply means that no member or manager will be liable for the company's debts just because they happen to be members or managers of the company. The non-liability of members is the main difference between an LLC and a general partnership (in which all of the partners are liable for the debts of the partnership). While members are not liable for the debts of the LLC because of their membership status, they may be liable for the company's debts based on other unrelated grounds.
A person cannot avoid liability for his personal acts regardless of the type of business in which he is engaged. Just as a shareholder is personally responsible for his own torts (civil wrongs), so is a member of an LLC. Example: If a member if an LLC illegally dumps hazardous wastes belonging to the company, he will be personally liable for the damages as well as the company being liable. The liability of the member is not because he is a member of the company but because he directly committed the tort. If a member could not be liable for torts committed for the benefit of the company, then all types of criminal or tortious conduct would be committed by individuals under the umbrella of their companies.
In the operating agreement or in the articles the members can agree that a member will be liable to the LLC or its individual members for damages derived from gross negligence or willful misconduct of the member. In fact, this is a common provision in most operating agreements because it requires all of the members to use ordinary business acumen and care in running the business. All members of a company are presumed by law to be bound by a fiduciary duty toward the other members. This same fiduciary duty exists between partners of a partnership and the officers of a corporation. A person who breaches such a fiduciary duty is normally liable to fellow members for all of the damages caused by the breach. The member may be sued by fellow members for damages caused to the company as a result of the breach. The member is liable for the debts or liabilities suffered by the company as a result of his gross negligence or willful misconduct.
Another instance in which liability may be imposed on a member is if the member agrees in the operating agreement or subsequent written agreement to make a future contribution, that is an asset of the company. If that contribution is not made and a creditor of the company obtains a judgement against it, the creditor may execute against the member for the value of the promised contribution. For example, assume that George had agreed to contribute $100,000 in the future as payment for his interest in the company. He had not paid the money by the time Ed obtained a judgment for $200,000 against the company. Ed can sue George for the $100,000 he agreed to contribute to the company.
In addition, a member will be liable for any company debt or obligation he personally guarantees. The liability for guaranteed debts is the same as that of shareholders who give personal guarantees for a corporation's debts. This is straight forward. If a lender loans a company money or grants it credit based on a member guaranteeing payment, the lender can sue the member for such payment if the company defaults on its performance.
The above are unique situations in which a member will be held liable for the debts or obligations of an LLC. They illustrate that liability for such debts occurs because a member breached a fiduciary duty or specifically agreed to be bound for the debts by a guarantee or promise to make future contributions.
III. LIABILITY UNDER THE ALTER-EGO THEORY
LLC's are rather new. As a result, much of the case law as to how courts will treat them is developing. A potential guide for this developing law is how the courts treat corporations. An aspect of corporate law that will be applicable to LLC's is the alter-ego theory (also called "piercing the corporate veil"). This theory is used to find shareholders personally liable for the debts of the corporation. Since LLC's share some of the characteristics of corporations, this theory should be of concern to LLC members.
Under the alter-ego theory, if shareholders disregard the corporate form and act as though the business were a partnership, it will be treated as a partnership. This is not for tax purposes but for personal liability for the company's debts. The courts look to substance over form. If a business acts as a partnership, it may well be treated as a partnership even if it was validly formed as an LLC. If a business is treated as a partnership, its members are personally liable for the debts of the company.
A court looks at several aspects to determine if the alter-ego theory applies. It determines if a corporations by-laws were ignored along with any pertinent state laws. In like manner, a court will probably investigate an LLC's comparable instrument, its operating agreement, to find violations of its provisions as well as violations of state laws. Many states also require corporations to maintain a minimum capitalization in order to conduct business. A court may look to the LLC for adequate capitalization, even though there is no statutory requirement.
As in corporate law, if members misrepresent the status of the LLC, such as saying it is a corporation or a partnership when it is a limited liability company, the courts will probably find it to be a partnership based upon those misrepresentations. In a practical sense, courts probably will be reluctant to declare an LLC the alter-ego of a partnership and LLC's are not required to maintain a minimum amount of capitalization. Consequently, they cannot be declared partnerships for failing to maintain a certain amount of capital.
Unless the members have actually disregarded the terms of the operating agreement or deliberately misled third parties as to the company's true form, it is unlikely that a court will declare the LLC to be a partnership.
IV. LIABILITY IN STATES NOT HAVING LLC LAWS
As of January 1996, only 48 entities permit LLC's to be formed in their boundaries. A minority of only two states (Hawaii and Vermont) do not permit their citizens to do business using LLC's. Not since the civil war has there been such a clear delineation of states along a single line. A conflict of law is imminent concerning treatment of an LLC wishing to or doing business in a state that does not recognize LLC's. The law, as yet, is unsettled as to whether a non-LLC company state will be forced to permit a LLC from another state the right to do business in the state with limited liability protection for its members.
Deep questions as to state sovereignty and public policy arise in discussing this issue. It would seriously erode a state's traditional power to provide for the health, safety and welfare of its citizens if it were forced to accept an LLC from another state while denying its own citizens the right to do business the same way. A business properly formed in one state should be permitted under the Full Faith and Credit Clauses of the United States Constitution to conduct business in any state. Forcing a state to grant full faith and credit to the LLC is to permit a foreign company to conduct business in the state in a manner that is not allowed the citizens of that state. This brings about the corollary: citizens of the state would be denied equal protection of the law because they are not permitted to conduct business as LLC's. The clear consequence is that the state will have to permit its own citizens to form LLC's even if it does not believe this is best for its citizens. This occurrence means that public policy for the state is being set, not by the state, but by the other states.
All of the states permitting LLC's have provisions that permit their LLC's to do business in other states. These states hope that through these provisions the states which do not have LLC's will be compelled to grant full faith and credit status to their companies.
Before an LLC does business in a state which does not permit LLC's, the members should consult a corporate and a tax attorney in that state. Before conducting business in a non-LLC state, the LLC must know how that state will treat the company. Many of the non-LLC states will permit foreign LLC's to do business in their state and will honor the terms of the operating agreement, including its limited liability provisions. While that may be the case in some states, it should not be assumed to be the case in all. Until the United States Supreme Court rules on the issue of whether a non-LLC state must recognize foreign LLC's, the matter will be decided by each individual state in its courts in small, difficult cases.
As it now stands, each of the non-LLC states can decide for themselves whether they will permit foreign LLC's to conduct business. If a state elects to prohibit foreign LLC's, an LLC doing business in the state will probably be treated as a partnership, and members of the company will be treated as partners and be personally liable for the debts and liabilities of the LLC incurred in the state.
Until the matter is decided by the United States Supreme Court, one should conclude that the members of an LLC will not have limited liability for debts incurred in any state that does not recognize LLC's. When business is conducted in any of the four states that do not permit the formation of LLC's, the members of the LLC must weigh the consequences of their acts. If chances of a lawsuit from the out-of-state business are slight, no harm is derived from doing the business. It is the function of any business to weigh the risks of any decision and to compare them to the potential benefits.
Most LLC's will do business solely within their own states or in states which permit LLC's so problems concerning limited liability of their members should not arise. It is only when the LLC seeks to do business in non-LLC states that the real potential for liability arises for the members. Before conducting business in a non-LLC state, legal advice should be obtained concerning state recognition of liability protection for the members. The advice should be in writing; the person who gave it can be sued for malpractice if it is wrong.
CHAPTER 6
CAPITAL CONTRIBUTIONS AND DISTRIBUTIONS
I. INTRODUCTION
This chapter discusses the financial arrangement of an LLC: the capital contributions of the members and how they affect members' rights in the company. The states that permit LLC's to be formed have adopted specific statutes concerning contributions of the members and their effects. This chapter explains how LLC states treat a member's contributions and distributions.
II. CAPITAL CONTRIBUTIONS
A. A MEMBER'S SHARE IN PROFITS AND LOSSES
The members of an LLC can agree to split the profits and losses in any manner they wish. In the absence of a specific method defined in either the articles of organization or the operating agreement, state law will determine how they will be allocated. Most states will base a member's ownership in an LLC on the member's percentage of contributions to the firm rather than the per capita basis used for a partnership.
In the following states, for example, book value or a member's contributions to the LLC is used to determine percentage of the member's interest absent an agreement to the contrary:
Florida Illinois Iowa Maryland
Minnesota Nevada Oklahoma Rhode Island
Texas Utah Virginia W. Virginia
Wyoming
The only contribution considered in determining a member's interest is the value of the capital contribution actually given to the company. For example, assume that a member guarantees a loan for the company. The loan does not increase the book value of the company, but for purposes of per capita valuing the loan would be included. For example, assume that the members contribute services to the company. The services will not increase the book value of the company.
In some states, such as the following, a member's voting interest is based upon per capita interest of the member in the company absent an agreement to the contrary:
Arizona Colorado Kansas Louisiana Delaware
Per capita interest means equal splitting of the profits and losses among the members. The per capita formula is most often used where the members are personally liable for the debts of the business such as a partnership. The personal liability of the members gives them a greater interest in the company than just capital contributions. Since members in an LLC have limited liability, the rational for using per capita sharing is not present.
In most small businesses the members participate equally in business operations. Since the members have no personal liability, there is little reason to maintain the records necessary for per capita sharing. The majority rule for sharing requires only a record of capital contributions. Per capita, however, requires a record of every form of contribution. Loan guarantees and service contributions have to be constantly updated and calculated. The per capita rule is basically the rule used for a partnership stating that all profits and losses of a partnership are split equally among the partners unless a partnership agreement is written otherwise.
Use of the per capita rule would be an unnecessary burden for most LLC's. Consequently, the operating agreement in this book is written for capital contributions (the majority rule rather than the per capita rule).
B. AMOUNT OF CONTRIBUTIONS
Unlike the statutes for corporations, states do not require an LLC to have or maintain a minimum amount of capital to be formed or to continue to exist. The traditional reason for requiring a minimum amount of capital was to provide security for creditors of the business. In the modern business world, creditors do not base their dealings with a business on any minimum capitalization. Instead, creditors base their loan or credit with businesses on credit reports. Recognizing this, states that permit LLC's do not require them to maintain minimum capitalization.
Since state law does not require any specific amount of contributions, it therefore falls on the members to agree on amounts and forms of contributions. The amount of each member's contribution must consider the total needs of the company to conduct business. The agreement regarding capital contributions must be included in the operating agreement. State laws also permit members to agree to make future capital contributions if requested. Any agreement that binds members to future contributions must be in writing to be enforceable.
Generally, it is not a good idea to have a provision in the operating agreement that permits calls upon members for additional capital. If a company needs more money, members may voluntarily contribute funds. Members making additional contributions have their capital accounts increased. Thus their ownership interest and share of profits in the company will increase.
C. FORM OF CONTRIBUTIONS
Most states permit members to make contributions to an LLC in any form that has value to the company. Contributions in the form of cash, property, service, guarantees or promissory notes are acceptable. Loans from a member to a company are not treated as a capital contribution because the money must be paid back. If, however, the member forgives the loan to the company, the value of the loan will be treated as a capital contribution.
A few states (most notably Arizona, Colorado, Delaware, Florida and Wyoming) forbid contributions of services for an interest in the company. Generally, it is not wise to count services as a contribution to capital. In a small company all members contribute services, and it would be derisive to value one member's services over that of the others. To do so risks disharmony among the members.
It is wiser to base members' interests on cash and property actually contributed. In the long run, it will prove the better way. It is the combined contributed services and capital that makes the company work. As such, if the actual division is too unfair, the business will not continue. The members can always agree in writing to adjust the division of profits and losses to reflect the intentions of the members.
**** end of sample view of chapter ****
CHAPTER 7
DOING BUSINESS IN OTHER STATES
I. INTRODUCTION
As an important consideration for an LLC that will be doing business in states other than where formed is how the company will be treated in these foreign states. Only 48 states and the District of Columbia permit LLC's to be formed (Hawaii and Vermont are the sole-holdouts as of January 1996). This split between states that permit LLC's and those that do not creates uncertainty for LLC's doing business across state lines.
This chapter mentions problems and offers resolutions available for LLC's doing business across state lines. Major concerns are how the LLC will be taxed and if members will be accorded limited liability for company debts incurred in an alien state. Because LLC's are new, it is unclear how non-LLC states will treat LLC's doing business in their boundary. Nevertheless, by drawing comparisons with corporations and limited partnerships, one can determine how LLC's will be treated.
II. FOREIGN LLC ENTITIES
A. IN STATES WHICH RECOGNIZE LLC
The states which permit LLC's to be formed also recognize LLC's from other states (these are generally called foreign LLC's). To conduct business in a state which permits LLC's, a foreign LLC merely registers with the secretary of state just as a foreign corporation or limited partnership must do. Once the foreign LLC has filed the appropriate documents to conduct business in the state (usually no more than an application), it is permitted to engage in business on the same footing as an LLC formed under that state's LLC law.
A foreign LLC remains governed by its operating agreement in another state as long as those provisions do not violate the other state's law. The statutes of most states permitting LLC's have provisions that specifically detail that the state law of the foreign LLC controls on such issues as members' voting rights, capital contributions, members' liability and distribution. On the other hand, no state will permit a foreign LLC to conduct a business which is barred to LLC's formed under its own state law. Example: A provision of Virginia's Limited Liability Company Act states that a foreign LLC shall :
"have no greater rights and privileges than a domestic limited liability company to exercise any of its powers of purposes than a domestic limited liability company. The registration shall not be deemed to authorize the foreign limited liability company to exercise any of its powers or purposes that a domestic limited liability company is forbidden by law to exercise in this Commonwealth."
The Virginia statute makes clear that once a foreign LLC registers in the state it will be treated the same as a Virginia LLC. The operative word is registered. A foreign LLC will obtain similar treatment to a domestic company after it registers with the secretary of state of that state. Registration as a foreign LLC usually means filing an application which discloses:
Upon its submission, the secretary of state will review the application for compliance. If the application satisfies state law, the secretary of state will issue a certificate of qualification. After the certificate of qualification is issued, a foreign LLC can legally conduct business in the state. If a certificate of compliance is not issued, a foreign LLC cannot legally do business in the state. A foreign LLC that does not register with the secretary of state is taking a great risk. Without a certificate of compliance, the company is not allowed to file and maintain a lawsuit in court. Moreover, if a foreign LLC does not register with the secretary of state but continues to do business in the state, its members may lose limited liability protection. For example, assume that a foreign LLC from state A fails to register in state B. Its members may become personally liable for debts incurred by the company in state B. In addition, a company which does not register with the secretary of state will be liable for both fines and penalties.
B. IN STATES THAT DO NOT RECOGNIZE LLC
A minority of only two states remain which do not recognize LLC's. This poses a unique Constitutional question. "How is a foreign LLC treated when it does business in a state that does not recognize LLC's? Because they are new, it is unclear how they will be treated when doing business in states that do not permit LLC's. The state, Hawaii or Vermont, has two options. It could:
Arguments concerning how the state should proceed are equally split. Granting full faith and credit to the LLC is to permit a foreign company to conduct business in the state in a form that is not permitted the citizens of that state. Therefore, the citizens of the state are denied the equal protection of the law because they are not permitted to conduct business as LLC's. The counter argument is that a business properly formed in one state should be permitted under the United States Constitution to conduct business in any state.
All of the states which permit LLC's have provisions that permit their LLC's to do business in other states. These states believe that these provisions will move the states that do not have LLC's to grant full faith and credit status to their companies.
The general consensus is that most probably the U. S. Supreme Court will not require those states not permitting their citizens to form LLC's to recognize foreign LLC's. The rationale would be premised on the belief that no state should be able to force another state to change its law as long as it is applied equally. If a state does not recognize a LLC for its citizens, it would seem reasonable that the Supreme Court would probably not be require it to recognize LLCs for citizens of other states.
The most compelling argument in favor of forcing states that have not adopted LLC statutes to permit foreign LLC's to do business is the contract clause of the U. S. Constitution, whereby no state is permitted to make any laws which impair the obligations of contracts. Thus the argument is members agreeing to conduct business as an LLC form a contract among themselves, and the state should not interfere. The weakness of this argument is that their contractual agreement also affects rights of third parties who had not agreed to be bound. Example: An employee of an LLC becomes involved in an accident in a state that recognizes LLC's. The members will not be liable for the damages. If the LLC is doing business in a state that does not recognize LLC's, the member may be found personally liable for the damages. The argument by the states that do not permit LLC's is that LLC's are not needed because the state already permits corporations and limited partnerships as vehicles for limiting liability for partners, shareholders or investors.
Until there are more decisions, it is wiser and safer to conclude that members of an LLC would probably not have limited liability for debts incurred in any of the five states that do not recognize LLC's. As a practical matter, most small companies do not engage in business across state lines. Those that do find it is not the type of business resulting in large lawsuits. An LLC formed in any of the 48 states or District of Columbia that permit them can freely engage in business in any of them without fear of losing limited liability protection for members. When business is conducted in any of the states that do not permit the formation of LLC's, the members of the LLC must weigh the consequences of their acts. If chances of a lawsuit from the out-of-state business is slight, no harm is derived from doing the business. On the other hand, as potential for a lawsuit increases, risk to members also increases.
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CHAPTER 8
BULK SALE
When members transfer assets of a prior business to an LLC in return for stock, the LLC must consider the state's Bulk Sale Law. All states have adopted the Uniform Commercial Code in some fashion. A portion of the Code deals with giving notice to creditors of a bulk transfer of assets of a business.
The purpose of the Bulk Sale Law is to prevent business owners from attempting to defraud or avoid creditors by transferring all or substantially all (i.e. the bulk) of the business assets to another person or entity. The law also inhibits the sale of assets in a bargain or sweetheart sale (below fair market value), a scheme whereby the owner of the business still retains some control. Example: The sale of business assets to another business that the owner also controls.
For most new LLC's involving prior existing businesses there is no intention to defraud creditors. An LLC is usually established to change the form of the business, not to disassociate from the debts of the prior business. Where the LLC assumes both assets and debts of an unincorporated business, compliance with the Bulk Sale Law is merely a formality. The new LLC is responsible for the debts of the old business to the extent of the value of the assets transferred.
The real concern arises where the business transferring all of its assets to the LLC will have debts that the LLC will not assume. In this situation, the LLC should consult an attorney to ensure it will not be liable for those debts. The Bulk Sale Law of each state was enacted to settle such disputes.
Under the Bulk Sales Act of the Uniform Commercial Code, a LLC can safely issue its membership interests for property transferred to it by a business with outstanding liabilities, which the LLC will not assume, if it does the following:
Section 6-104 of the Uniform Commercial Code (adopted by all states) reads in part:
(1) Except as provided with respect to auction sales (Section 6-108), a bulk transfer subject to this Article is ineffective against any creditor of the transferor unless:
(a) The transferee requires the transferor to furnish a list of his existing creditors prepared as stated in this section, and
(b) The parties prepare a schedule of the property transferred sufficient to identify it, and
(c) The transferee preserves the list and schedule for six months next following the transfer and permits inspection of either or both and copying therefrom, or files the list and schedule in (a public offic to be here identified).
After the notice is given to the creditors, if the creditors do not object to the transfer, the LLC can take possession and title to the assets free of all creditors claims. If, however, creditors for the prior business present claims against the property, special rules apply. Section 6-106 Uniform Commercial Code reads as follows:
"In addition to the requirements of the two preceding sections:
(1) Upon every bulk transfer subject to this Article for which new consideration becomes payable except those made by sale at auction it is the duty of the transferee to assure that such consideration is applied so far as necessary to pay those debts of the transferor (Section 6-104) or filed in writing in the place states in the notice (Section 6-107) within 30 days after the mailing of such notice. This duty of the transferee runs to all the holders of such debts, and may be enforced by any of them for the benefit of all.
(2) If any of such debts are in dispute the necessary sum may be withheld from distribution until the dispute has been settled or adjudicated;
(OPTIONAL PROVISIONS FOR THE STATES)
(3) If the consideration payable is not enough to pay all of the said debts in full distribution shall be made pro rata.
(4) The transferee may within 10 days after he takes possessions of the goods pay the consideration into the (specify court) in the county where the transferor has its principal place of business in the state and thereafter may discharge his duty under this section by giving notice by registered or certified mail to all the persons to whom the duty runs that the consideration has been paid into that court and they should file their claim there. On motion of any interested party, the court may order the distribution of the consideration to the persons entitled to it."
Basically, if the LLC wants to exchange an equity interest for property of a another business and creditors of that business are asserting their rights, the LLC has two choices. It can pay off the creditors of that business. This amounts to paying twice for the property. Secondly, the LLC can deposit the membership interest with the court and let the court decide who owns them. The court may decide to present the LLC with some entirely unexpected members with whom the other members cannot operate. Neither of these eventualities are especially appealing. The third unspoken alternative is probably the one most often followed, forgetting the entire transaction. For this reason, in the event of a bulk transfer dispute, the LLC should, for its own protection, seek legal advice before proceeding with the transaction.
A typical form for a "Notice to Creditors" follows.
RECORDING REQUESTED BY
WHEN RECORDED MAIL TO
______________________________________________________________________________________ Space above the line is for Recorder's use
NOTICE is hereby given to the CREDITORS of _______________________________________Transferor (s), whose business address is ________________________________________________________,County of ________________________, State of ____________________________ .
The property is described as general: ALL STOCK IN TRADE, FIXTURES EQUIPMENT AND GOOD WILL OF THAT:
______________________________________________________________________________ TYPE OF BUSINESS
BUSINESS KNOWN AS ________________________________________________ NAME OF BUSINESSand located at ___________________________________________ ___________________________________,County of ________________ State of __________ .
The Bulk Transfer will be consummated on or after the ______day of ______ , 199__ at ________ _____________________________
####END OF SAMPLE VIEW###
CHAPTER 9
SECURITY LAWS AND COMPLIANCE
I. INTRODUCTION
Membership certificates in an LLC are considered securities under both state and federal law. An LLC's sale of its membership certificates requires the membership certificate be registered and a permit (license) for the sale be obtained unless the membership certificate is exempt from registration. The costs for registering a security under federal law are $100,000 or more and it takes a year or longer to complete.
Both state and federal security laws provide exemption from registration for certain kinds of membership certificates. These exemptions are available only to small businesses that have not attempted to sell their securities through a public offering (public advertisement or solicitation). Exemptions for both state and federal security laws apply when the LLC is a new business being formed or an existing business (whether sole proprietorship or partnership) is being changing into an LLC. The company's members are the prior owners and possibly some of those who have worked closely with the prior business. In such a situation, there is no need for a public solicitation or advertisement. Therefore, exemptions from registration under both state and federal security laws will apply.
This book is not intended to be used by anyone desiring to raise money for an LLC through a public offering. Anyone intending to do so must consult with an attorney. There probably is not an exemption from registration under state or federal law.
Even if an LLC is exempt from the registration requirement for the sale of its securities, the LLC will still be governed by the anti-fraud provisions of the Securities and Exchange Act.
II. EXEMPTION UNDER FEDERAL LAW
The Securities and Exchange Act of 1933 specifies that the sale in the United States of any security (including membership certificates of an LLC) must be registered with the Securities and Exchange Commission unless the security is exempt. The Securities and Exchange Act (the Act) lists several exemptions that are available for small businesses and small private offerings.
A. INTRASTATE EXEMPTION
Section 3(a)(11) of the Securities and Exchange Act offers an intrastate exemption from registration for any offer or sale of securities to residents of a single state who reside in the same state where the LLC was formed and does business. The Securities and Exchange Commission interprets the intrastate exemption to have four requirements:
(1) The LLC must be doing business in the state in which it was formed. This is defined to mean the LLC must have substantial operational activities in the state.
(2) All the offers and sales of membership certificates must be to residents of the LLC's state of organization.
(3) The membership certificate may not be resold by the member to out-of-state purchasers until at least nine months after the last sale of the LLC.
(4) No public solicitation or advertisement is permitted under this exemption.
This is the most commonly used exemption from federal registration. Usually an LLC is established to change the legal form of operation for an existing business or to begin a new business with family members or close friends. Normally, all of the members will reside in the same state and qualify for the intrastate exemption. If not, the exemption is not available for the LLC; however, other exemptions from registration for the sale of the membership certificates may still be available.
B. EXEMPTION UNDER REGULATION D
Section 3(b) of the Securities and Exchange Act grants the SEC (Securities and Exchange Commission) authority to adopt special exemptions for the issuance of securities to a maximum of $5,000,000. The SEC adopted Rules 504 and 505 of Regulation D. Section 4(2) grants the SEC authority to issue special exceptions for "transactions by an issuer not including any public offering," and the SEC defines this type of exemption under Rule 506.
Rule 504 of Regulation D exempts from registration the sale of securities (such as LLC's membership certificates) when:
Rule 505 of Regulation D exempts the sale of an LLC's membership certificate when:
Rule 506 of Regulation D also exempts certain offerings from registration. An LLC, to be exempt form registration of sale of its membership certificates, must conform to specific requirements:
This chapter has an example of a Member's Subscription Certificate that should be executed and filed with the LLCs books for each sale of a LLC membership interest. This certificate is sufficient to satisfy the requirement that the investor is sophisticated and accredited. This subscription agreement should be used by every LLC to protect against allegations of fraud. Generally, when a business fails the members try to get their money back. it is not uncommon in such situations for disgruntled investors to claim that they were innocent dupes and tricked into investing in the business. Using a subscription certificate is evidence, though not dispositive, that the member was given all of the available necessary to make an informed decision. Use of the form limits the success of suit for security fraud by upset members.
When substantial amounts of capital are sought to be raised through the sale of LLC membership interests that are exempt under Rules 504, 505 or 506, the LLC should consult an attorney.
Although qualified offerings are exempt under Rules 504, 505 or 506, the LLC must nonetheless file a Form D with the Securities and Exchange if interest are sold to out of state members. It is envisioned that the limited partnership to be formed using this book will use the intrastate exemption instead and not be required to file the Form D.
This book assumes that the LLC will be a small business with less than 35 members (for exemption from federal registration) who will be intimately associated with the day-to-day operations of the company. Consequently, the exemptions will apply. If substantial amounts of capital are to be raised through the sale of membership certificates that are exempt under Rules 504, 505 or 506, the LLC should consult an attorney. Although qualified offerings are exempt under Rules 504, 505 or 506, the LLC must nonetheless file a Form D with the SEC.
This book is written for LLC's where:
(1) The members will participate in the daily management of the business or reserve sufficient review powers in the operating agreement to be able to oversee effectively thE conduct of the managing members.
(2) The LLC is not selling its membership certificate to raise money.
It is envisioned that the LLC to be formed using this book will use the intrastate exemption and not be required to file Form D.
C. EXEMPTION UNDER STATE LAW
As with federal law, nearly all states require that any LLC wishing to sell LLC membership interests in the state either obtain a permit to sell the LLC membership interests or that the LLC membership interests be exempt from registration. Most states have similar limited offering exemptions that permit a LLC to sell a LLC membership interest in the state without having to obtain a permit. Most states also have laws which exempt from registration any security where the LLC has either registered the security with the SEC or has filed Form D for a federal exemption under Rule 504, 505 or 506.
In addition to an exemption based upon a federal filing, all states have limited offering exemptions. LLCs not engaged in a public offering may sell LLC membership interests without a permit. Even though the sale of the LLC interest is exempt, many states require that the LLC file some type of notice with the Secretary of State or security commissioner and pay a small fee. Although notice is for tax purposes, it also serves other informational needs.
Most states do not require a LLC issuing exempt membership interests to file any notification documents. To determine if a notice requirement exists, the person forming the limited partnership can ask the state's department of corporations (or equivalent agency) if there is any state requirement that a form be filed when a newly formed LLC makes a limited exempt offering. If there is a requirement, the agency will supply the necessary form on request. This information can also be obtained from the attorney the LLC is consulting. The laws governing the limited offering exemptions for each state are:
ALABAMA
Section 8-6-11. Sales of the securities are exempt if sold to less than 10 persons within twelve months, no commissions are paid on the sales and no public solicitations or public offerings are employed.
ALASKA
Section 45-55-140. Sales of securities are exempt if sold to less than 10 persons within 12 months, the sales do not exceed $100,000, no commissions are paid on the sales and no public solicitation is employed.
ARKANSAS
Section 23-42-504. Sales of securities are exempt if sold to less than 25 persons within a year, no commissions are paid on the sales and no public solicitation is presented. Proof of the exempt nature of the transaction must be filed with the Secretary of State. The state has also adopted the Uniform Federal-State Limited Offering Exemption 14(b) (14) which basically provides for a state exemption if the issuer received a federal exemption by filing a Form D.
ARIZONA
Section 44-1844. Sales of securities are exempt if sold to less than 10 persons within 24 months, no commissions are paid on the sales and no public solicitations or public offerings are employed.
CALIFORNIA
Corporation Code section 25102(f). Sales to no more than 35 persons are exempt if no commissions are paid on the sales and no public solicitation or public offering is employed. The corporation is required to file a Notice of Transaction with the Corporations Commissioner. The Notice is to be filed within 15 days of the sale. The fee for filing the Notice is usually about $25.00. This book has a copy of the notice form. As can be seen from the form, there is no requirement that the identity of the shareholders be revealed. Failure to file the Notice does not invalidate the exemption.
California has also enacted a new intra-state offering exemption under Section 25102(n). Under this exemption, if the offeror satisfies the same requirements as necessary for a Federal Regulation D exemption, the offeror can sell to an unlimited number of people in California and can engage in limited advertising in a newspaper. The advantage of this offering is that the offeror, if the sales are limited only to California, can advertise in a limited fashion which it can not do in a Federal Regulation D offering if the sales are made in other states. The costs for a Regulation D or 25102(n) offering is around $20,000 when an experienced security law firm is utilized. Most offerings in California rely on the 25102(f) exemption is used because it extremely cheap and fast even though the number of sales is limited to 35 persons.
COLORADO
Section 11-51-308. Sales of securities are exempt if sold to less than 25 persons prior to formation and afterward if the offer of sales is not made to more than 20 persons and the actual sales are made to not more than 10 persons per 12-month period, no commissions are paid on the sales and no public solicitation or public offering is employed.
CONNECTICUT
Section 36-490(B). Sales of securities are exempt if sold to less than 10 persons within 12 months, no commissions are paid on the sales and no public solicitation or public offerings are employed.
DELAWARE
Section 6-7309(b). Sales of securities are exempt if sold to less than 25 persons within the first year and no more than 35 persons in total, no commissions are paid on the sales and no public solicitations or public offerings are employed.
DISTRICT OF COLUMBIA
Section 2-2601(6) lists as exempt transactions as follows:
(E) Any transaction pursuant to an offer directed by the offeror to not more than 25 persons in the District during any 12 consecutive months whether or not the offeror or any of the offerees is then present in the District if the Seller reasonably believes that all of the buyers in the District are purchasing for investment.
(F) Any offer or sale of a preorganization certificate or subscription if:
(i) No commission or other remuneration is paid or given directly or indirectly for soliciting any prospective subscribers;
(ii) The number of subscribers does not exceed 25; and
(iii) No payment is made to the subscriber.
FLORIDA
Section 517.061. Sales of securities are exempt if sold to less than 35 persons within a year, no commissions are paid on the sales and no public solicitations or public offerings are employed. Proof of the exempt nature of the transaction must be filed with the Secretary of State.
GEORGIA
Section 10-5-9. Sales of securities are exempt if sold to less than 35 persons within a year, no commissions are paid on the sales and no public solicitations or public offerings are employed.
HAWAII
Section 485-6. Sales of securities are exempt if sold to less than 25 persons within 12 months, no commissions are paid on the sales and no public solicitations of public offerings are employed.
IDAHO
Section 30-1435. Sales of securities are exempt if sold to less than 10 persons within 12 months, no commissions are paid on the sales and no public solicitations or public offerings are employed.
ILLINOIS
Section 815 ILCS 5/4. Sales of securities are exempt if less than $100,000 is raised or if sold to less than 35 persons within a year, no commissions are paid on the sales and no public solicitations or public offerings are employed.
INDIANA
Section 23-2-1-2. Sales of securities are exempt and no filing is necessary if each purchaser is either an accredited investor or will participate in the management of the business and either (1) there are no more than 15 purchasers in the state or (2) there are no more than 25 shareholders in total and the offering raises less than $500,000.
IOWA
Section 502.203(9). Sales of securities are exempt if sold to less than 35 persons within a year, no commissions are paid on the sales and no public solicitations or public offerings are employed. The exemption does not apply for offerings involving oil, gas or mining.
KANSAS
Section 17-1262. Sales of securities are exempt if sold to less than 15 persons within 12 months, no commissions are paid on the sales and no public solicitations or public offerings are employed.
KENTUCKY
Section 292.410. Sales of securities are exempt if sold to less than 25 persons, no commissions are paid on the sales and no public solicitations or public offerings are employed.
LOUISIANA
Title 51, section 709. Sales of securities are exempt if sold to less than 20 persons within 12 months, no commissions are paid on the sales and no public solicitations or public offerings are employed.
MAINE
Title 32, section 10502. Offers and sales of securities to no more than 10 persons are exempt. Sales from 10 to 25 persons are exempt if the issuer files a Notice of Exemption.
**** end of partial view of this section ****
MEMBER'S SUBSCRIPTION CERTIFICATE
FOR
KEPTON MINING COMPANY
This certificate is for use with security offerings exempt from registration under SEC Rules 504, 505 or 506. This certificate must be used for the sale of a limited liability company membership interest.
The statements contained herein are made and given by the undersigned hereinafter referred to as "the Subscriber" to KEPTON MINING COMPANY , a LIMITED LIABILITY COMPANY duly formed and existing under the laws of the State of COLORADO hereinafter referred to as "THE LIMITED LIABILITY COMPANY" as a condition for the purchase of TWENTY PERCENT (20%) membership interest of the limited liability company hereinafter referred to as "the Securities."
I. NAME AND ADDRESS OF THE SUBSCRIBER.
Name: ABNER TIMMONS
Social Security Number: 444-333-2222
Residence Address: 237 Tyler Rock
Denver, Colorado
Business Address:
II. SUBSCRIBER'S REPRESENTATIONS AND UNDERSTANDING.
A. PURCHASE FOR OWN ACCOUNT.
The Subscriber hereby expressly represents, warrants and covenants with the LIMITED LIABILITY COMPANY that the Securities are being purchased in the Subscriber's own name and acco