1. ENTITY BASICS
1.0 Entity Status. Limited Liability Companies are legal entities. An entity is established so that the entity has a legal existence separate from its ownership (“members”). If a Limited Liability Company is an entity that has a legal existence separate from its ownership, personal assets are not subject to the Limited Liability Company’s creditors, including judgment creditors, except to the extent that the members have agreed to be personally liable, such as by signing a personal guarantee, by signing an agreement or note as a co-obligor, or by providing personally owned assets as security. Here are some key definitions:
1.1 Members. The owners of a Limited Liability Company are called “members” and their interests are usually represented by share certificates representing a number of shares in the Limited Liability Company. Different types of shares can be issued with different rights relative to managerial rights, participation in income distributions, and participation in the company’s asset upon liquidation.
a) Managers and Officers The members may elect one or more managers who direct the affairs of the Limited Liability Company. The managers and/or members may elect the Limited Liability Company’s officers, such as President, Vice-President, and Secretary-Treasurer, although officers are not required. The managers are the day to day decision makers of the Company, and the members typically have voting power over major policy decisions of the Company, although the issues over which the members have the right to vote may vary from LLC to LLC depending on Operating Agreement the members put into force.
1.2 Multiple Roles. Under California law, a Limited Liability Company only needs one member, one manager, and one person acting in the role of several officers. However, where there is only one member, the entity is disregarded for income tax purposes and, under California law, a single member LLC is not afforded the same creditor protection rights as an LLC that is a bona fide partnership. Consult with my office if you are concerned or are interested in learning more about the difference between the single member LLC or what constitutes a bona fide partnership.
2.0 Formation: A Limited Liability Company’sformation is governed by state law. If a Limited Liability Company formed in one state wishes to do business in another, it must qualify to do business in that other state according to the laws of that state.
2.1 Articles of Organization. A Limited Liability Company is formed by filing “Articles of Organization” with the Secretary of State. The Articles are usually brief, containing only the most basic information about the Limited Liability Company that is being formed. The Articles set forth the name of the Limited Liability Company, location of the principal office, the name of the agent for service process, the names of the initial members and managers, etc. The Articles of Organization are simple, but they are only a part of the formalities that must be followed in order to be entitled to the benefits of LLC status.
· Resident Agent. The Limited Liability Company must appoint a party to serve to serve as the “resident agent” or “agent for service of process”. This is a person or business in California that agrees to be served with papers in the event of lawsuit. This agent must accept that position in writing, and that written acceptance must be filed with the Articles of Organization.
· 60-Day List. Within sixty days of the filling of the Articles of Organization, an officer of the Limited Liability Company must sign a Statement of Information containing the names and mailing addresses for all managers of the Limited Liability Company.
2.2 Operating Agreement. The Operating Agreement outlines the government of the Limited Liability Company. The Operating Agreement specifies the duties and responsibilities of the Limited Liability Company’s members, managers, and officers (if any). While the Articles of Organization are usually very brief, the Operating Agreement is usually much more detailed, including information regarding meetings and the Limited Liability Company’s technical operations. Sometimes the Articles will contain provisions that may be modified by the law, but the general rule is that a provision in the Articles of Organization will take precedence over a contrary provision in the Operating Agreement.
2.3 Organizational Meetings Once the Limited Liability Company has been legally formed by filing the Articles of Organization, the Limited Liability Company must be organized. The managers named in the Articles must authorize the issuance of shares, elect officers (if any), and adopt the Operating Agreement. The managers may also want to approve a corporate seal, authorize the opening of one or more banks accounts, and make other decisions relating to the start up of the business or transition into the LLC form.
2.4 Share Issuance. Shares certificates should be issued to each member. Each person receiving shares must pay for the shares, but the payment can be in almost any form, including promissory notes and services.
3.1 Maintenance: A Limited Liability Company requires maintenance. If it is not properly maintained, it may be ignored. If you need assistance with any of this, please contact us or another qualified professional.
3.2 Financial Records. A business’s most important records are its financial records. Corporate accounting records should be kept current, and all tax returns should be filed. The Limited Liability Company’s financial records must be maintained separate from those of any manager, officer, or member. The Limited Liability Company must have a separate tax identification number, which should be used for all corporate transaction and tax returns, Corporate assets, including bank accounts, investments, real property, and vehicles should be titled in the name of the Limited Liability Company if the Limited Liability Company is the intended owner. If a member or employee of the company uses corporate assets for personal use, he or she must either pay rent or recognize taxable income (in accordance with acceptable business accounting practices and in accordance with applicable tax laws). Once the Limited Liability Company is formed and officially recognized, one should never pay an LLC obligation with a personal check, and one should never pay a personal obligation with an LLC check.
3.3 Meetings. The members and managers should meet as often as necessary to hold elections and make decisions, and probably not less than once a year. It is common to have the members’ and managers’ meetings together or on the same day.
a) Minutes of the meetings are kept to record the decisions that are made, usually documented in the form of “resolutions” that are adopted pursuant to parliamentary procedure.
b) California law permits resolutions to be adopted in the absence of a formal meeting, if a “consent resolution” is utilized.
· As to decisions made by the managers, the consent resolution must be signed by all managers. This is sometimes referred to as a “unanimous consent resolution;”
· As to decisions made by the members, the consent resolution must be signed by the number of members that would have been required if a meeting had been held, and all eligible to vote had attended.
c) We recommend that at least once a year the members elect the managers and officers, if any, of the Company. Of course, the officers and managers can be elected for more than a one-year term, and the election of various managers and officers can be staggered so that all are not elected during any one election. These elections may be done at a meeting or by consent resolution (as discussed in paragraph 3.2 (b), above).
3.4 Business License. You must comply with all applicable local ordinances in the operation of the Limited Liability Company’s business. Obtain and maintain all required business licenses. Contact city, country, and/or state agencies to make sure that you have been licensed by all appropriate authorities
3.5 Trade Names, Trade Marks, Copyrights, and Patents. You cannot operate a Business using the name of a company or product that is the same or “deceptively similar” to the name already in use by another individual business. Similarly, you cannot conduct business in violation of applicable copyright and patent law. You are responsible to make sure you are not infringing on the rights of others, and you may need to take steps to discourage others from violating your rights, and to do this, it may be advisable to engage a patent and trademark attorney.
3.6 Employees. You must follow federal, state, and local laws relating to employment, payroll taxes, worker’s compensation insurance, occupational safety, and all other laws and regulations relating to employees.
4. PROTECTING AGAINST LIABILITY
4.1 The “Alter Ego” Rule. A Limited Liability Company will be ignoredby the courts if it is deemed to be nothing more than the “alter ego” of its members.
a) The “alter ego” argument is used by company creditors where the Limited Liability Company has debt that the Limited Liability Company itself is unable to pay. Such creditors want the Limited Liability Company to be ignored so that they can seek payment from the Limited Liability Company’s owners, and they can be successful in having the Limited Liability Company disregarded as a legal entity if the corporate formalities are not observed,if personal and corporate assets are commingled, if personal obligation are paid for out of the company funds, if company assets are used for personal use without payment or without being treated as part of an employee’s compensation, and/or if corporate financial records are not properly kept;
b) The “alter ego” will not be applied to a Limited Liability Company that keeps accurate records of its meetings of managers and members, that keeps its financial affair completely separate from those of its members, that has its financial records maintained or at least reviewed by a certified public accountant, and that makes sure that all business is conducted in the LLC’s name.
4.2 Co-Obligor vs. Guarantor. For new Limited Liability Companies without a solid net worth and an established business track record, it is common for a company creditor (referring to anyone who extends credit to the Limited Liability Company) to require a member whose financial resources are substantial to either be a guarantor or co-obligor with the Limited Liability Company.
a) A “guarantor” is one who has agreed to meet the Limited Liability Company’s obligations if the Limited Liability Company is unable to do so. Traditionally, a guarantor could not be held responsible for a guaranteed obligation unless and until the creditor had exhausted its remedies against the primary obligor, the Limited Liability Company;
b) A Limited Liability Company’s creditor may consider the enforcement of a guarantee unnecessarily burdensome, and so it is common for the creditor to insist that the member be a “co-obligator” with the Limited Liability Company. It is not common to see the world “co-obligor” in a written agreement, but it is common to see a provision that makes the Limited Liability Company and the member “jointly and severally liable”. Such a provision allows the creditor to sue either the Limited Liability Company or the members or both, and the member could be required to pay the entire obligation if the Limited Liability Company to do so.
Of course, there are arrangements that amount to a cross between a guarantee and a joint obligation, requiring the creditor to make some attempt to collect the obligation from the Limited Liability Company first, but not requiring the creditor to exhaust all remedies before turning to the members. So, while a Limited Liability Company exists to eliminate a member’s personal liability for LLC obligations, a member can negate the protection by signing an agreement that makes the member a guarantor or co-obligator.
If you are going to establish a Limited Liability Company, do it right. This will involve the observance of proper legal formalities, and it requires the advice of qualified financial advisors.
5.1 Business Formalities. A Limited Liability Company should not conduct business as a Limited Liability Company until it has been properly formed under state law. This means, at a minimum, that the Articles of Organization must be accepted by the Secretary of State, and that the members have met to elect managers and adopt an Operating Agreement, and the members have met to adopt resolutions regarding the operation of the company’s business
5.2 Financial Affairs. The most important advisor for a Limited Liability Company is its accountant. Making sure that financial records are properly kept and tax returns are timely filed will go long way to preserve the Limited Liability Company’s good standing and continued legal existence. Of course, if investments are to be maintained, an investment advisor should also be consulted.
5.3 Legal Matters. Business operations rely on compliance with the law, and the company’s attorney can assist in discovering what laws apply and how to comply with those laws. In addition, it is a rare business that will not be involved in negotiating, signing, and complying with legally binding contracts. Sometimes it can be penny wise and pound foolish for company managers who are not attorneys to act without advice of legal counsel. Similarly, a member or manager who is asked to sign an agreement as a guarantor or co-obligor should not do so without the advice of independent legal counsel.