Category: LLC forms

WHAT SHOULD BE THE PURPOSE OF LLC MODEL OPERATING AGREEMENTS?

By , July 24, 2010 8:01 am

The tools you need the most in your LLC formation practice are model operating agreements.  As discussed in the last two posts in this blog, these include general-purpose and special-purpose model agreements. 

What purposes should these model agreements be designed to fulfill?  In my view, they should be designed to provide you with optimum assistance in addressing each of the four main tasks you must perform in forming LLCs. 

  1. Issue identification.  They must assist you in identifying with your LLC formation clients all of the legal and tax issues likely to be significant for them in the operating agreements for the LLC they want you to form.
  2. Issue resolution.  They must assist you in determining with your clients the best way to resolve each of these issues in the operating agreement in your clients’ best interest.
  3. Negotiation.  They must assist you in effectively negotiating these terms on behalf of your clients with the other parties to the formation.
  4. Drafting.  They must facilitate your drafting of operating agreements in a manner that accurately and enforceably reflects the outcome of these negotiations.

Well-designed model operating agreements provide you with optimal assistance in  accomplishing all four of these tasks.  In future posts in this blog, I’ll explain how.

THE SUBTLE TYRANNY OF THE TERM “LLC FORM”

By , July 19, 2010 10:50 am

The words we use to discuss a topic can exercise a subtle tyranny over the way we think about that topic.  And if the topic is one that involves action, these words can exercise a subtle tyranny over how we act in respect of the topic.

This is true with regard to the topic to which this blog is devoted—namely, LLC formation practice.  If you don’t use the right terms in thinking about LLC formation practice, there’s a risk that you won’t properly think about that practice or properly conduct it.

To illustrate:  People sometimes ask me if I can give them a “good LLC form” for, say, an LLC under the Arkansas LLC Act.  

In my view, this question makes no sense.  It’s as if one carpenter were to ask another, “Hey, can you lend me a tool?”  Obviously, the first carpenter’s request will be meaningless unless he specifies the type of tool he wants; and if he can’t do that, he’s a terrible carpenter.

It’s the same with LLC lawyers.  In my last post in this blog, dated July 10, 2010, I expressed the view that there are five quite distinct types of forms that lawyers need in order to be well-equipped for their LLC formation practice.  These are:

  • General-purpose model operating agreements;
  • Special-purpose model operating agreements;
  • Model non-tax plug-in provisions;
  • Model tax plug-in provisions; and
  • “Miscellaneous” forms.

However, the usual understanding of the term “LLC form” among LLC lawyers—basically, that “forms” mean “general-purpose model operating agreements”—can exercise a subtle tyranny over how they think about their LLC formation practice and how they conduct it.  More specifically, the term may tend to keep them from focusing adequately on the fact that there are many different basic types of LLCs; that each of these LLC types needs its own general-purpose model operating agreement; that there are many specialized types of LLCs; that each of these specialized types of LLCs needs its own special-purpose model operating agreement; that operating agreements based on general-purpose and special-purpose model operating agreements often need substantial tailoring through the use of tax and non-tax plug-in provisions; and that many of these operating agreements need to be accompanied by exhibits in the form of bylaws, agreements with managing members and other specialized forms.

The only way to overcome this subtle tyranny is to get analytical.  To do so, ask yourself these questions:  “Wait a minute, what do I mean by ‘LLC form’?  Is it possible there’s more than one basic type of LLC form?  Is it possible that there are five basic types.”

Because there are.

WHAT FORMS DO YOU NEED FOR YOUR LLC FORMATION PRACTICE?

By , July 10, 2010 1:23 pm

What forms do you need for your LLC formation practice? 

I addressed this question in my March 23, 2010 post in this blog, but since that date, my thinking about the question has significantly evolved.  My current thinking is that you need five distinct types of forms.  These forms are listed below.  I’ll be grateful for any comments you may have on this list.

1)     General-purpose model operating agreements.  You need general-purpose model operating agreements.  These model agreements should be designed to provide a basis for planning, negotiating and drafting all of the basic types of operating agreements that any LLC formation client is likely to need for any purpose (except the purposes addressed in the special-purpose model operating agreements discussed below). 

The best way to organize general-purpose model operating agreements is on the basis of their three main structural features—namely, (i) their ownership structure, (ii) their management structure and (iii) their federal income tax structure.  If you organize them this way, you will find that there are 10 main types of LLCs (click here for a list of these types); and you will find that you need 28 specific general-purpose model operating agreements.  For a list of these 28 model agreements, click here

In the summary and detailed tables of contents after the title page in each general-purpose model operating agreement and in the captions of its provisions, each of these agreements should identify all principal legal and tax issues relevant to the type of LLC for which the agreement is designed.  The tables of contents of the agreement should provide you with a comprehensive issues checklist in handling LLC formations. The provisions of each model agreement should provide you with optimal starting-points for resolving each of these issues. 

For an example of a general-purpose model operating agreement for multi-member LLCs, click on the “forms” button of the top navigation bar of this blog and then click on the button marked “Form 6.2.”

2)     Special-purpose model operating agreements.  Depending on your practice, you probably need one or more types of special-purpose model operating agreements.  These may include, for example, model agreements for (i) husband-wife LLCs; (ii) Delaware series LLCs; (iii) promoter-controlled and investor-controlled investment funds; and (iv) LLCs whose members want short-form operating agreements. 

3)     Model non-tax plug-in provisions.  You need a wide variety of model non-tax plug-in provisions that you can copy and paste into operating agreements you are drafting on the basis of general-purpose or special-purpose model operating agreements.  The purpose of these plug-in provisions is to supplement or replace the standard non-tax provisions in these model agreements when these provisions don’t meet your clients’ needs.  Examples of model non-tax plug-in provisions are (i) right-of-first-offer and right-of first-refusal provisions; (ii) drag-along and tag-along provisions; (iii) provisions to eliminate fiduciary duties in Delaware LLC agreements; and (iv) securities law compliance provisions.

4)    Model tax plug-in provisions.  You need various model tax plug-in provisions.  These are individual model provisions or sets of related model provisions on federal and state tax issues that you can copy and paste into general- and special-purpose model operating agreements to meet special tax needs of your clients.  Model tax plug-in provisions include, for example, (i) sets of plug-in provisions under IRC §§ 704(b) and 704(c)(1)(A); (ii) plug-in provisions under Prop. Reg. § 1.1402(a)-2 that will enable your clients to avoid the Self-Employment Tax on their shares of LLC income; and (iii) plug-in provisions for tax matters partners. 

5)     Miscellaneous forms.  You need miscellaneous forms, including (i) forms for articles of organization or similar documents to file with relevant state officials to create LLCs; (ii) bylaws for use by LLCs with corporate management structures; and (iii) documents, in the form of attachments to operating agreements, which set forth the rights and duties of managing members and management committees.

HOW MANY FORMS DO LLC LAWYERS NEED?—GENERAL-PURPOSE FORMS, SPECIAL-PURPOSE FORMS AND PLUG-IN PROVISIONS

By , March 23, 2010 8:39 am

Most LLC lawyers will agree that, second only to their knowledge of the LLC business organization form, the most important asset they need in their LLC formation practice is their LLC forms.

So here’s the question:  For an LLC formation practice, how many forms do you need?

In my view, you can only answer this question if you first focus on a fundamental fact about LLCs—namely, that although they can be used for an unlimited number of purposes, they differ from one another fundamentally in only basic ways:  their ownership structure, their management structure and their federal tax structure.  On the basis of these three structures, there are 10 main types of LLCs; and to form all of the main subtypes of these 10 types, you need a total of 28 general-purpose LLC forms.  For tables showing these 10 types and 28 forms, click here and here.

However, in the real world of LLC formation practice, these 28 general-purpose forms aren’t enough; you also need a fairly wide array of special-purpose forms.  These include, for example, special-purpose forms for:

  • Husband-wife LLCs;
  • LLCs who need short-form operating agreements because their members don’t want or can’t afford comprehensive LLC operating agreements; and, depending on your practice,
  • Hedge funds;
  • Corporate joint ventures; and
  • Real estate development companies.

These special-purpose forms must always be based on general-purpose forms.  However, all of them must also contain at least a few specialized provisions that suit their special needs;  and many of them omit provisions that general-purpose forms need.

Finally, in the real world of LLC formation practice, you need not only general-purpose and special-purpose forms but also many dozens of “plug-in provisions.”  These are off-the-shelf provisions you can use to replace or supplement standard provisions in general-purpose and special-purpose forms for clients for whom these standard provisions are inappropriate or insufficient.

For example, if you are representing a prospective manager in an LLC formation, you will probably want to replace any standard “ordinary prudence” standard of care in an LLC general-purpose form with a more lenient “avoidance of gross negligence” provision.  Indeed, if you are drafting an LLC agreement under the Delaware Limited Liability Company Act, you may want to replace the ordinary prudence provision with a provision that eliminates the duty of care altogether.

For a partial list of the plug-in provisions you are likely to need, click here.

So if you’ve got the forms you need for your LLC formation practice and a lawyer friend of yours asks you to “share” your “LLC form,” you should respond by asking, “Which one?  I’ve got dozens.”

WHAT LLC FORMS DO YOU NEED FOR SINGLE-MEMBER LLCs WHOSE MEMBERS ARE INDIVIDUALS?

By , February 25, 2010 12:42 pm

WHAT LLC FORMS DO YOU NEED FOR SINGLE-MEMBER LLCs WHOSE MEMBERS ARE INDIVIDUALS?

IRS statistics indicate that about one-third of all U.S. LLCs consist of single-member LLCs whose members are individuals.

This statistic is not surprising. People love being their own bosses.

That is why there are over 25 million U.S. single-owner businesses owned by individuals. Most of these businesses are, from a business organization law viewpoint, state-law sole proprietorships. But many as 3 million are single-member LLCs. And since the owners of single-owner business that have third-party employees need liability shields, millions of single-owner businesses owned by individuals that operate as sole proprietorships ought to operate as single-member LLCs.

So there’s a lot of potential business out there for LLC lawyers who are properly equipped to form single-member LLCs.

If you’re an LLC lawyer, what model operating agreements (“forms”) do you need in order to be fully equipped to form these LLCs?

I would answer this as follows:

  • All operating agreements for single-member LLCs whose members are individuals contain numerous provisions that are essentially identical from one single-member LLC to another. These include, for example, introductory provisions concerning the name, taxable year and method of accounting of the LLC and provisions about contributions, allocations and distributions.
  • However, these LLCs differ from one another with respect to two critical LLC structures—their management structure and their federal tax structure.
  • Single-member LLCs whose members are individuals can have any of three main management structures—(i) a structure in which the member is also the manager; (ii) a structure in which the member is the manager but in which there is also a non-member assistant manager who can manage the LLC if the member is unable to do so because of death, injury or otherwise; and (iii) a structure in which the member doesn’t want to manage the LLC, but rather, appoints a non-member to manage it.
  • In theory, single-member LLCs whose members are individuals can also have any of three main federal tax structures—(i) a sole proprietorship structure; (ii) taxation under Internal Revenue Code (“IRC”) Subchapter C; and (iii) taxation under IRC Subchapter S. However, because Subchapter C is a double-tax regimen, it almost never makes sense as the federal tax structure for a single-member LLC whose member is an individual. Thus, in practice, single-member LLCs whose members are individuals should normally be taxable only as sole proprietorships or as S corporations.
  • The bottom line: In order to be fully equipped to form single-member LLCs for individuals, you need forms for LLCs with any of three possible management structures and two possible federal tax structures. Since three times two is six, this means you need six forms. For a table identifying these forms, here.

Does my reasoning about the forms you need in order to form single-member LLCs for individuals make sense to you? Am I missing anything?