We Love LLCs For Their Flexibility

Limited liability companies are popular because they afford business owners so much flexibility in the way the company is structured from a financial, tax, and management point of view.  Owners can tailor financial payouts to match their respective contributions.  The entity can be taxed as a partnership, S Corporation, or C Corporation, simply by filing a piece of paper with the IRS and checking the appropriate box.  And as far as management is concerned?  State statutes usually impose few requirements and give LLC owners a lot of leeway to design their owner relationships using an operating agreement.

LLC Management Flexibility Can Cause Confusion

With this LLC management flexibility comes some confusion both inside and outside of the company concerning the roles and responsibilities of those who own and operate the company.  For this reason, it is not unusual to see executives associated with limited liability companies adopt corporate titles like “President,” or form more or less ad hoc groups of decision-makers that they describe as the “Board of Directors,” to clarify who’s in charge.  If the entity were a corporation, the duties and powers associated with these titles would be described in state statutes or in the bylaws of the corporation.  Limited liability company statutes and operating agreements, however, sometimes make no mention of these roles, which invites disputes and litigation.

Consider Some Corporate Flair to Cure LLC Confusion

State statutes usually do not require that the owners (members) of limited liability companies enter into an operating agreement.  If they don’t, then the minimalist provisions of the state’s limited liability act govern the relationship among the members.  Although the minimalist approach has its appeal in terms of saving the time and money needed to create an operating agreement, most LLC owners would be well served to take the time to define their relationship in an operating agreement.  The operating agreement is where owners decide who gets paid what when, who makes decisions, and how owners can separate from the business (among other things).  Particularly if the LLC is taxed as a partnership, the operating agreement contains critical partnership tax provisions, including the mandatory designation of a partnership representative to the Internal Revenue Service.

Although introducing a quasi-corporate management structure may not be appropriate for a company when it is first established, it may become more attractive when a company has several owners or accepts investment from passive investors who would be more comfortable with a corporate governance model of leadership.  The types of provisions that an LLC might consider adding to an operating agreement to provide this “corporate flair” are typically found in the bylaws of a corporation. Here are section headings for some of the potentially desirable provisions:

Members (Instead of Stockholders)

• • Annual Meeting
  • Special Meetings
  • Notice of Meetings
  • Quorum
  • Organization (To Define Who Runs Member Meetings)
  • Conduct of Business (To Define How Member Meetings Are Run)
  • Proxies and Voting
  • Member List
  • Consent of Members in Lieu of Meeting

Board of Directors

• • Number and Term of Office
  • Vacancies
  • Regular Meetings
  • Special Meetings
  • Quorum
  • Participation by Remote Transmission
  • Conduct of Business
  • Powers
  • Compensation of Directors
  • Indemnification of Officers and Directors

Officers

• • Generally
  • President
  • Treasurer
  • Secretary
  • Delegation of Authority
  • Removal

Harmonize Quasi-Corporate Roles with State LLC Statutes

Most state statutes afford LLC owners enough flexibility to design their company as they choose. The Maryland statutes are particularly flexible:[M]embers may enter into an operating agreement to regulate or establish any aspect of the affairs of the limited liability company or the relations of its members, including provisions establishing . . . [t]he manner in which the business and affairs of the limited liability company shall be managed, controlled, and operated, which may include the granting of exclusive authority to manage, control, and operate the limited liability company to persons who are not members.

MD Corporations and Associations CODE ANN. § 4A-402(a)(1). Other state statutes, like those of Delaware and Colorado, seem less flexible on their face, in that they seem to establish that their states’ LLCs may be managed either by members or by one or more managers. For example, one Delaware statute provides:

• 18-402 Management of limited liability company.

Unless otherwise provided in a limited liability company agreement, the management of a limited liability company shall be vested in its members… ; provided, however, that if a limited liability company agreement provides for the management, in whole or in part, of a limited liability company by a manager, the management of the limited liability company, to the extent so provided, shall be vested in the manager who shall be chosen in the manner provided in the limited liability company agreement.

6 Del. C. § 18-402. In one Delaware case, the court refused to give effect to the quasi-corporate structure that the members apparently intended to establish because, among other things, the members did not “harmonize” the quasi-corporate structure of a board of directors and president “with LLC management concepts.” See Phillips v. Hove, 2011 Del. Ch. LEXIS 137, p. 58. Although the court did not elaborate on what it meant by “harmonize,” it would seem advisable under Delaware law to characterize “directors” and “officers” of Delaware LLCs as “managers” in the meaning of § 18-402. As a general principle, it would also be advisable to look at the rest of the relevant limited liability statute to see what other limits the statute may impose on the provisions of an operating agreement.

Conclusion

Under the right circumstances, LLC owners may benefit from implementing corporate management concepts that include roles and procedures that are commonly used in corporations. The LLC operating agreement is the place to do this. When injecting corporate management provisions into an LLC operating agreement, care should be taken to harmonize those provisions with LLC management concepts under the relevant state statutes.