How to Use Limited Liability Companies & Limited Partnerships. Garrett Sutton
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filing. To answer this question the following must be considered:
1. In what state – or states – will the company operate?
2. Is the company willing to pay extra to file in a more favorable state?
Case Number 1 – John and Liz
John and Liz know that J & L Consulting, LLC will operate in a number of states right away. They already have clients lined up in California, Nevada, Texas and Florida. They have been advised by their accountant that by going into Florida, for example, they will need to have their company qualified to do business in Florida. This entails filing as a foreign (or out of state) LLC with the Florida secretary of state’s office.
The decision then for John and Liz is which state to use for the original formation. While Wyoming offers excellent protections at a lower cost, the two have clients in Nevada, which means they will have to register in Nevada anyway. With their professional advisor they review the LLC statutes for the states in question. They decide on Nevada because it offers the advantage of greater protections for managers. After filing originally in Nevada they then go ahead and qualify as a foreign LLC doing business in California, Texas and Florida (already being aware of the special state tax issues associated with California LLCs, as addressed in one of the last questions in Chapter Four). They realize that they will have to pay annual fees in each state as well as, where applicable, file an annual tax return to each state. However, John and Liz know that these are the costs of doing business and they sleep better at night knowing they are following the rules. In addition, they know that if they have not registered they could be prohibited from bringing a lawsuit or transacting any future business in the state(s) in question.
Case Number 2 – Mary and Gary
Mary and Gary live in California and the first asset they seek to protect is a four-plex apartment building they are purchasing in California. Mary and Gary have learned that LPs (and LLCs) are effective asset protection entities, in part because of the charging order procedure. (Refer to Chapter Seven for details on what a charging order is and how it works). However, they have also learned that in California the charging order is not always enforced. In two cases California courts have ignored the charging order procedure and allowed partnership interests to be reached by a creditor. We shall further discuss California issues ahead.
This disturbs Mary and Gary. They want to protect their assets, not expose them. After reviewing the situation with their professional advisors they decide to use a Nevada or Wyoming LP to hold the apartment building – and then qualify that entity to do business in California.
Of course, this means that they have to spend more money than is ordinarily required. If California law had been favorable they could have originally filed in California and be done. But they want to assert that Nevada law, which has never overturned or ignored the charging order remedy and has legislatively made it the exclusive remedy for creditors, will apply. (Later we will review the benefits of Nevada and Wyoming law.) While there is no guarantee that a California court hearing such a case will apply Nevada law, at least Mary and Gary, by creating a Nevada LP and qualifying it in California, can make the Nevada argument. We will discuss this issue later in the book.
And so Mary and Gary find themselves in the position of paying extra to be in a more favorable state. For them it is worth another several hundred dollars per year to use a Nevada LP.
As they proceeded both Mary and Gary and John and Liz learn it is also important to consider the specific issues associated with each document, as outlined next:
Limited Liability Companies
As mentioned, the first step in organizing an LLC is to prepare and file the Articles of Organization. While each state has different rules, there are common requirements:
Articles of Organization
LLC Name: Check for name availability with your state’s secretary of state. Consider separately trademarking and protecting the name within your state through your local secretary of state or within the country through the United States Trademark Office. (Visit www.uspto.gov for the government’s trademark search service. Our free guide “Winning with Trademarks” is available at www.corporatedirect.com/asset-protection/winning-with-trademarks.) Know that using a name like ‘bank’ or ‘finance’ in your entity name may require a license from the state. Other name restrictions may exist. For example, use of the words “Olympic” and “Olympiad” are restricted in Utah.
Purposes and Powers: You must make a statement about what kind of business your entity will engage in. Many states allow a broad, unlimited purpose and power to be stated, essentially saying that your entity has all rights available to engage in any and all legal businesses within that state.
Name and Address of Resident Agent: To provide claimants with an office in the state upon which to serve lawsuits, a resident agent must be obtained and a registered address listed. Please note that, as with LPs and Corporations, if you live in your state of organization you can serve as your own resident agent, although you may not want to do so. (First of all, you have just put your home address out on the internet. As you can imagine we have a number of horror stories associated with this lack of privacy.) Some states require the registered agent to be open during business hours. If you use your home address you may not meet this requirement. Your option is to use a private service. Most corporate entities (such as our firm) that act as resident agents charge a small yearly fee for this service.
Manager Managed or Member Managed: Unlike an LP or Corporation, either all of the members or a manager may run the LLC. Usually, this decision must be stated in the Articles of Organization.
Operating Agreement
Like the bylaws of a corporation, the Operating Agreement provides the rules for operation of the LLC. Common provisions likely to be found are:
Managers: The number of managers, the term, election and removal of managers will all be set out.
Restrictions on Transfer of Interests: Unlike shares of a corporation, the transfer of LLC membership interests is more complicated. The rules are set out in the Operating Agreement.
Distributions to Members: Profits and Losses: Profit distributions and loss allocations are governed by partnership law, which is different from the laws governing payment of dividends in a corporation. The rules for partnership law are more complex and are set out in the Operating Agreement.
Meetings: Many states leave the whole need for meetings up to the members. We suggest that annual meetings be held to satisfy entity formality issues. Any requirements should be set out in the Operating Agreement.
Charging Order: Although many states require creditors to follow the charging order procedure as a matter of state law, it is a good idea to include it in the Operating Agreement.
Other Requirements: You should also be aware of any requirements that your own state’s statute may have regarding Operating Agreements. In some cases, if you don’t provide for an issue you default to the state’s position on it. For example, Nevada law (Nevada Revised Statutes (NRS) 86.286) provides:
“A limited liability company may, but is not required to, adopt an operating agreement. An operating agreement may be adopted only by the unanimous vote or unanimous written consent of the members, and the operating agreement must be in writing. Unless otherwise provided in the operating agreement, amendments to the agreement may be adopted only by the unanimous vote or unanimous written consent of the persons who are members at the time of amendment.”
If you don’t provide otherwise, amendments must be approved by 100% of the members. If you don’t like the state’s default position you’ll have to draft the Operating Agreement to allow for a less than unanimous vote.
Limited Partnerships
To organize an LP, most states require