LLC membership certificate reflecting the amount of money they have invested. Their Operating Agreement does not call for annual meetings or even special meetings to decide major issues. Eric and Sherry get actively involved in running the business, and before long, several years go by without any communication with the investor/members.
One of their investors, a Mr. Beye, has put more into the LLC than he probably should have. Now, he needs his $10,000 investment back for certain upcoming medical expenses. Mr. Beye calls Eric and demands his money back. While Eric is not obligated to give an equity investment back, it is really not possible anyway, as the business is not that profitable as of yet.
Mr. Beye is furious. He calls all the other investors and alleges that Eric and Sherry are cheating them. While most know Eric and Sherry well enough to know that this is not the case, the investors are universally resentful that they have not heard from Eric and Sherry regarding the business. No meetings have ever been called to explain where the business stands or to answer investor questions.
Before long, a lawyer is retained to look into Eric and Sherry’s activities. Fortunately, cooler heads prevail. Eric and Sherry are allowed to hold a meeting to answer any and all questions. Eric and Sherry borrow enough money to buy out Mr. Beye so he can pay his medical expenses.
A valuable lesson is learned. Eric and Sherry now hold an annual members’ meeting every year.
The failure to hold meetings can lead to miscommunication and legal jeopardy. It is a certainty that someday some court is going to hold that the fact that regular meetings were never held, that votes on major issues were never recorded and that managers went about their business for years without reporting to the members is clear evidence of a lack of formality in business affairs. And who could effectively challenge a court for such a finding? Your defense of being flexible only supports the lack of formality. That court will then pierce the LLC veil and hold the managers and perhaps members personally responsible for the obligations of the LLC.
In the legal field it is said that bad facts make bad law. Courts are human, and they respond to human situations. Many judges are elected and must face the public every four or six years. In certain situations, an extreme and disturbing case (bad facts) will lead to a decision that may be appropriate in the individual case but is inapplicable to the entire field (bad law). Precedent is established, allowing for future cases to be decided in the same fashion.
This is what will happen in the area of piercing the LLC veil, and perhaps in other areas of LLC law. As has been mentioned, the LLC is a new business entity without a completely defined body of law. Although more and more LLC cases are being reported, the opportunity for bad facts to make bad law exists.
Which brings us to the key point in all of this. Despite that fact that you may draft your Operating Agreement so that no meetings are required and despite the fact that many state laws take a hands-off attitude toward the necessity of meetings, you should make meetings a regular feature of your LLC operation. Your Operating Agreement should require the preparation and retention of meeting minutes. It should provide for notice and call of meeting procedures and detail how many members or managers must be present for a valid meeting to be conducted. In this way, you will prevent some future decision allowing the piercing of the LLC veil (and it will come) from cutting against you. At the same time, you will prevent miscommunication and misunderstanding from undermining your organization.
As well, when the IRS comes calling on an audit they like to see the formalities of meeting minutes and issued ownership certificates. Following the corporate formalities in your LLC (or LP) goes a long way when the IRS is reviewing your records.
We shall again discuss this issue in later chapters, only because it is so important.
Limited Partnership Management
Management issues for Limited Partnerships are greatly simplified and are as follows:
1. A Limited Partnership must be managed by a general partner.
2. A Limited Partnership cannot be managed by a limited partner.
Case Number 2 – Mary and Gary
M & G Holdings, LP has been formed for several years now and is working well for Mary and Gary. The Limited Partnership holds their brokerage account and they are so pleased with the way it works they set up another Limited Partnership, G & M Properties, LP, to hold a four-plex apartment building they own. They are gifting Limited Partnership interests to each of their three children, thus reducing their taxable estate. Until the children reach age 18, their interests are held custodially by the parents under the Uniform Transfers to Minors Act (UTMA) (or in South Carolina and Vermont the Uniform Gifts to Minors Act (UGMA)). They are protecting and growing their assets.
Their oldest son, Charlie, who is not yet 18 years old, holds a Limited Partnership interest in both entities. He takes a liking to helping fix up and repair the apartment building and soon asks if he can manage it and collect the rents. This is fine with his parents for it shows he wants responsibility and using Charlie is cheaper than the management company they are currently paying.
One day Gary is casually speaking with his attorney and mentions that Charlie is handling the apartment building. The attorney comes unglued. In his legal opinion, for a limited partner to manage the property is to lose all protections afforded by the Limited Partnership, including that limited partner’s limited liability. Charlie cannot be involved in the management of the property. And so, to preserve and protect their limited liability protection, Mary and Gary go back to using their old management company and loan Charlie the down payment money so he can buy and manage his own apartment building. In time, however, when Charlie is old enough he is made a part of the general partner management group and all is well.
While the general partner has complete authority and control, he or she must still act in the best interests of the limited partners. A fiduciary duty is owed by the general partner to the limiteds (as is true for a manager in an LLC). The general partner must not waste or dissipate partnership assets, improperly maintain the books and records of the partnership or do any other act in contravention of the Partnership Agreement. The general partner also may not confess any judgments (i.e., agree to be held liable) against the partnership or perform any act that makes it impossible to carry on the partnership’s ordinary business. With absolute control comes absolute responsibility.
Most state partnership laws require that the general partner obtain the majority vote (or greater, if so set out in the Partnership Agreement) of the limited partners to (1) sell all or substantially all of the partnership’s assets; (2) admit a new general partner and (3) admit, in some cases, a new limited partner. At the same time, many states allow the Partnership Agreement to eliminate the right of the limiteds to replace the general partner. As such, it is possible to have a Limited Partnership controlled by a general partner who must only call meetings to discuss the most important of matters.
Again, we cite the Nevada law that provides: “The partnership agreement may grant to all or certain identified general partners the right to vote on a per-capita or any other basis, separately or with all or any class of the limited partners, on any matter.” (NRS 88.465)
It is then possible to provide for controlled management continuity for several generations through a Limited Partnership. By having one or more managing general partners, and designating successor managing general partners, control can be maintained. In addition, by utilizing a corporate general partner and providing for the multi-generation succession of shares, continuity can be achieved. Of course, given the complexity of some of these issues it may be appropriate to consult with your professional advisors to make sure your maximum advantage is being achieved.
For Limited Partnerships, when considering the term of a
