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An LLC makes the election to be manager-managed or member-managed in either its articles of organization or its operating agreement. Some states dictate that the election to be manager-managed or member-managed be made in the articles of organization. Nevada is an example of a state where such an election is mandatory. Delaware, on the other hand, does not impose such an election.
If your LLC’s articles of organization do not require you to elect your form of management, you’ll make that election in your operating agreement. An operating agreement is a close equivalent of a corporation’s bylaws. Naturally, because a manager-managed LLC and a member-managed LLC are quite different, their operating agreements will differ greatly. LLC operating agreements cover matters such as who governs the LLC, how managers are appointed, how members can be ousted from the LLC, and such. Operating agreements, like bylaws, are not filed with the state. In fact, typically an LLC is not required to have any operating agreement in place, although it is advised. In the absence of an operating agreement, the LLC will follow the default rules of governance set forth in the laws of the state of organization. LLCs that operate without operating agreements are extremely rare. We discuss operating agreements in Chapter 3. In that chapter, we’ll also discuss the advantages and disadvantages of the two types of governance structure.
PROFESSIONAL LIMITED LIABILITY COMPANIES
Professional limited liability companies (PLLCs) are simply LLCs in which the members are engaged in rendering professional services, such as the practice of medicine or law. Forming a professional LLC is slightly more difficult than forming a standard LLC. Much like the shareholders of a professional corporation, the members of a professional LLC may enjoy personal liability protection for the acts of other members; however, each member remains liable for his or her own professional misconduct. State laws generally require professional LLCs to maintain generous insurance policies or cash reserves to pay claims brought against them.
Professional LLCs are not recognized in all states, most notably California. Professional LLCs are more sophisticated enterprises than standard LLCs, and their organization should be left to a qualified attorney.
LLCS VS. S CORPORATIONS
While both S corporations and LLCs provide limited liability and partnership-like taxation, they differ in significant ways, as shown in this table. There are other important differences, and legislation that makes S corporations more attractive to investors was passed by Congress in 1996. You should work closely with your tax advisor in choosing any entity for your business.
| S Corporation | LLC | |
|---|---|---|
| Owners (Number) | No more than 75. All shareholders must consent to the election at the time it is made. | No maximum and no minimum. All states allow single-member LLCs. |
| Owners (Eligibility) | Individuals, U.S. citizens and resident aliens, death estates, bankruptcy estates, and certain tax-exempt organizations. | All people and entities eligible to own S corporations plus corpora-tions, partnerships, most trusts, nonresident aliens, and pension plans. |
| Nature of Ownersip | Single class of stock. | Different classes and priorities of ownership permitted. |
| Essential Documents | Articles of incorporation, bylaws, stock certificates, stock ledger, IRS and state election of S corporation status. | Articles of organization, operating agreement (optional) |
| Management | Managed by board of directors and officers. | Managed either by the owners or by managers appointed by the owners. |
| Tax treatment | The entity is not taxed: profits and losses are passed through to the shareholders. | The entity is not taxed: profits and losses are passed through to the members. |
LIMITED LIABILITY COMPANY ACTS
Every state has a limited liability company act and there are many similarities from state to state, but there is no uniform law in effect in all states. When you organize an LLC in a particular state, you agree to comply with its limited liability company act and it is presumed that you know its requirements. If there is a conflict between the state statute and your articles or operating agreement, the statute will prevail.
▼ Good to Know
There is no federal corporation law or federal LLC law. The federal government has chosen to stay out of the corporation law arena. Thus, it is not possible to charter an LLC in the United States: all U.S. corporations are chartered within one of the 50 states or other jurisdictions, such as the District of Columbia. The United States differs in this respect from some other nations, which charter their corporations at the national level.
The Uniform Limited Liability Company Act (ULLCA), drafted by the National Conference of Commissioners on Uniform State Laws in 1996 and revised in 2006, has been adopted by a few states. The ULLCA reflects the modern trend in business laws and it represents the subjects commonly found in all state LLC statutes.
Therefore, to help you better understand limited liability company act requirements and to guide this chapter’s discussion, the ULLCA will serve as a model of a typical limited liability company act.
Before jumping into this discussion, two concepts should be explained.
The first is the concept of sources of authority. An LLC is a creature of statute and can only do what state laws permit it to do. All states have some written LLC laws and all states’ LLC laws provide a general outline of what LLCs can and cannot do. The laws often defer to an LLC’s articles of organization or operating agreement to fill in the gaps. As a result, the LLC laws and an LLC’s articles of organization and operating agreement provide the sources of authority that control what an LLC can do and how it must act.
The second concept is the distinction between a statute and an act. Both terms refer to laws duly adopted by Congress or by a state legislature. All the laws adopted by Congress or a state legislature are statutes. Some of these statutes may empower an administrative agency like the Internal Revenue Service to pass rules to implement the statute. A specific body of statutes is an act. For example, in most states, all the statutes that pertain to LLCs are found together in the limited liability company act. Acts are sometimes referred to as codes, including the Internal Revenue Code, Uniform Commercial Code, or a criminal code.
Where to Find Your State Statutes
