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ALTERNATIVE FORMS OF BUSINESS ORGANIZATIONS

LIMITED PARTNERSHIPS _____ LIMITED LIABILITY COMPANIES _____ LIMITED LIABILITY PARTNERSHIPS June 27, 2007

INTRODUCTION We have studied business organizations in the form of a partnership and a corporation and now we will examine 3 alternative forms of business organizations: Limited partnerships Limited liability companies Limited liability partnerships These 3 forms of doing business are separate types of business organizations and they are each governed by a different set of statutes. Traditionally, and still today, the primary considerations in selecting a form of business organization are taxation and liability.

INTRODUCTION: Taxation The Internal Revenue Code generally recognizes 2 distinct methods of taxing business income, which are generally characterized as corporate taxation and partnership taxation. Corporate income taxation is encompassed by Subchapters C and S of the Code and partnership taxation is described in Subchapter K of the Code. Corporations are treated as separate taxable entities with their own set of rules and their own tax rate schedules. Partnership income taxation is generally applicable to unincorporated forms of business, including a general partnership, limited partnership, limited liability partnership, or limited liability company.

INTRODUCTION: Taxation Such a business that has at least 2 owners will generally be classified as a partnership and not be treated as a separate taxable entity for federal income tax purposes, unless it elects to be classified for federal income tax purposes as a corporation. Because of the elective nature of this tax classification regime, it is commonly referred to as check the box. The basic difference between corporation taxation and partnership taxation is that the former treats the corporation business organization as a separate entity for tax purposes while the latter does not and imposes taxation solely at the owner level. Corporation income tax is entity-level versus partnership pass-through taxation.

INTRODUCTION: Taxation When tax rates on corporate and personal income are compared, the differences at first seem modest. Personal income that is, basically, over poverty level, is taxed beginning at 15% and so is corporate tax. The rates then progress to a maximum of 35%.

INTRODUCTION: Taxation Corporate taxation requires taxation at the entity level at applicable rates. Distributions to shareholders of the corporation, in the form of cash dividends, salaries, bonuses, or otherwise are then taxed at the shareholder level as income. Hence, double taxation results. Double taxation does not occur with partnership taxation of unincorporated businesses. However, separate self-employment taxation and taxation of income at the owner level based on income realized at the business level, whether actually received by the owner, results in a need for careful analysis and projections during the form of business selection process.

INTRODUCTION: Taxation

An LLC, however, results in the payment of self-employment tax by the members of the LLC whereas an S corporations owners do not generally suffer such tax. Therefore, for tax purposes, an LLC is sometimes disfavored relative to an S corporation and this becomes a significant consideration in choosing which type of entity to utilize in forming a business organization.

Limited Partnerships

LIMITED PARTNERSHIPS (LPs) The limited partnership was the first significant unincorporated limited liability form of business entity. The first limited partnership statute was adopted in New York in 1822 and spread to most other industrialized states. More satisfactory forms of limited partnership statutes were promulgated with a Revised Uniform Limited Partnership Act (RULPA) in 1976 and a ReRULPA has been proposed with additional improvements.

LIMITED PARTNERSHIPS (LPs) The limited partnership allows investors to share in the profits of a business and limits their risk of loss to their investment (i.e., their capital contribution) so long as they observe certain legal formalities. A LLP has 2 classes of partners: 1 or more general partners, who have complete control, manage the LP, are agents of the LP, have fiduciary duties, and are subject to unlimited liability 1 or more limited partners, who are similar to creditors but are subordinated to creditors on insolvency or liquidation; not agents of the LP; ordinarily do not have day-to-day control of the business; limited or no fiduciary duties

LIMITED PARTNERSHIPS (LPs)

Definition of limited partnership: A partnership formed by two or more persons under the laws of this state and having one or more general partners and one or more limited partners. Ala. Code 10-9B-101(9) A limited partnership must have at least 1 general partner and at least 1 limited partner.

LIMITED PARTNERSHIPS (LPs)

A general partner of a limited partnership has the same liabilities as a partner of a partnership without limited partners. That is, his liabilities extend beyond the amount of his capital account in the limited partnership. See Ala. Code 10-9B-403

LIMITED PARTNERSHIPS (LPs)

A limited partnership agreement may be written or oral. PARTNERSHIP AGREEMENT. Any valid written or oral agreement of the partners as to the affairs of a limited partnership and the conduct of its business. Ala. Code 10-9B-101(11)

LIMITED PARTNERSHIPS (LPs)

General Partner (1 or more)

General Partner: Controls Manages Unlimited liability Agent of the LP

Limited Partner (1 or more)

Limited Partner: No control No day-to-day management Liability limited to investment Subordinated to creditors Not an agent of the LP

LIMITED PARTNERSHIPS (LPs) An ordinary general partnership can be formed by an informal agreement, either intentionally or unintentionally. A limited partnership, however, can only be formed through a filing of a certificate of limited partnership in compliance with statute, much like an incorporation of a corporation. Limited Partnership Formation (by any 2 persons) Office Of Judge Of Probate (in Alabama)

FILING REQUIRED

LIMITED PARTNERSHIPS (LPs)

One of the important issues relating to LPs is: How much control by a limited partner over the LPs business is too much, causing a loss of the limited partners limited liability? The major drawback to the limited partnership is the limitation on limited partners ability to participate actively in the business.

LIMITED PARTNERSHIPS (LPs)

Gateway Potato Sales v. G.B. Investment Co. (Ariz. Ct. App. 1991)

LIMITED PARTNERSHIPS (LPs)

Sunworth Packing Limited Partnership was a potato farm that was organized by Sunworth Corporation as general partner and G.B. Investment as limited partner. The partnership agreement stated that the LP would not participate in control of the business and would not be liable for the LPs debts beyond its initial capital contribution.

LIMITED PARTNERSHIPS (LPs)

Sunworth Packing (the limited partnership) ordered potato seeds from Gateway Potato Sales, which allegedly sold to Sunworth solely because Sunworths president assured Gateway that G.B. Investment (the limited partner) was financing the venture, was actively managing it, and had approved the seed purchase. Gateway contended that it was thereby led to believe that Sunworth was a general partnership rather than a limited partnership.

LIMITED PARTNERSHIPS (LPs) Gateway sued to recover from Sunworth Packing (the limited partnership), its general partner Sunworth Corporation, and its limited partner G.B. G.B. moved for summary judgment claiming that it did not control Sunworth Packing. Sunworth Packings president testified in an affidavit that G.B. supervised daily operations of the limited partnership, demanded approval of most decisions and expenses, purchased machinery, obtained financing independently, prepared financial statements, and spent some of the LPs expenses independently. He also said that he had explained the extent of G.B.s control to Gateway. G.B. contradicted the presidents affidavit.

LIMITED PARTNERSHIPS (LPs) The trial court granted the G.B. motion for summary judgment. Gateway appealed and contended that the conflicting evidence of control was sufficient enough to present a triable issue of fact.

LIMITED PARTNERSHIPS (LPs)

What issue was presented to the court? When are limited partners personally liable for debts of their general partner?

LIMITED PARTNERSHIPS (LPs) The outcome of the case depended upon the extent to which the limited partner controlled the limited partnership. The Arizona statute (RULPA 1976 version) provided that limited partners are not liable for limited partnership obligations unless they control to the extent to make them substantially the same as the general partner. The court reversed the lower court and remanded the case for trial on the basis that evidence was sufficient to withstand summary judgment and raise the triable issue of what degree of control G.B. exercised over Sunworth Packing.

LIMITED PARTNERSHIPS (LPs) Alabama Code 10-9B-303(a) Liability to third parties. Except as provided in subsection (d), a limited partner is not liable for the obligations of a limited partnership unless he or she is also a general partner or, in addition to the exercise of his or her rights and powers as a limited partner, he or she participates in the control of the business. However, if the limited partner participates in the control of the business, he or she is liable only to persons who transact business with the limited partnership reasonably believing, based upon the limited partner's participation in such control, that the limited partner is a general partner.

LIMITED PARTNERSHIPS (LPs)

Alabama Code 10-9B-303(b) Liability to third parties. A limited partner does not participate in the control of the business within the meaning of subsection (a) solely by doing one or more of the actions listed in the statute.

LIMITED PARTNERSHIPS (LPs)

Alabama Code 10-9B-303(c) Liability to third parties. The enumeration in subsection (b) does not mean that the possession or exercise of any other powers by a limited partner constitutes participation by him or her in the business of the limited partnership. This subsection is a safe harbor from personal liability.

LIMITED PARTNERSHIPS (LPs)

What is a safe harbor, as noted in Gateway Potato Sales? Section 303(b) establishes a safe harbor for activities that will not expose a limited partner to unlimited liability for participating in the control of the LP. The listed activities are protected, but other activities that are not listed do not necessarily result in unlimited liability. Courts examine these other activities and decide whether they constitute participation in control. Engaging in such other activities risks an adverse judicial determination.

LIMITED PARTNERSHIPS (LPs)

Corporate General Partners Sections 10-9B-303(b)(1) and 402(9) provide that a corporation can be a general partner of a LP. A limited partner does not participate in the control of the business within the meaning of subsection (a) solely by doing one or more of the following: (1) Being a general partner or being an officer, director, or shareholder of a general partner that is a corporation.

LIMITED PARTNERSHIPS (LPs)

Corporate General Partners Subsection 402(9) provides that, in the case of a general partner that is a corporation, a person ceases to be a general partner of a limited partnership upon the filing of a certificate of dissolution, or its equivalent, for the corporation or the revocation of its charter.

LIMITED PARTNERSHIPS (LPs)

LPs are used traditionally for tax reasons (e.g., tax shelters) and for passive investments (e.g., investment clubs). But tax law changes have made this form less beneficial for federal income tax purposes. Limited liability partnerships and limited liability companies were created to overcome the control limitations applicable to LPs. But LPs remain popular for estate planning and other purposes because tax advisors like the certainty of relying on the substantial body of IRS precedent regarding LPs versus LLPs and LLCs, which do not have such extensive precedent behind them.

Limited Liability Companies

LIMITED LIABILITY COMPANIES (LLCs)

The LLC has become the business entity of choice for many small and closely held businesses. The LLC is essentially a partnership with limited liability. The beauty of the LLC is that it brings together in a single business organization the best features of all other business formsproperly structured, its owners (which are referred to as members) obtain both a corporate-styled liability shield and the pass-through tax benefits of a partnership.

LIMITED LIABILITY COMPANIES (LLCs)

General and limited partnerships do not offer their partners a corporate-styled liability shield. Corporations, including those having made a Subchapter S election, do not offer their shareholders all the pass-through tax benefits of a partnership. Even though there is great diversity among the states LLC statutes, all state LLC acts contain provisions for a liability shield and partnership tax status.

However, one must keep in mind the disadvantage of the self-employment tax in choosing the LLC over the Subchapter S corporation.

LIMITED LIABILITY COMPANIES (LLCs)

A little history
The limited liability company form of business was the result of innovative lawyers and other professionals who created a solution for the client when the existing legal alternatives failed to meet the clients needs. Hamilton Brothers Oil Company had been involved in international oil and gas exploration since the late 1960s. It had used foreign LLCs in its businesses, primarily a Panamanian entity called the limitadas, which provided limited liability for its owners and partnership classification for tax purposes.

LIMITED LIABILITY COMPANIES (LLCs)

In the 1970s, major oil and gas producers sought to expand opportunities while, at the same time, they struggled with serious problems relating to the turbulent middle eastern oil supply. Because no U.S. entity existed with the favorable characteristics of foreign LLCs such as the limitadas, Hamiltons representatives developed legislation that authorized an unincorporated domestic entity with characteristics akin to those of the limitadas. The legislation was first adopted in Wyoming (my kind of place) in March 1977 with little controversy.

LIMITED LIABILITY COMPANIES (LLCs)

However, a critical question remained open: Would the IRS issue a ruling that an unincorporated entity that provided all of its members limited liability qualify for partnership taxation? Following a long battle, the IRS issued a favorable tax ruling in 1988. (See Revenue Ruling 88-76, 1988-2 Cum. Bull. 360.) Following this ruling, states quickly adopted LLC statutes and by 1995, all 50 states had LLC statutes.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs ORGANIZATION

1 or more persons may form a limited liability company by filing the articles of organization for the limited liability company with the probate judge of the county in which the initial registered office of the limited liability company is located.
Prior to 1997 amendments to the statute, at least 2 persons were required preserve the partnership taxation status of LLCs. But a 1996 IRS recognition of 1-member LLCs permitted this change to the statute.

LIMITED LIABILITY COMPANIES (LLCs) Therefore, as is the case with corporations and limited partnerships, a limited liability company can only be formed through a filing of articles of organization.

LLC Formation (by any 1 person)

FILING REQUIRED

Office Of Judge Of Probate (in Alabama)

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs ORGANIZATION

Alabama Code section 10-12-10 sets forth the requirements for the contents of the articles of organization.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs OPERATING AGREEMENT

An LLCs articles of organization are usually sketchy and the critical foundational document is an operating agreement. It typically provides for governance of the LLC, its capitalization, the admission and withdrawal of members, and how distributions will be made. An operating agreement is not required, but, if there is to be one, it must be in writing.
Section 10-12-2(k) defines an operating agreement as [a] written agreement of the member or members governing the affairs of a limited liability company and the conduct of its business.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs OPERATING AGREEMENT

An amendment to the operating agreement must be approved by a unanimous vote of members unless provided otherwise in the original operating agreement. Ala. Code 12-12-24

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs MANAGEMENT

The default rule in Alabama is that an LLC is managed by its members, unless the articles of organization provide otherwise.
If the articles provide for management by one or more managers, who may or may not be members, the operating agreement sets forth their powers of management. Alabama Code section 10-12-22 provides that the managers shall have the power to manage the business or affairs of the limited liability company as provided in the operating agreement.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs MANAGEMENT

In member-managed LLCs, the majority rule is that all members have apparent authority to bind the LLC, similar to the apparent authority of a partner to bind a partnership.
In a manager-managed LLC, the manager(s) have apparent authority to bind the LLC, but the nonmanager members do not. They are treated similarly to shareholders of a corporation, who do not have apparent authority to bind the corporation. See Ala. Code 12-12-21

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs VOTING

Voting rights may be set forth in the articles of organization or in the operating agreement. Voting by members or managers may be on a per capita, number, financial interest, class, group, or any other basis. Many LLCs base voting rights on capital contributions (such as with corporations and limited partnerships).
If voting rights are not set forth in these fundamental documents, the default rule in Alabama is that voting is on a per capita or oneman, one-vote basis (such as with general partnerships).

See Ala. Code 10-12-22

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs LIABILITY

All states LLC statutes provide that LLC members are not liable for the LLCs liabilities. See ULLCA 303. The extent of members liability is the loss of their capital contribution to the LLC, just as is the case of corporations. The ULLCA does not contain a specific provision the allows for vicarious liability, or piercing the veil, and imposing personal liability upon members.
However, section 10-12-21of the Alabama Code does explicitly open the door to piercing the veil. It provides that [a] member of a limited liability company may become liable by reason of the member's own acts or conduct. See Ala. Code 10-12-20(c).

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs LIABILITY

The commentary to this Alabama Code provision states that the section is not intended to relieve a member from liability arising out of the member's own acts or omissions to the extent such actions or omissions would be actionable, either in contract or in tort, against the member if the member were acting in an individual capacity.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs LIABILITY

The text discusses the issue of whether it is possible to pierce the veil of corporate protection in the context of a member-managed LLC. Courts that have addressed the issue have applied traditional notions of imposing boundaries on limitations of liability in the corporations context to LLCs. Courts have been willing to hold that members of an LLC can be held personally liable for the debts of the LLC. These courts have applied a couple of tests in reaching their results.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs LIABILITY

There are at least 2 theories whereby an LLC veil can be pierced:


The instrumentality rule and The identity rule

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs LIABILITY

The Instrumentality Rule:


Requires, in any case, except an express agency case, proof of 3 elements Control through complete domination of finances, policy, and business practice regarding the transaction attacked so that at the time question the LLC had no separate mind, Control was used to commit fraud, wrong, breach of statute or other legal duty, and Such control or breach proximately caused the damage or unjust loss complained of

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs LIABILITY

The Identity Rule:


Requires proof of a degree of identity of interest and ownership that the LLC had in effect ceased or had never begun such that recognition of the separate identity would serve to defeat justice and equity.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs LIABILITY

There does not appear to be any case in Alabama that has held that the piercing the veil doctrine is applicable to LLCs. However, in a June 24, 2004, ruling by Judge Myron Thompson in the U.S. District Court for the Middle District of Alabama, he denied a motion to dismiss (for failure to state a claim upon which relief could be granted) the members of an LLC who claimed that members of a LLC could not be sued for liabilities of the LLC. See Filo America, Inc. v. Olhoss Trading Co., L.L.C., 321 F.Supp.2d 1266 (M.D. Ala. Jun 22, 2004).

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs LIABILITY

Judge Thompson wrote that the court does not findany Alabama case addressing the question of whether the veil of an LLC can be pierced in the same way that a corporate veil can be pierced. This may be due to the fact that LLCs are a relatively new legal form in Alabama, having been created by statute only in 1993.
He went on to say that this court is convinced that, under Alabama law, it is possible to pierce the veil of an LLC. Because the LLC borrows its limited liability characteristics from the law applicable to corporations, the veilpiercing exception applicable to corporations should also apply to LLCs.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs Members Interests

A LLC members interest includes financial rights to receive distributions and governance rights to participate in management, to vote on certain issues, and to receive information.
A member does not have any legal interest in specific LLC property. In Alabama, an assignment of a members interest transfers only financial interests and a purported transfer of anything else is void.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs Fiduciary Duties

Members and managers of LLCs may have fiduciary duties to one another and to the LLC.
The statutory fiduciary duties are: Duty of Loyalty Duty of Care An overriding duty to discharge the foregoing duties consistent with the "obligation of good faith and fair dealing.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs Fiduciary Duties Members and managers, and their delegatees, owe to the LLC and to the other members and managers only the fiduciary duties of loyalty and care and the obligation of good faith and fair dealing set forth in the statute. An operating agreement may not waive or eliminate the duties or obligation, but may, if not manifestly unreasonable, identify activities and determine standards for measuring the performance of them.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs Fiduciary Duties

MEMBER-MANAGED LLCs
The only fiduciary duties a member owes to the company or to its other members are the duty of loyalty and the duty of care imposed by 10-1221(f) through (g) A members duty of care to a member-managed LLC and its other members in the conduct or winding up of the LLCs businessto refrain from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs Fiduciary Duties

MANAGER-MANAGED LLCs
The only duty a member who is not also a manager owes to the LLC or to the other members solely by reason of being a member is to not disclose or otherwise use information described in subsection (b) of Section 10-12-16, whether or not obtained under the authority of subsection (b) of Section 10-12-16, to the detriment of the company or the other members

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs Fiduciary Duties

In summary, the ULLCA imposes the duties of care and loyalty on managers. The duty of loyalty requires the manager to account for and to hold as trustee any profit derived from using the LLCs assets. The manager may not compete with the LLC or otherwise deal with it in a manner adverse to its interests.

LIMITED LIABILITY COMPANIES (LLCs)


Characteristics of LLCs Fiduciary Duties

Members of a manager-managed LLC owe no fiduciary duties as a result of being members. However, when they exercise managerial powers, they are bound by the same fiduciary duties as managers with respect to those powers. If the LLC is member-managed, the members have fiduciary duties to the LLC and the other members under the ULLCA. The ULLCA does not permit members to eliminate the duty of loyalty, but they may modify it as long as not manifestly unreasonable. Similarly, the duty of care may not be unreasonably reduced and reasonable standards may be set for the good-faith and fairdealing obligations.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs Fiduciary Duties

Duty of Loyalty: a duty to account to the LLC and hold as trustee for it any property, profit, or benefit derived in the conduct and winding up of the LLCs business or in use of its property; a duty to refrain from dealing as, or on behalf of, an adverse party in the conduct and winding up of the LLCs business; and a duty to refrain from competing with the LLC in the conduct of its business before dissolution. See Ala. Code 1012-21(f).

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs Fiduciary Duties

Duty of Care: a duty to refrain from "grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law. See Ala. Code 10-12-21(h). The duty of care is not deemed violated because of conduct that merely furthers one's "own interest. See id. 10-1221(i).
Whether an Alabama court would reach the same result that was reached by the New York Supreme Court in Salm v. Feldstein applying New York law is debatable.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs Fiduciary Duties

Provisions which modify the fiduciary duties may be included in the articles of organization or an operating agreement, but no modification may eliminate the duty of loyalty, eliminate the obligation of good faith and fair dealing, unreasonably reduce the duty of care, or unreasonably restrict a right of information or access to records under 10-12-16.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs Fiduciary Duties In the context of LLCs, there is a relatively scant body of case law concerning interpretation of the statutes or actions of members and managers that give rise to personal liabilities.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs: Dissolution

Alabama Code section 10-12-37 sets forth events causing a dissolution of a LLC. A voluntary dissolution absent any provisions of the articles of organization or an operating agreement requires the consent of all of the LLCs members.

LIMITED LIABILITY COMPANIES (LLCs) Characteristics of LLCs: Dissolution

On winding up, the assets of an LLC are distributed in the following order:
To creditors (including members who are creditors) To members of the LLC and former members for interim distributions and in respect of their contributions To members 1st for the return of their contributions and 2nd with respect to their interests in the LLC, in the proportions in which the members share in distributions

LIMITED LIABILITY COMPANIES (LLCs) Since limited liability companies have only recently become popular, the law is still evolving. Some developing issues include: whether states, which do not recognize limited liability company status for their own businesses, would nevertheless honor that status for companies organized under the limited liability company law of another state and whether membership interests are securities for purposes of the federal securities laws. In determining whether LLC membership interests constitute a security, courts have turned to the definition of Security, according to the Securities Act of 1933, which includes investment contracts."

LIMITED LIABILITY COMPANIES (LLCs) The Supreme Court decision of SEC v. Howey, established a three part test in order to determine if an interest is an investment contract, showing that there is: (1) investment of money, (2) in a common enterprise, and (3) with profits to come solely from the efforts of others. Additionally, some states' blue sky laws, specifically identify LLC membership interests as securities. Each case, however, is fact specific and determining whether a membership interest constitutes a security will largely depend on whether the LLC is member-managed and the jurisdiction of the LLC's organization.

LIMITED LIABILITY COMPANIES (LLCs) Lets summarize The LLC, a creature of state law, has emerged as the preferred form of conducting business. The LLC is a hybrid entity, possessing attributes of both corporations and partnerships. The LLC, if structured properly, is treated as a partnership for federal income tax purposes (i.e., income and losses pass through to the members, thus avoiding the double level of tax normally associated with a corporation) while its members enjoy the limited liability protection afforded shareholders of a corporation.

LIMITED LIABILITY COMPANIES (LLCs) The LLC as a choice of entity imposes fewer restrictions than an S corporation and, unlike a limited partnership which affords limited liability protection only to those partners who do not participate in the management of the business of the limited partnership, all members of an LLC receive limited liability protection without regard to their level of participation. These favorable attributes have resulted in all 50 states and the District of Columbia authorizing the LLC as a new investment vehicle.

LIMITED LIABILITY COMPANIES (LLCs) The S corporation, the limited partnership, and the LLC all enjoy limited liability for at least some of their owners and all avoid a federal entity level tax. However, the LLC avoids many of the restrictions imposed on S corporations and is not subject to many of the burdens associated with limited partnerships. For example, an S Corporation cannot have more than 100 shareholders, and these shareholders cannot be corporations, partnerships, certain trusts, or nonresident aliens. In addition, an S Corporation is not permitted to have more than one class of stock. None of these limitations are applicable to an LLC.

LIMITED LIABILITY COMPANIES (LLCs) Moreover, since an LLC generally is treated as a partnership for federal income tax purposes, the LLC may utilize the great flexibility afforded partnerships, such as the use of special allocations of tax items among owners. Limited partnerships afford limited partners protection from liability. However, protection is available only to partners who do not participate in the management and control of the limited partnership's business. This restriction is not applicable to an LLC; all members of an LLC receive limited liability protection without regard to their level of participation in management of the entity.

Limited Liability Partnerships

LIMITED LIABILITY PARTNERSHIPS (LLPS) Under Alabama law, a partnership becomes a "registered limited liability partnership" by filing specified documentation "with the judge of probate in the county in which the partnership has its principal office, or if the partnership is required to have a registered agent, with the judge of probate in the county in which the registered office is located and with the Secretary of State. After such a filing is effected and the necessary fees remitted, the registration becomes immediately effective and continues until it is voluntarily canceled, or is canceled involuntarily because of a failure to satisfy specified requirements as to "annual notice" and payment of an "annual fee."

LIMITED LIABILITY PARTNERSHIPS (LLPS) The effect of registration is that a partner is "not personally liable or accountable for debts, obligations and liabilities of, or chargeable to, the partnership, or another partner or partners solely by reason of being such a partner. Notwithstanding this limitation, "all or specified partners" may be personally liable for "all or specified debts, obligations or liabilities to the extent all of the partners shall have agreed. These provisions do not affect the liability of the partnership itself "to the extent of partnership assets for partnership debts, obligations and liabilities."

LIMITED LIABILITY PARTNERSHIPS (LLPS) In the case of a partnership which provides professional services, e.g., a law firm, a partner or employee who renders such service is liable for negligence, wrongful acts, or omissions in which the individual personally participates. The personal liability of a partner by reason of being a partner, or acting in such capacity, is in all other instances governed by the limitations applicable generally to limited liability partnerships. These provisions are independent of those imposed by a professional licensing authority.

LIMITED LIABILITY PARTNERSHIPS (LLPS) A limited partner is not generally liable for obligations of a limited partnership. Assume, for example, that A and B form a $100,000 limited partnership for the purpose of operating a grocery store. A contributes $50,000 and is the sole general partner, and B contributes $50,000 and is a limited partner. If $1,000,000 tort or contract liability is incurred by the partnership, and the partnership has $100,000 of assets, the additional $900,000 will be a responsibility of A, as the general partner. The limitation on B's liability is dependent on B's relinquishment of control over partnership activities and decision making.

LIMITED LIABILITY PARTNERSHIPS (LLPS) Where a partner participates in "control," Alabama Code 10-9A-42 provides that the partner may incur liability for partnership debts. Such "control must be "substantially the same as the exercise of the powers of a general partner" or else the partner is liable only "to persons who, with actual knowledge of his participation in control and in reasonable reliance thereon, transact business with the partnership. In the latter case, the limited partner's participation does not create a general liability for obligations of the business.

LIMITED LIABILITY PARTNERSHIPS (LLPS) In Pitman v. Flanagan Lumber Co., an Alabama Supreme Court case in 1990, a limited partner who did not exercise general control responsibilities in a partnership was held liable to a creditor who lent funds to the partnership on the strength of the limited partner's personal credit reputation and at his urging.

LIMITED LIABILITY PARTNERSHIPS (LLPS) The question of how much control is required in a given situation is a factual matter to be determined in each instance and may depend on the type of business involved and past control practices. Section 10-9A-42(b) sets forth various types of participation which, in and of themselves, do not amount to participation in control. This is another safe harbor provision. One factor which has led to litigation in other jurisdictions is participation as an officer, director, or shareholder of a general partner.

LIMITED LIABILITY PARTNERSHIPS (LLPS) The exemption suggests that a limited partnership may be able to remove its partners from liability over and beyond contributions to the business by designating a corporation controlled by limited partners as the partnership's sole general partner. A "person" for purposes of qualifying as "partner" under 10-9A-1(8) includes a corporation.

LIMITED LIABILITY PARTNERSHIPS (LLPS) The opportunities for imposing liability for partnership obligations on limited partners based on participation in control are limited considerably under the 1997 Alabama Limited Partnership Act. Section 10-9B-303, the successor to the counterpart of 10-9A-42, states that a limited partner is liable because of participation in control "only to persons who transact business with the limited partnership reasonably believing, based upon the limited partner's conduct, that the limited partner is a general partner."

LIMITED LIABILITY PARTNERSHIPS (LLPS) Thus, regardless of how much control a limited partner exercises, liability would be imposed only if third parties rely on the partner's participation as a basis of transacting business with the partnership. The scope of items which do not, per se, constitute participation in "control" by a limited partner is considerably broader under the 1997 Alabama Limited Partnership Act.

END OF SLIDES 6/27/2007