Cross, Chapter 17

Chapter 17
Limited Liability Business Forms
Cross/Miller, The Legal Environment of Business: Text and Cases, Eleventh Edition. © 2021 Cengage. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part.
17-1 The Limited Liability Company
• Limited liability company (L L C) – A hybrid form of business

enterprise that offers the limited liability of a corporation and the
tax advantages of a partnership.
• The L L C has become the preferred structure for many small
businesses.
• L L Cs are governed by state statutes, which vary from state to
state.
• In an attempt to create more uniformity, the National Conference of
Commissioners on Uniform State Laws issued the Uniform Limited
Liability Company Act (U L L C A).
• Less than one-fifth of the states have adopted it, however.
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
17-1a The Nature of the L L C (slide 1 of 3)
• L L Cs share many characteristics with corporations.
• Like corporations, L L Cs must be formed and operated in compliance with state law.
• Like the shareholders of a corporation, the owners of an L L C, who are called members,
enjoy limited liability [U L L C A 303].
• Member – A person who has an ownership interest in a limited liability company.
Limited Liability of Members

• Members of L L Cs are shielded from personal liability in most situations.
• In other words, the liability of members normally is limited to the amount of their
investments.
• An exception arises when a member has significantly contributed to the L L C’s tortious
conduct.
When Liability May Be Imposed

• The members of an L L C, like the shareholders in a corporation,
can lose their limited personal liability in certain circumstances.
• When an individual guarantees payment of a business loan to the L L C,
that individual is personally liable for the business’s obligation.
• If an L L C member fails to comply with certain formalities, such as by
commingling personal and business funds, a court can impose personal
liability.
• On rare occasions, courts ignore the corporate structure (“pierce the
corporate veil”) to expose the shareholders to personal liability when it is
required to achieve justice.
Other Similarities to Corporations

• Another similarity between corporations and L L Cs is that L L Cs
are legal entities apart from their owners.
• As a legal person, the L L C can:
• Sue or be sued
• Enter into contracts
• Hold title to property [U L L C A 201]
• The terminology used to describe L L Cs formed in other states or
nations is also similar to that used in corporate law.
• Example: An L L C formed in one state but doing business in another
state is referred to in the second state as a foreign L L C.
17-1b The Formation of the L L C (slide 1 of 2)
Articles of Organization
• To form an L L C, articles of organization must be filed with a central state
agency—usually the secretary of state’s office [U L L C A 202].
• Articles of organization – The document that is filed with the appropriate state
official, usually the secretary of state, when an LLC is formed and that contains basic
information about the business, including:
• The name of the business
• The business’s name must include the words “Limited Liability Company” or the initials
“L L C” [U L L C A 105 (a)].
• The business’s principal address
• The name and address of a registered agent
• The members’ name
• How the L L C will be managed [U L L C A 203]
17-1b The Formation of the L L C (slide 2 of 2)
Preformation Contracts
• Persons who are forming an L L C may enter into
preincorporation contracts during the process of organization but
before the L L C becomes a legal entity.
• The individual promoters who sign the contracts are bound to their terms.
• Once the L L C is formed and adopts the preincorporation
contracts (by means of novation, which substitutes a new
contract for the old contract), it can enforce the contract terms.
17-1c Jurisdictional Requirements
• A significant difference between L L Cs and corporations involves

federal jurisdictional requirements.
• Under the federal jurisdiction statute, a corporation is deemed to be a
citizen of the state where it is incorporated and maintains its principal
place of business.
• The statute does not mention the state citizenship of partnerships, L L Cs, and other
unincorporated associations.
• The courts, however, have tended to regard these entities as citizens of every state of
which their members are citizens.
17-1d Advantages of the L L C (slide 1 of 3)
• The L L C offers many advantages to businesspersons, which is

why this form of business organization has become increasingly
popular.
Limited Liability
• A key advantage of the L L C is the limited liability of its members.
• The L L C as an entity can be held liable for any loss or injury caused by
the wrongful acts or omissions of its members.
• Members themselves generally are not personally liable.
Flexibility in Taxation
• Another advantage of the L L C is its flexibility in regard to
taxation.
• An L L C that has two or more members can choose to be taxed as either
a partnership or a corporation.
• An L L C that wants to distribute profits to its members usually prefers to be taxed as
a partnership to avoid the “double taxation” that is characteristic of the corporate
entity.
• Unless an L L C indicates that it wishes to be taxed as a corporation, the Internal
Revenue Service (I R S) automatically taxes it as a partnership.
• This means that the L L C, as an entity, pays no taxes, and the profits are “passed
through” the L L C to the members, who then personally pay taxes on the profits.
• An L L C that has only one member cannot be taxed as a partnership.
• For federal income
Cross/Miller, tax Environment
The Legal purposes,of one-member
Business: Text andLCases,
L CsEleventh
are automatically taxed as
Edition. © 2021 Cengage. All Rights
sole proprietorships unless they indicate that they wish to be taxed as corporations.
Management and Foreign Investors

• Another advantage of the L L C is the flexibility it offers in terms
of business operations and management.
• Foreign investors are allowed to become L L C members, so
organizing as an L L C can enable a business to attract investors
from other countries.
17-1e Disadvantages of the L L C
• The main disadvantage of the L L C is that state L L C statutes

are not uniform.
• Therefore, businesses that operate in more than one state may not
receive consistent treatment in these states.
17-2 L L C Management and Operation
• The members of an L L C have considerable flexibility in

managing and operating the business.
17-2a Management of an L L C
• L L C members have two options for managing the firm:

1. A “manager-managed” L L C
2. A “member-managed” L L C
• Most state L L C statutes and the U L L C A provide that unless the articles of
organization specify otherwise, an L L C is assumed to be member managed [U L L
C A 203 (a) (6)].
Exhibit 17-1 Management of an L L C
17-2b Fiduciary Duties
• Under the U L L C A, managers in a manager-managed L L C

owe fiduciary duties (the duty of loyalty and the duty of care) to
the
L L C and its members [U L L C A 409 (a), 409 (h)].
• Because not all states have adopted the U L L C A, some state statutes
provide that managers owe fiduciary duties only to the L L C and not to
the L L C’s members.
17-2c The L L C Operating Agreement (slide 1 of 2)
• The members of an L L C can decide how to operate the various

aspects of the business by forming an operating agreement
[U L L C A 103 (a)].
• Operating agreement – An agreement in which the members of a limited
liability company set forth the details of how the business will be managed
and operated.
• In many states, an operating agreement is not required for an L L C to exist, and if
there is one, it need not be in writing.
Exhibit 17-2 Provisions Commonly Included
in an L L C Operating Agreement
17-2c The L L C Operating Agreement (slide 2 of 2)
• If a dispute arises and there is no agreement covering the topic

under dispute, the state L L C statute will govern the outcome.
• When an issue is not covered by an operating agreement or by
an L L C statute, the courts often apply principles of partnership
law.
• Sometimes, an operating agreement and the state’s L L C
statutes are applied together to determine the outcome of a
dispute between the members of an L L C.
17-3 Dissociation and Dissolution of an L L C
• In an L L C, dissociation occurs when a member ceases to be associated in
the carrying on of the L L C business.
• A member of an L L C has the power to dissociate at any time but may not have the right
to dissociate.
• Under the U L L C A, the events that trigger a member’s dissociation from an L L C
include:
• Voluntary withdrawal
• Expulsion by other members
• Court order
• Incompetence
• Bankruptcy
• Death
• If a member dies or otherwise dissociates from an L L C, the other members may
continue to carry on the L L C business unless the operating agreement provides
otherwise.Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
17-3a Effects of Dissociation from an L L C
• The following occur when a member dissociates from an L L C:
• The member loses his or her right to participate in management.
• The member loses his or her right to act as an agent for the L L C.
• The member’s duty of loyalty to the L L C terminates.
• The member’s duty of care continues only with respect to events that occurred before
dissociation.
• The member has a right to have his or her interest in the L L C bought out by the other
members.
• The L L C’s operating agreement may contain provisions establishing a buyout price.
• If it does not, the member’s interest is usually purchased at fair value.
• If the member’s dissociation violates the L L C’s operating agreement, it is
considered legally wrongful, and the dissociated member can be held liable
for damages caused by the dissociation.
17-3b Dissolution of an L L C
• Regardless of whether a member’s dissociation was wrongful or rightful,
normally the dissociated member has no right to force the L L C to dissolve.
• The remaining members can opt either to continue or to dissolve the business.
• Members can:
• Stipulate in their operating agreement that certain events will cause dissolution
• Agree that they have the power to dissolve the L L C by vote
• A court can order an L L C to be dissolved in certain circumstances.
• Examples: When the members have engaged in illegal or oppressive conduct; when it is
no longer feasible to carry on the business
17-3c Winding Up of an L L C
• When an L L C is dissolved, any members who did not wrongfully dissociate
may participate in the winding-up process.
• To wind up the business, members must collect, liquidate, and distribute the L L C’s
assets.
• Members may preserve the assets for a reasonable time to optimize their return.
• Members continue to have the authority to perform reasonable acts in conjunction with
winding up.
• In other words, the L L C will be bound by the reasonable acts of its members during the
winding-up process.
• Once all of the L L C’s assets have been sold, the proceeds are distributed.
1. Debts to creditors are paid first (including debts owed to members who are creditors of the
L L C).
2. The members’ capital contributions are returned next.
3. Any remaining amounts are then distributed to members in equal shares or according to their
operating agreement.
17-4 Limited Liability Partnerships
• Limited liability partnership (L L P) – A hybrid form of business

organization that is used mainly by professionals who normally do
business in a partnership.
• An L L P is a pass-through entity for tax purposes.
• A partner’s personal liability for the malpractice of other partners is limited.
• Almost all of the states have enacted L L P statutes.
• The L L P is especially attractive for professional service firms
and family businesses.
17-4a Formation of an L L P
• L L P s must be formed and operated in compliance with state statutes,
which may include provisions of the U P A.
• The appropriate form must be filed with a central state agency, usually the secretary of
state’s office, and the business’s name must include either “Limited Liability Partnership”
or “L L P” [U P A 1001, 1002].
• An L L P must file an annual report with the state to remain qualified as an L L P in that
state [U P A 1003].
• In most states, it is relatively easy to convert a general partnership into an
L L P.
• The firm’s basic organizational structure remains the same.
• All of the statutory and common law rules governing partnerships still apply (apart from
those modified by the L L P statute).
17-4b Liability in an L L P (slide 1 of 3)
• An L L P allows professionals, such as attorneys and

accountants, to avoid personal liability for the malpractice of other
partners.
• A partner in a L L P is still liable for her or his own wrongful acts, such as
negligence.
• Also liable is the partner who supervised the individual who committed a
wrongful act.
• Although L L P statutes vary from state to state, generally each
state statute limits the liability of partners in some way.
• The U P A more broadly exempts partners in an L L P from
personal liability for any partnership obligation, “whether arising in
contract, tort, or The
Cross/Miller, otherwise”
Legal Environment[U P A 306
of Business: Text and (c)].
Cases, Eleventh Edition. © 2021 Cengage. All Rights
Liability outside the State of Formation

• When an L L P formed in one state wants to do business in
another state, it may be required to file a statement of foreign
qualification in the second state [U P A 1102].
• Because state L L P statutes are not uniform, a question sometimes
arises as to which law applies if the L L P statutes in two states provide
different liability protection.
• Most states apply the law of the state in which the L L P was formed, even when the
firm does business in another state, which is also the rule under U P A 1101.
Sharing Liability among Partners

• When more than one partner in an L L P commits malpractice:
• Most states provide that each partner is jointly and severally liable for the
entire result.
• Some states provide for proportionate liability—that is, for separate
determinations of the negligence of the partners.
17-4c Family Limited Liability Partnerships
• Family limited liability partnership (F L L P) – A limited liability

partnership (L L P) in which the majority of the partners are
members of a family.
• A person acting in a fiduciary capacity for persons so related can also be
a partner.
• All of the partners must be:
• Natural persons
• Acting in a fiduciary capacity for the benefit of natural persons
• Probably the most significant use of the F L L P is in agriculture.
17-5 Limited Partnerships
• Limited partnership (L P) – A partnership consisting of one or more general
partners and one or more limited partners.
• General partner – A partner who assumes responsibility for the management of the
partnership and has full liability for all partnership debts.
• Limited partner – A partner who contributes capital to the partnership but has no right to
participate in its management and has no liability for partnership debts beyond the
amount of his or her investment.
• Most states and the District of Columbia have adopted laws based on the
Revised Uniform Limited Partnership Act (R U L P A).
• Limited partnerships differ from general partnerships in several ways.
Exhibit 17-3 A Comparison of General
Partnerships and Limited Partnerships (slide 1 of 2)
Exhibit 17-3 A Comparison of General
Partnerships and Limited Partnerships (slide 2 of 2)
17-5a Formation of an L P
• In contrast to the private and informal agreement that usually

suffices to form a general partnership, the formation of a limited
partnership is a public and formal proceeding.
• The partners must strictly follow statutory requirements.
• A limited partnership must have at least one general partner and one limited partner.
• The partners must sign a certificate of limited partnership.
• Certificate of limited partnership – The document that must be filed with a designated
state official to form a limited partnership.
• The certificate of limited partnership must include certain information, including:
• The partnership’s name
• The partnership’s mailing address
• The capital contribution of each general and limited partner
17-5b Liabilities of Partners in an L P (slide 1 of 3)
• General partners are personally liable to the partnership’s

creditors.
• Thus, at least one general partner is necessary in a limited partnership so
that someone has personal liability.
• This policy can be circumvented in states that allow a corporation to be the general
partner in a partnership.
• Because the corporation has limited liability by virtue of corporation statutes, if a
corporation is the general partner, no one in the limited partnership has personal liability.
• The liability of a limited partner is limited to the capital that she or he

contributes or agrees to contribute to the partnership [R U L P A 502].
• Limited partners enjoy this limited liability only so long as they do not
participate in management [R U L P A 303].
• A limited partner who participates in management and control of the business will be
just as liable as a general partner to any creditor who transacts business with the limited
partnership.
• Liability arises when the creditor believes, based on the limited partner’s conduct, that the
limited partner is a general partner [R U L P A 303].
• Such conduct includes:
• Acting as a general partner
• Knowingly allowing her or his name to be used in partnership business
• Contributing services to the partnership
• A number of “safe harbors” protect a limited partner from liability

for acting as a general partner [R U L P A 303 (a)].
• Safe harbors allow a limited partner to:
• Consult with the general partner regarding partnership business
• Act as a contractor or employee of the partnership
• Participate in winding up the business
• A limited partner who engages in only one of the safe-harbor activities
normally is not exposed to personal liability for participating in the
management and control of the business.
17-5c Rights and Duties of Partners in an L P
• With the exception of the right to participate in management,

limited partners have essentially the same rights as general
partners.
• Limited partners:
• Have a right of access to the partnership’s books
• Have a right of access to information regarding partnership business
• Are entitled to a return of their contributions in accordance with the partnership
certificate, on dissolution of the partnership [R U L P A 201 (a) (10)]
• Can assign their interests subject to the partnership certificate [R U L P A 702, 704]
• Can sue an outside party on behalf of the firm if the general partners with authority to
do so have refused to file suit [R U L P A 1001]
17-5d Dissociation and Dissolution of an L P
(slide 1 of 4)
• A general partner has the power to voluntarily dissociate, or

withdraw, from a limited partnership unless the partnership
agreement specifies otherwise.
• Under the R U L P A, a limited partner can withdraw from the
partnership by giving six months’ notice, unless the partnership
agreement specifies a term.
• However, some states have passed laws prohibiting the withdrawal of
limited partners.
(slide 2 of 4)
Events That Cause Dissociation

• In addition to voluntary dissociation, a general partner can be dissociated from a limited
partnership in any of the following ways:
• Bankruptcy
• Retirement
• Death
• Mental incompetence
• These events will cause the dissolution of the limited partnership unless all partners agree to
continue the firm [R U L P A 801].
• A limited partnership can also be dissolved by court decree [R U L P A 802].
• A limited partnership cannot be dissolved by a limited partner’s:
• Bankruptcy (unless it causes the bankruptcy of the firm)
• Death
• Assignment of interest (right to receive distributions) [R U L P A 702, 704, 705]
(slide 3 of 4)
Distribution of Assets
• On dissolution, creditors’ claims, including those of partners who are
creditors, take first priority.
• After that, partners and former partners:
• Receive unpaid distributions of partnership assets
• Are entitled to a return of their contributions in the proportions in which they share in
distributions [R U L P A 804]
Valuation of Assets
• Disputes commonly arise about how the partnership’s assets should be
valued and distributed and whether the business should be sold.
(slide 4 of 4)
Buy-Sell Agreements
• Both general and limited partners can agree ahead of time on
how the partnership’s assets will be valued and divided if the
partnership dissolves.
• Buy-sell agreements can help the partners avoid disputes.
• However, buy-sell agreements do not eliminate all potential for litigation, especially if
the terms are subject to more than one interpretation.
17-5e Limited Liability Limited Partnerships
• Limited liability limited partnership (L L L P) – A type of limited

partnership in which the liability of the general partner is the same
as the liability of the limited partners—that is, the liability of all
partners is limited to the amount of their investments in the firm.
• A few states provide expressly for L L L Ps.
• In states that do not provide for L L L Ps but do allow for limited
partnerships and limited liability partnerships, a limited partnership should
probably still be able to register with the state as an L L L P.
Appendix
Note to Instructor:
The following activities are also included at the end of each chapter.
We have provided them here to aid with in-class facilitation.
Practice and Review:
Limited Liability Business Forms (slide 1 of 2)
• The city of Papagos, Arizona, had a deteriorating bridge in need of repair on a prominent
public roadway.
• The city posted notices seeking proposals for an artistic bridge design and reconstruction.
• Davidson Masonry, L L C, which was owned and managed by Carl Davidson and his wife,
Marilyn Rowe, decided to submit a bid to create a decorative concrete structure that
incorporated artistic metalwork.
• They contacted Shana Lafayette, a local sculptor who specialized in large-scale metal
creations, to help them design the bridge.
• The city selected their bridge design and awarded them the contract for a commission of
$184,000.
Practice and Review:
Limited Liability Business Forms (slide 2 of 2)
• Davidson Masonry and Lafayette then entered into an agreement to work together on the
bridge project.
• Davidson Masonry agreed to install and pay for concrete and structural work, and Lafayette
agreed to install the metalwork at her expense.
• They agreed that overall profits would be split, with 25 percent going to Lafayette and 75
percent going to Davidson Masonry.
• Lafayette designed numerous metal sculptures of trout that were incorporated into colorful
decorative concrete forms designed by Rowe.
• Davidson performed the structural engineering.
• The group worked together successfully until the completion of the project.
Using the information presented in the chapter,

answer the following questions.
Practice and Review: Questions (slide 1 of 4)
1. Would Davidson Masonry automatically be taxed as a

partnership or a corporation?
2. Is Davidson Masonry member managed or manager managed?
3. Suppose that during construction, Lafayette asked Carl

Davidson to rent space in a warehouse that was close to the
bridge so that she could work on her sculptures near the site
where they would eventually be installed. Carl Davidson signed
the rental contract in his own name rather than the name of the
L L C. The other members of Davidson Masonry were not aware
of the rental agreement. In this situation, would a court likely hold
that Davidson Masonry was liable on the contract that Carl
Davidson had entered? Why or why not?
4. Now suppose that Rowe has an argument with her husband and
wants to withdraw from being a member of Davidson Masonry.
What is the term for such a withdrawal, and what effect would it
have on the L L C?
Debate This…
Because L L Cs are essentially just partnerships with limited liability

for members, all partnership laws should apply.

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Chapter 17

Limited Liability Business Forms

• Limited liability company (L L C) – A hybrid form of business

Limited Liability of Members

When Liability May Be Imposed

Other Similarities to Corporations

• A significant difference between L L Cs and corporations involves

• The L L C offers many advantages to businesspersons, which is

Management and Foreign Investors

• The main disadvantage of the L L C is that state L L C statutes

• The members of an L L C have considerable flexibility in

• L L C members have two options for managing the firm:

• Under the U L L C A, managers in a manager-managed L L C

• The members of an L L C can decide how to operate the various

• If a dispute arises and there is no agreement covering the topic

• Limited liability partnership (L L P) – A hybrid form of business

• An L L P allows professionals, such as attorneys and

Liability outside the State of Formation

Sharing Liability among Partners

• Family limited liability partnership (F L L P) – A limited liability

• In contrast to the private and informal agreement that usually

• General partners are personally liable to the partnership’s

• The liability of a limited partner is limited to the capital that she or he

• A number of “safe harbors” protect a limited partner from liability

• With the exception of the right to participate in management,

• A general partner has the power to voluntarily dissociate, or

Events That Cause Dissociation

• Limited liability limited partnership (L L L P) – A type of limited

Using the information presented in the chapter,

1. Would Davidson Masonry automatically be taxed as a

2. Is Davidson Masonry member managed or manager managed?

3. Suppose that during construction, Lafayette asked Carl

Because L L Cs are essentially just partnerships with limited liability

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