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Limited Liability Companies — A New Alternative to Corporations and Partnerships

by E. Christopher Caravette

Illinois has recently joined the growing list of states which now recognizes a new form of business organization, the Limited Liability Company (“LLC”). The legislation which recognizes the LLC is called the Illinois Limited Liability Company Act (“the Act”), which was passed into law on September 11, 1992, and became effective January 1, 1994. By June of 1994, it is expected that almost all fifty states will have adopted similar legislation recognizing LLCs.

But just what is a Limited Liability Company, and how does it differ from the more familiar forms of business organization, the corporation and the partnership? An LLC is a form of business organization which, in essence, allows a business to organize and function like a corporation in some respects and like a partnership in others. While there are a number of characteristics unique to an LLC, perhaps the most attractive is that an LLC provides all of the members of the business with the recognized corporate characteristic of limited liability (hence, the name) without limiting the ability of the equity owners of the business to participate in the management of the venture (like a limited partnership), while providing pass-through income tax treatment (again like a partnership or an “S” corporation). An LLC can either more closely resemble a corporation or a partnership in its structure and operations, depending upon the desires and goals of its members.

How is an LLC established? Under the Act, one or more persons may organize an LLC by filing Articles of Organization with the Secretary of State. The filing fee is $500.00. The Act also requires that an LLC must have at least two “members”, or owners. Members of an LLC may be individuals, corporations, or partnerships. In contrast, a corporation may have only one owner or shareholder, an “S” corporation is limited to thirty-five (35) owners or shareholders (all of whom must be individuals or meet other strict requirements), and a partnership is unlimited in the number of owners or partners it may have.

What types of businesses can organize as an LLC? The Act provides that any lawful business may organize as an LLC, except banking or insurance companies. Illinois Supreme Court rules also bar lawyers from organizing as an LLC.

An LLC is also required to have an Operating Agreement, which is a combination of what we recognize as corporate by-laws and a partnership agreement. This Operating Agreement defines the relationship of the LLC members to each other and describes the management and operation of the business. Unless otherwise provided in the Articles of Organization, an LLC is managed by its members, although management may be vested in a group of non-owner managers. For example, the management of an LLC is generally reserved to its members, much like a partnership. However, an LLC may also elect managers who are charged with the day-to-day operations and who make management decisions, much like a corporation. Furthermore, unless the Articles of Organization provide otherwise, any one or more of the members can bind the LLC by that member’s actions, much like the partners of a general partnership.

How is an LLC treated for tax purposes, and what, if any, are the liability concerns which are peculiar to an LLC? For federal income tax purposes, an LLC is treated similarly to a partnership if it is properly formed, and therefore avoids the double income tax characteristic of many corporations. There is, however, a very significant difference between an LLC and a partnership which relates not to tax issues, but to liability. Specifically, in a partnership, all partners are responsible for the liabilities of the partnership. Likewise, in a limited partnership, at least one general partner is personally responsible for the liabilities of the limited partnership. In an LLC, however, no member is required to be liable for the debts of the LLC, much like a corporation where there is also limited liability. Furthermore, limited partners of a limited partnership are generally prevented from participating in the management and control of the partnership’s business. If a limited partner does take part in management activities, that limited partner may lose his limited liability. In contrast, members of an LLC may participate in the management and control of the business without becoming liable for the debts of the LLC.

What are an LLC’s powers? Similar to that of a corporation, an LLC has the ability to sue and be sued; to purchase, sell, lease or mortgage property; and to lend and borrow money.

What, if any, are the drawbacks of an LLC? Perhaps the biggest is that, at present, there are necessarily a number of unknowns. Specifically, since it is a relatively new form of business organization, there is little case law for precedent in the treatment of LLCs in areas such as bankruptcy and tax matters. Second, like a corporation, the attractive limited liability feature can, under certain circumstances, be set aside by a court of law. Finally, recognition of an LLC in a state outside the one in which it has been established may be problematic. Under the Illinois Act, LLCs validly formed in other states are recognized as such here. However, LLCs organized in Illinois may or may not be recognized as such in other states, depending upon the applicable laws in that particular state.

For any new business, the Limited Liability Company form of organization should be considered as an alternative to a partnership or corporation. We will be happy to advise you further as to whether a Limited Liability Company is the right type of organization for your business.

(Note: The information in this article is intended to be general in nature. Plan to discuss your particular circumstances with an attorney for how this might apply to you.)