This article appeared in the August 1994 issue of The Louisiana Bar Journal. It may be cited as William C. Kalmbach, Formation and Governance of the Louisiana Limited Liability Company, 42 Louisiana Bar Journal 134 (August 1994). Reprinted by permission of the Louisiana State Bar Association.

*William C. Kalmbach III practices law with the Shreveport law firm of Cook, Yancey, King & Galloway, where he concentrates in the areas of business and tax planning. Kalmbach is a Phi Beta Kappa graduate of Vanderbilt University, where he received a BA degree, and an honors graduate of Georgetown University, where he received his law degree.

The limited liability company (LLC) is Louisiana's newest form of business entity and may well be the entity of choice for many investors and entrepreneurs. Properly formed and maintained, the LLC provides its members with both the corporate shield of limited liability and the advantages of pass-through partnership taxation, while avoiding the restrictions on ownership and operations that limit the attractiveness of the S corporation. As a result, more and more practitioners are being asked to prepare LLC formation and management documents.

There is good news and bad news for such professionals. The good news is, like a general partnership, the LLC is a creature of contract, and, thus, the parties have enormous freedom to design an entity that precisely serves their needs. The bad news is, because the LLC is a creature of contract and new to Louisiana jurisprudence, there exists no formulary and very little guidance is available as to how one properly designs and maintains the entity.

This article is intended to furnish the practitioner with a basic outline for the formation and maintenance of the LLC. (Practitioners also should be aware that income tax considerations drive many LLC formation decisions. The classification of LLCs for purposes of the federal and state income tax laws is beyond the scope of this article. An article on tax considerations in LLC formation was published in the June 1994 Louisiana Bar Journal.) State law provides the statutory minimum requirements for organization. Beyond those minimums, the practitioner designing an LLC is limited only by his or her imagination and the client's budget.

The three primary formation and governance issues for the LLC are:

* internal management and regulation of the LLC;

* powers and duties of members and managers of a LLC;

* the LLC operating agreement.

State law supplies the basic rules for formation of the LLC. See La. Rev. Stat. Ann. §§ 12:1301-1369 (hereinafter referred to as the "LLC statute). Similar in many respects to the rules for formation of a business corporation, these rules provide the legal authority for creation of the LLC, the procedure for that formation and the requirements of the LLC's articles of organization and initial report. These rules are the parameters around which the attorney may construct the business vehicle according to the client's specific needs.

Procedure for Formation of the Limited Liability Company

Two or more persons may form the LLC by filing articles of organization and an initial report with the secretary of state. These documents may be delivered to the secretary of state up to 30 days in advance of a specified date for filing. La. Rev. Stat. Ann. § 12:1304(A). Provided the articles of organization and initial report comport with the requirements of the LLC statute, the secretary of state will issue a certificate of organization, evidencing the creation of the LLC.

The Articles of Organization

The LLC's articles of organization are similar to the business corporation's articles of incorporation. They are the ultimate governing instrument of the LLC. The LLC statute provides minimum requirements for the articles of organization and provides several optional provisions for inclusion.

The LLC statute requires that the articles be executed by at least one person, who need not be a member or manage of the LLC. The articles also must set forth the name of the LLC and the purpose for which it is formed or that its purpose is to engage in any lawful activity for which LLCs may be formed. La. Rev. Stat. Ann. §§ 12:1305(A) and (B).

The LLC statute also provides that the articles may set forth any of the following:

* any limitations on the ability of members to bind the LLC or a statement that such limitations are contained in the operating agreement;

* whether and to what extent the LLC will be managed by managers;

* any restrictions on the authority of managers or that such restrictions are provided in the operating agreement

* the latest date, if any, on which the LLC is to dissolve; and

* any other provision that is not inconsistent with law. La. Rev. Stat. Ann. § 12:1305(C).

The Initial Report

The LLC's initial report serves the same purpose as the initial report of the business corporation: it provides a public record of the management and service of process information for the entity. The initial report must set forth the following information:

* the location and address of the LLC's registered office;

* the location and address of each of its registered agents;

* a notarized affidavit of acknowledgment and acceptance signed by each of its registered agents; and

* the names and addresses of the initial managers of the LLC, or members, if management of the LLC is reserved to the members. La. Rev. Stat. Ann. § 12:1305(E).

From the perspective of state law, management of the LLC is a matter of contract. The members of the LLC may agree among themselves regarding matters such as management of the LLC by the members, appointment of managers for the entity, voting requirements for members and the method of removal of a manager. If the members do not make agreements among themselves regarding these issues, the LLC statute's default provisions supply them.

Management by Members

The LLC statute provides that, except as stated in the articles of organization, the business of the LLC shall be managed by the members, subject to any provision in a written operating agreement. La. Rev. Stat. Ann. § 12:1311. Thus, the default management provision for the LLC is equal management powers by each member of the LLC. This legal structure is the familiar general partnership management structure and may well be suited to most LLCs.

The LLC statute provides the LLC organizers with two different (and complementary) methods of altering the default management provisions. The articles of organization may state an alternative method of management. For example, the articles of organization might provide that the business of the LLC shall be managed by a manager. The articles of organization also might state that the business of the LLC shall be managed by a manager (or by the members) but that such authority shall be subject to the terms and conditions of the operating agreement.

The requirement that non-default management provisions be referenced in the articles of organization is designed to give public notice of the authority of individuals to speak for the LLC. With respect to the LLC that buys and sells immovable property, for example, the articles of organization might identify a member who is authorized to deal in immovables on behalf of the LLC. Such specificity simplifies transactions and facilitates the activities of title examiners and loan underwriters.

Management by Managers

The LLC statute states that the articles of organization may provide that the business of the LLC shall be managed by or under the authority of one or more managers. These persons or entities need not be members of the LLC to perform their duties as managers. La. Rev. Stat. Ann. § 12:1312(A).

The organizer of the LLC is required to specify in the articles of organization or an operating agreement the number of managers and may designate their qualifications. La. Rev. Stat. Ann. §§ 12:1312(B) and (C). In the absence of particularized qualifications, the LLC statute default provisions state that a plurality vote of the LLC members shall be sufficient to fill the initial positions of managers and any vacancies that may occur. La. Rev. Stat. Ann. § 12:1313(1).

Similarly, unless the articles of organization or any operating agreement otherwise provides, any manager may be removed from office by a majority vote of the members at a meeting called for that express purpose. Such removal may be made with or without cause. La. Rev. Stat. Ann. § 12:1313(2).

Analogous to its treatment of the management structure of the entity, the LLC statute provides certain default provisions for the duties of managers and members of the LLC. In most instances, those statutory default provisions may be overridden by the articles of organization or the operating agreement.

What Must You Do: The Fiduciary Relationship

Notwithstanding the general freedom of the LLC members to contract among themselves regarding the LLC, the LLC statute does provide several statutory absolutes, from which the members' contract may not deviate. The most important of these statutory absolutes is the fiduciary relationship between the LLC, its members and its management.

The LLC statute provides that a member, if management is reserved to the members, or a manager, if management is vested in a manager, stands in a fiduciary relationship to the LLC and its members. Accordingly, a member or manager must discharge his duties in good faith, with the diligence, care, judgment and skill an ordinary prudent person in a like position would exercise under similar circumstances and in the manner he reasonably believes to be in the best interests of the LLC. La. Rev. Stat. Ann. § 12:1314(1).

What Can You Do: Voting Rights of Members and Managers

The activities of the LLC are limited only by the statutory prohibitions of La. Rev. Stat. Ann. § 12:1302(A), e.g., the LLC may not operate a bank. Beyond that prohibition, the LLC may conduct any lawful activity, and the members and managers of the LLC may accomplish their goals in any way they deem suitable. Absent a complete delegation of members' management rights to a single manager, the most common means of administration is majority voting.

The voting rights of members and managers of the LLC are a matter of agreement among the members. Customarily, such agreements are specified in the operating agreement. If no provision for voting rights is made in the articles of organization or operating agreement, the LLC statute default provisions provide the applicable rules.

The default provision for manager-based management states that each manager shall be entitled to a single vote on all matters brought before the managers. Unless otherwise specified, a simple majoprity vote is sufficient to carry an issue. La. Rev. Stat. Ann. § 12:1316.

Similarly, unless otherwise specified in the articles of organization or operating agreement, each member of the LLC may cast a single vote on all matters brought before the members, and a majority is sufficient to approve a matter. La. Rev. Stat. Ann. § 12:1318(A).

The LLC statute default provisions also state that unless the articles of organization or operating agreement provide otherwise, and regardless of the existence of a manager or managers, a majority vote of the members is required for the following activities:

* the dissolution and winding up of the LLC;

* the sale, exchange, lease, mortgage, pledge or other transfer of all of substantially all of the assets of the LLC;

* the merger or consolidation of the LLC;

* the incurring of indebtedness by the LLC other than in the ordinary course of business;

* the alienation, lease or encumbrance of any immovables of the LLC; and

* any amendment to the articles of organization or operating agreement. La. Rev. Stat. Ann. § 12:1318(B).

Having reviewed the LLC formation procedure and the LLC statute's default provisions, it is clear that, with some ease and moderate expense, one can create a LLC that will likely provide its members with limited liability and pass-through taxation. If the practitioner stops there, however, he may well be doing a disservice to the client. One of the primary benefits of the LLC is the ability of the members, through contract, to design a customized entity. The attorney should be prepared to offer a client such a service by means of the carefully-crafted operating agreement.

Many of the "customized" provisions to be discussed may be included in the LLC's operating agreement or the articles of organization. However, as the articles of organization are available to the public, many LLCs prefer to keep them as short and nondescript as possible and use the operating agreement as the primary contract between the members and the governing instrument of the LLC.

Obviously, there is no standard operating agreement. There are, however, types of provisions that are often found in operating agreements and greatly facilitate both the operation and maintenance of the LLC. Some of those provisions include agreements among the members regarding the following:

* the term of the LLC;

* the transferability of membership interests;

* the capital, allocations and distributions of the LLC; and

* the means by which LLC members may act.

Agreement Regarding Term of the LLC

Louisiana law imposes no mandatory termination date on the life of the LLC. However, for federal income tax purposes, organizers of the LLC likely will want to include such a provision. A suggested form of termination provision is a simple statement that the LLC shall have a term of, e.g., 25 years and shall dissolve on a date specific, unless extended by the members.

Agreement Regarding Transferability of Membership Interests

The LLC statute states that, unless otherwise provided in the articles of organization or the operating agreement, an assignee of an interest in an LLC shall not become a member or participate in the management of the LLC, unless the other members of the LLC consent in writing. La. Rev. Stat. Ann. § 12:1332(A). Instead, such an assignee is entitled only to the LLC income payable to that membership interest. Deviations from this default provision, e.g., rights of first refusal or a provision permitting transfers within families, can be contained in the operating agreement.

Agreement Regarding Contributions, Accounts and Allocations

The LLC statute provides that the contribution of a member to the LLC may take the form of cash, property, services rendered or a promissory note or other binding obligation to contribute cash or property or to perform services. La. Rev. Stat. Ann. § 12:1321. The operating agreement should contain the members' agreement as to the percentages of capital each has contributed to the LLC.

The operating agreement also should contain the agreement that capital accounts are to be maintained for each member of the LLC, and such maintenance (and adjustment if any) will be consistent with the capital account maintenance provisions of applicable IRS regulations, including the rules of Treasury Regulation 1.704-1(b). Similarly, the operating agreement is the appropriate document to recite the allocations of gain, income, costs, expenses and distributions.

Agreements Regarding Actions by Members

The method by which the members of the LLC manage the entity is solely a matter of contract between the parties. As noted above, the LLC statute provides that, unless otherwise specified in the articles of organization, the business of the LLC shall be managed by the members. La. Rev. Stat. Ann. § 12:1311. If this is the method of management desired, it is still advisable to create a decision-making process in the operating agreement.

What that process might be is limited only by the organizers' imagination. LLC organizers might borrow from corporate law and provide that actions by members may only be taken at a meeting of the members at which a quorum is present. Alternatively, the operating agreement might provide that the written consent of a majority of the LLC's members is sufficient to pass a motion or that votes taken by means of telephonic meetings are acceptable.

On the other end of the spectrum, the members might agree to manage the LLC as a general partnership, with each member acting as a mandatary of the LLC. Indeed, the LLC statute provides that unless the articles of organization state otherwise, each member, if management is reserved to the members, is the mandatary of the LLC for all matters in the ordinary course of the entity's business (excluding the alienation, lease or encumbrance of immovables). La. Rev. Stat. Ann. § 12:1317(A).

Whatever method of membership action the organizers choose, that decision should be reflected in the operating agreement and referenced in the articles of organization. There are at least two important benefits to formalizing the decision-making process. The first is that a formal process forces the participants to keep records, minutes of meetings and the like. These documents are indispensable in an audit proceeding, a dispute regarding entity finances, or upon the withdrawal or addition of a member.

The second benefit of a written record of the members' agreement regarding the member decision-making process is that it affords the LLC protection from a single member's actions with third parties. The LLC statute provides that persons dealing with members of the LLC shall be deemed to have knowledge of restrictions on the authority of such members contained in a written operating agreement, if the articles of organization of the LLC contain a statement that such restrictions exist. La. Rev. Stat. Ann. § 12:1317(B).

Thus, inclusion in the articles of organization of a statement that the ability of a member to bind the LLC is restricted according to the operating agreement will negate an individual member's default agency powers with respect to the LLC and protect the remaining members from the individual member's power to bind the LLC without consent of the other members.

Agreement Regarding Managers

In lieu of membership management, the operating agreement may contain provisions for the appointment of a manager. These provisions should include a designation of the original manager and the method by which a manager may be removed and another manager selected. The operating agreement should also contain a general direction that the manager is authorized to conduct the day-to-day affairs of the LLC.

Optional provisions regarding management by a manager might include designations of specific powers of the manager, for example, the power to execute, on behalf of the LLC, deeds, mortgages, bonds and contracts. Other provisions could include limitations on the ability of the manager to expend funds beyond a certain amount.

The LLC is fast becoming the most popular form of new business entity. Properly designed and maintained, it offers unique benefits to its members. Poorly-designed formation or governance documents, however, can result in unexpected and unattractive taxation as well as practical problems in the day-to-day operation of the entity. A complete understanding of the LLC statute's rules and options regarding formation and governance of the LLC is required of every Louisiana business lawyer.

Return to The Castle Classroom

Copyright ©2002 by M. R. Franks - ALL RIGHTS RESERVED