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By:
James G. Leyden, Jr. (e-mail:
leyden@rlf.com) I. Introduction Delaware continues to be on the cutting edge in offering the business community flexible legal entities through which to conduct business. Already the forum of choice when it comes to organizing corporations, limited partnerships and business trusts, Delaware intends to achieve a comparable position for Delaware limited liability companies ("DLLCs"). This result should be attainable since DLLCs have many of the same features currently available to Delaware corporations, limited partnerships and business trusts. The Delaware Limited Liability Company Act, 6 Del. C. § 18-101, et seq. (the "DLLC Act"), which became effective on October 1, 1992, is modeled on Delaware's well accepted limited partnership statute, the Delaware Revised Uniform Limited Partnership Act, 6 Del. C. § 17-101, et seq. In addition, several provisions from the Delaware General Corporation Law have been incorporated into the DLLC Act. Delaware's commitment to updating its laws relating to limited liability companies is evidenced by the fact that the DLLC Act has been amended in 1994, 1995, 1996, 1997, 1998 and 1999. It is contemplated that the DLLC Act will be amended again in August of 2000. As of the date hereof, over 95,000 DLLCs have been formed. This compares with approximately 290,000 Delaware corporations. The formation of over 95,000 DLLCs in less than a decade is remarkable. A substantial majority of such DLLCs have been formed over the last four years. A DLLC is a separate legal entity that is permitted to carry on any lawful business, purpose or activity except certain insurance or banking activities. As a separate legal entity, a DLLC is distinct from its owners, who are known as "members." Thus, a DLLC may acquire and dispose of real or personal property in its own name, make contracts in its own name, participate with others in business opportunities and sue and be sued in its own name. If properly formed, a DLLC is similar to a corporation with respect to the liability of its members, and for federal income tax purposes a DLLC may be treated as a partnership or a division of the member. On December 17, 1996, the United States Internal Revenue Service issued the "check-the-box" regulations for non-corporate, domestic and foreign business entities with a simplified regimen in which such business entities generally may elect their desired U.S. federal tax classification as a partnership or corporation. Such regulations became effective on January 1, 1997. A DLLC formed on or after January 1, 1997 will have partnership tax classification, absent an affirmative election to the contrary. If the DLLC has only a single member, its classification will be that of a sole proprietorship, branch or division of the member and may be ignored for U.S. federal tax purposes absent an affirmative election to the contrary. Therefore, no general liability exists for members and pass-through taxation may be achieved. The liability of a member of a DLLC is somewhat analogous to the "limited liability" of a stockholder of a Delaware corporation. Another key feature of the DLLC, in addition to protecting members and managers from personal liability to third parties, is the freedom of contract principles that pervade the DLLC Act. Section 18-1101(b) of the DLLC Act expressly provides that "It is the policy of [the DLLC Act] to give maximum effect to the principle of freedom of contract and to the enforceability of [Delaware] limited liability company agreements" ("DLLC Agreements"). II. Formation of a DLLC A. The Limited Liability Company Agreement. In order to form and organize a DLLC, there should be a DLLC Agreement. (See § 18-101(7) of the DLLC Act.) A DLLC Agreement sets forth the rules relating to the internal affairs of a DLLC in much the same way that a limited partnership agreement governs the internal affairs of a limited partnership, the certificate of incorporation and by-laws govern the internal affairs of a Delaware corporation, and a trust agreement governs the internal affairs of a Delaware business trust. A DLLC Agreement is not filed with the Delaware Secretary of State. The DLLC Act permits oral DLLC Agreements. Notwithstanding the foregoing, it is always recommended to have a written limited liability company agreement that defines the rights, duties and liabilities of the members, and managers if applicable, of a DLLC. The DLLC Act also permits the formation of a one-member DLLC. B. The Certificate of Formation. While a DLLC Agreement is the governing document of a DLLC, the organization of a DLLC is not complete until one or more authorized persons executes and files a certificate of formation with the Delaware Secretary of State. (See § 18-201 of the DLLC Act.) A person may be designated as an "authorized person" in a DLLC Agreement. A certificate of formation must only set forth: (i) the name of the DLLC, which must contain the words "Limited Liability Company" or the abbreviation "L.L.C." or the designation "LLC," and (ii) the address of the registered office, and the name and address of the registered agent for service of process on the DLLC in the State of Delaware. (See § 18-201 of the DLLC Act.) Information such as the identity of the members and managers of a DLLC, the amount of their investment, the nature of the business and the capital structure need not be disclosed in the certificate of formation. A DLLC is deemed to have been formed at the time of the filing of the certificate of formation with the Delaware Secretary of State, and will continue as a separate legal entity until the cancellation of the certificate of formation. (See § 18-201(b) of the DLLC Act.) A certificate of formation may provide for a future effective date or time if desired. In addition, a certificate of formation may be filed with the office of the Secretary of State of the State of Delaware prior to the member entering into a DLLC Agreement. Section 18-201(d) of the DLLC Act provides that a DLLC Agreement may be entered into before, after, or at the time of the filing of the certificate of formation and may be made effective as of the formation of the DLLC or at such other time or date as provided in the agreement. Section 18-201(d) of the DLLC Act adds a considerable amount of flexibility to the formation process. A practical advantage of the DLLC Act is the ability to file documents (including filing by facsimile) with the Delaware Secretary of State and receive certified copies of such filed documents on an expedited basis. Certified copies of filed documents and Good Standing Certificates for DLLCs may also be obtained on an expedited basis from the office of the Delaware Secretary of State. Most filings may be made with the office of the Secretary of State of the State of Delaware on a priority-one basis (within 2 hours), same day basis or 24 hour basis. C. Who May Be a Member of a DLLC. A member of a DLLC may be a natural person, partnership (whether general or limited), limited liability company, trust, estate, association, corporation, custodian, nominee, or any other individual or entity in its own or any representative capacity. (See § 18-101(11) and § 18-101(12) of the DLLC Act.) Therefore, unlike a Subchapter S Corporation which contains restrictions on who may be a stockholder, virtually any natural person, legal entity or representative may be a member of a DLLC. D. Admission As a Member. In connection with the formation of a DLLC, a person is admitted as a member of the DLLC upon the latter to occur of the formation of the DLLC or at the time provided in and upon compliance with the DLLC Agreement, or if the DLLC Agreement does not so provide when the person's admission is reflected in the records of the DLLC. Generally, a person will make a contribution to a DLLC or be obligated to make a contribution to a DLLC at the time of such person's admission. A contribution to a DLLC may take the form of cash, property, services rendered or a promissory note or other obligation to contribute cash or property or to perform services. (See § 18-101(3) and § 18-501 of the DLLC Act.) A DLLC Agreement may also provide for conditional obligations to make a contribution. A conditional obligation may not be enforced unless the conditions of the obligation have been satisfied or waived as to or by the members. Conditional obligations include contributions payable upon a discretionary call of a DLLC prior to the time the call occurs. (See § 18-502(b) of the DLLC Act.) This feature is ideal for equity and debt investment funds conducted through a DLLC. A person may be admitted as a member (including as the sole member) of a DLLC and may receive a limited liability company interest without making a contribution to the DLLC or being obligated to make a contribution to the DLLC. (See § 18-301(d) of the DLLC Act.) In addition, unless otherwise provided in a DLLC Agreement, a person may be admitted to a DLLC as a member (including as the sole member) of the DLLC without acquiring a limited liability company interest in the DLLC. The DLLC Act also provides that a DLLC Agreement may provide that a member who fails to make a contribution he or she is obligated to make may be liable for specified penalties and consequences as set forth in the DLLC Agreement. (See § 18-502(c) of the DLLC Act.) III. Purposes -- Uses of DLLCs A. Broad Purposes and Powers of a DLLC. A DLLC, as a separate legal entity, may engage in any type of lawful business, purpose or activity with the exception of certain insurance and banking activities. (See § 18-106 of the DLLC Act.) A DLLC shall possess and exercise all of the powers and privileges granted by the DLLC Act or by any other law or by its DLLC Agreement, together with any powers incidental thereto, so far as such powers and privileges are necessary or convenient to the conduct, promotion or attainment of the business, purposes or activities of the DLLC. The purposes and powers of a DLLC may be restricted by provisions in a DLLC Agreement if desired. For example, it is permissible to structure a special purpose DLLC or bankruptcy remote DLLC if desired that may only engage in specified purposes. Some advantageous uses of DLLCs include, inter alia:
(1) corporate joint venture transactions and strategic alliances; The advantageous use of DLLCs in private business transactions is virtually unlimited. B. Certain Limitations of a DLLC. Notwithstanding the ability of a DLLC to engage in virtually any lawful business, there are a few special characteristics of limited liability companies ("LLCs") that make it more appropriate to use an entity other than an LLC in certain types of transactions. An LLC, for instance, is generally not the best form of business entity to use when it is desirable to have publicly traded equity interests. Under existing federal tax laws, except in limited circumstances such as certain real estate ventures, oil and gas ventures and registered investment companies, DLLCs with publicly traded limited liability company interests are likely subject to the publicly traded partnership federal tax rules. Such federal tax rules tax such partnerships in the same manner as corporations for federal income tax purposes. C. Foreign Jurisdictions. Practitioners, when forming a DLLC, need to consider the jurisdictions in which the DLLC will be conducting its business. For example, consideration needs to be given as to whether the DLLC can qualify as a limited liability company in the jurisdictions where it proposes to conduct its business if it will conduct business in a jurisdiction other than Delaware. Currently, all 50 states and the District of Columbia have enacted limited liability company statutes that permit the qualification of foreign limited liability companies. Nevertheless, it is important to check the jurisdiction where the DLLC will conduct business to determine the classification and treatment of the DLLC under such laws. It is also prudent to check the classification of a limited liability company for state tax purposes. For Delaware state tax purposes, Section 18-1107(a) of the DLLC Act provides that,
IV. Limited Liability of Members and Managers of a DLLC A. Limitation of Liability to Third Parties. As previously noted, a fundamental policy of the DLLC Act is the limitation of liability of members and managers for the debts, obligations and liabilities of a DLLC. Section 18-303(a) of the DLLC Act provides that,
Thus, the general rule is that members and managers are not liable for the debts, obligations or liabilities of a DLLC. This limitation on liability is an advantage that a DLLC has over a general partnership or a limited partnership. As a general rule, partners of general partnerships (other than in some circumstances general partners of limited liability partnerships) and general partners of limited partnerships (other than in some circumstances general partners of limited liability limited partnerships) are liable for the debts and liabilities of a partnership to the extent that partnership assets are insufficient to satisfy such debts and liabilities. B. Contractual Obligations and Wrongful Conduct. Notwithstanding the limitation on liability afforded members and managers for the debts and obligations of a DLLC that is provided in the DLLC Act, a member or manager of a DLLC under certain circumstances may be obligated for the member's or manager's own tortious or wrongful conduct or acts. In addition, a member is liable to make its contributions to the DLLC and other payment obligations that are provided in a DLLC Agreement (See § 18-502 of the DLLC Act), and, under certain limited circumstances, a member of a DLLC may be required to return distributions wrongfully distributed to it. (See § 18-607 of the DLLC Act.) V. Contractual Freedom -- Operating Procedures and Management of a DLLC A fundamental policy of the DLLC Act is to give maximum effect to the principle of freedom of contract. (See § 18-1101(b) of the DLLC Act.) The DLLC Act's basic approach is to permit members of a DLLC to have the broadest discretion in drafting their DLLC Agreement and to furnish rules concerning the internal governance of the DLLC only in situations where members have not expressly included provisions in their DLLC Agreement. Thus, for example, members of a DLLC are free to contract among themselves concerning the management standards governing the internal affairs of the DLLC, including the establishment of classes or groups of members, voting rights, procedures for holding meetings of members, action by consent without a meeting, the establishment of record dates, quorum requirements, voting in person or by proxy, or any other matter with respect to the exercise of any right to vote. A. Classes or Groups of Members and Voting Rights. Section 18-302 of the DLLC Act provides that a DLLC Agreement may provide for classes or groups of members having such relative rights, powers and duties as the DLLC Agreement may provide. In addition, a DLLC Agreement may provide for the taking of an action, including the amendment of the DLLC Agreement, without the vote or approval of any member or class or group of members. A DLLC Agreement may grant to all or certain identified members or classes or groups of members the right to vote, separately or with all or any class or group of the members or managers, on any matter. Such voting by members may be on a per capita, number, financial interest, class, group or any other basis. (See § 18-302 of the DLLC Act.) For example, a DLLC Agreement may provide for classes of members with rights similar to those of common stockholders and preferred stockholders of business corporations governed by the Delaware General Corporation Law. When drafting a DLLC Agreement that grants a right to vote, it is important to consider the procedures relating to: notice of the time, place or purpose of any meeting at which any matters are to be voted on by any members; waiver of any such notice; action by consent without a meeting; the establishment of a record date; quorum requirements; voting in person or by proxy; or any other matter with respect to the exercise of any such right to vote. In other words, the DLLC Agreement should contain provisions relating to voting rights since the DLLC Act does not set forth such procedures in most instances. Similar provisions exist in the DLLC Act relating to the ability to have classes and groups of managers and voting by managers. (See § 18-404 of the DLLC Act.) It should be noted that Section 18-302(d) of the DLLC Act provides that, "unless otherwise provided in a [DLLC Agreement], on any matter that is to be voted on by members, the members may take such action without a meeting, without prior notice and without a vote, if a consent or consents in writing, setting forth the action so taken, shall be signed by the members having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all interests in the [DLLC] entitled to vote thereon were present and voted." Section 18-302(d) also provides that, "unless otherwise provided in a [DLLC Agreement], on any matter that is to be voted on by members, the members may vote in person or by proxy." A similar provision exists in Section 18-404(d) of the DLLC Act relating to managers acting by written consent and by proxy. Generally, directors of a Delaware corporation may not act by proxy, but, absent a provision to the contrary in a DLLC Agreement, members and managers of a DLLC may act by proxy. In addition, directors of a Delaware corporation, when acting by written consent, must act by unanimous written consent of the board of directors. (See 8 Del. C. § 141f of the Delaware General Corporation Law.) As noted, the default rule for a DLLC is that such action by written consent shall be effective if it is signed by members or managers, as the case may be, having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting. Thus, Section 18-302(d) and 18-404(d) of the DLLC Act add a considerable amount of flexibility for members and managers to take action by written consent or by proxy. B. Management. Unless otherwise provided in a DLLC Agreement, management of the DLLC is vested in its members in proportion to the then current percentage or other interest of members in the profits of the DLLC, the decision by members owning more than 50% controlling. (See § 18-402 of the DLLC Act.). Therefore, if the members of a DLLC desire that management be by managers in whole or in part, such management structure should be set forth in the DLLC Agreement. Moreover, even if the DLLC will be member managed, if the members of the DLLC do not desire that all management decisions be determined by a majority in interest of the members based upon the then current percentage or other interest in profits of the DLLC, such management structure should be set forth in the DLLC Agreement. For example, it is permissible to include in a DLLC Agreement super-majority voting provisions and unanimous voting provisions for certain DLLC actions. Section 18-402 of the DLLC Act also states, "Unless otherwise provided in a DLLC Agreement, each member and manager has authority to bind the Company." If the members do not want each of the members or each of the managers to be permitted to bind the DLLC to third party contracts, the default rule in Section 18-402 of the DLLC Act needs to be modified in the DLLC Agreement. It is generally advisable to include in a DLLC Agreement provisions relating to who may bind the DLLC. Thus, the management of a DLLC needs to be carefully considered when drafting a DLLC Agreement. In addition, Section 18-407 of the DLLC Act permits members and managers to delegate management rights to other persons, including to delegate to agents, officers and employees of a member or manager or the DLLC, and to delegate by a management agreement or another agreement with, or otherwise to, other persons, unless otherwise provided in the DLLC Agreement. Therefore, if delegation of management rights is not desired, the DLLC Agreement should so provide. An advantage of the DLLC Act is the contractual flexibility afforded in structuring the management of a DLLC. Management may be vested in members, managers, or partially in members and partially in managers. Management functions may be delegated to other persons, unless otherwise provided in the DLLC Agreement. Section 18-402 of the DLLC Act makes clear that a DLLC may have more than one manager, if desired. There is no limit on the number of managers (or classes or groups of managers) that may be used in managing a DLLC, and thus the DLLC Act grants members the flexibility to have a board of managers or a board of representatives of members who act in a manner similar to a board of directors of a Delaware business corporation if so provided in a DLLC Agreement. It is also permissible to provide in a DLLC Agreement for separate classes and groups of managers including "independent managers" or "alternate managers" and it is permissible to designate "directors," "independent directors" and "alternative directors" of a DLLC as "managers" within the meaning of the DLLC Act. DLLCs may also be structured to have officers with titles and duties similar to officers of a corporation organized under the Delaware General Corporation Law if so provided in the DLLC Agreement. This feature has been particularly beneficial in corporate joint venture transactions conducted through a DLLC. It cannot be overemphasized how important it is to draft carefully the management structure if a manager managed DLLC structure, managing member structure or a corporate management type structure is desired since there are few "default rules" in the DLLC Act to deal specifically with issues that are not addressed by the DLLC Agreement. Thus, it is permissible to structure a DLLC with a management structure similar to a corporation, general partnership, limited partnership, trust or sole proprietorship or a combination of such management structures. C. Financial Aspects of a DLLC. The members of a DLLC are also free to contract with respect to the DLLC's financial aspects and thus, profits and losses and distributions of assets may be allocated in the manner provided in a DLLC Agreement. The DLLC Act is primarily a "default rule" statute and governs the allocations of DLLC profits and losses and distributions of DLLC assets among the members of a DLLC in the absence of controlling provisions in a DLLC Agreement. (See § 18-503, § 18-504, § 18-601.) In the absence of a provision in a DLLC Agreement, profits and losses of a DLLC shall be allocated among the members, and among classes or groups of members, on the basis of the agreed value of the contributions (as stated in the records of the DLLC) made by each member. Similar to allocations of profits and losses, distributions of cash and other assets of a DLLC are allocated among the members, and among classes or groups of members, on the basis of the agreed value (as stated in the records of the DLLC) of the contributions made by each member unless otherwise provided in the DLLC Agreement. A DLLC Agreement may also contain provisions authorizing distributions of assets in kind. D. Fiduciary Duties of Members, Managers and Other Persons. One of the most important examples of contractual flexibility contained in the DLLC Act relates to the duties and liabilities of members and managers to the DLLC and the other members and managers. The DLLC Act provides that, "To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) and liabilities relating thereto to a DLLC or to another member or manager, (1) any such member or manager or other person acting under a DLLC Agreement shall not be liable to the DLLC or to any such other member or manager for the member's or manager's or other person's good faith reliance on the provisions of the DLLC Agreement, and (2) the member's or manager's or other person's duties and liabilities may be expanded or restricted by provisions in a DLLC Agreement." (See § 18-1101(c) of the DLLC Act (emphasis added).) Therefore, fiduciary duties may be defined contractually in a DLLC Agreement. Moreover, a member, manager or other person (such as a director, officer or stockholder of a member) is not liable for breach of fiduciary duty if such person relies in good faith on the provisions of the DLLC Agreement. This has been perceived by many to be a significant advantage of the DLLC Act. A similar provision to Section 18-1101(c) of the DLLC Act is Section 17-1101(d) of the Delaware Revised Uniform Limited Partnership Act. Section 17-1101(d) has been held to prevent a breach of fiduciary duty where a general partner relied in good faith on the provisions of a limited partnership agreement. (See United States Cellular Investment Co. of Allentown v. Bell Atlantic Mobile Systems, Inc., C.A. No. 12984 (Del. Ch. March 11, 1994)). The ability to modify fiduciary duties by contract is different than that permitted by the Delaware General Corporation Law. Under the Delaware General Corporation Law, as a general rule, the fiduciary duties of loyalty and care may not be modified by contract. Under Delaware law it is possible to limit the monetary liability of a director for the breach of the duty of care. (See 8 Del. C. § 102(b)(7) of the Delaware General Corporation Law.) The DLLC Act does not define the scope of the duties that a member or manager owes to a DLLC and to other members and managers, and does not state whether any duty even exists. It does, however, enable members and managers to modify such duties, if any, by the terms of a DLLC Agreement. Thus, if such duties and liabilities are expressly provided for in a DLLC Agreement, the members and managers will have greater assurance that actions taken in accordance with such provisions will be protected. If such duties and liabilities are not set forth in a DLLC Agreement, there is some uncertainty as to what standards and what laws will apply (e.g., limited partnership, general partnership, corporate or trust laws). Based upon the emerging law in the Delaware limited partnership area, it is likely that a member or manager will owe fiduciary duties to the DLLC and its members to the extent that such member or manager controls DLLC property for the benefit of another. See, e.g., In re USA Cafes, L.P. Litig., 600 A.2d 43 (Del. Ch. June 7, 1991) and In re Integrated Resources, Inc., No. 90-B-10411(CB) (Bankr. S.D.N.Y. Oct 22, 1990) that was cited in USA Cafes. Delaware corporate law fiduciary duty principles may also be applicable in many cases since in the limited partnership area Delaware courts have looked to the Delaware corporate law for guidance when the limited partnership agreement and the Delaware Revised Uniform Limited Partnership Act did not address the issue presented to the court. Under Delaware law, directors of a Delaware corporation stand in a fiduciary relationship with the corporation and its stockholders. As fiduciaries, directors owe duties of loyalty and care to all of the stockholders of the corporation. In addition, directors owe a fiduciary duty of disclosure to the stockholders of the corporation. Simply stated, the directors' duty of loyalty mandates that a director not consider or represent interests other than the best interest of the corporation and its stockholders. A director must not only affirmatively protect the interests of the corporation, but also must refrain from doing anything that would work injury to the corporation or deprive it of profit or advantage which his skill and ability might properly bring to it. Thus, a director of a Delaware corporation generally has a duty of undivided and unselfish loyalty to the corporation which demands that there be no conflict between such duty and the director's self-interest. It may be determined by Delaware courts that the members and managers who manage DLLC assets possess a duty of loyalty similar to that of directors of Delaware corporations in the absence of provisions in a DLLC Agreement which modify such duty. Simply stated, the duty of care under Delaware law requires that directors inform themselves, prior to making a business decision, of all material information reasonably available to them. In determining whether a director's judgment is informed, a court will consider the material and/or advice the board of directors had available to it, and whether the directors have a sufficient opportunity to acquire knowledge concerning the matter before acting. Directors have the affirmative duty to protect the financial interest of the corporation and its stockholders and must proceed with a critical eye in assessing information. The duty of loyalty and duty of care, as generally described above, would apply to the members and managers of a DLLC if corporate fiduciary duty principles are applicable to DLLCs and the DLLC Agreement does not otherwise provide. It should be noted that if a manager or a representative of a member also serves on the board of another entity, such as a Delaware corporation that is a member of the DLLC, such manager or representative of a member will likely owe an equal fiduciary duty of good management to the DLLC and the member. Unless otherwise provided in the DLLC Agreement, such manager representative will not be able to act in the best interest of the member who appointed such person as a manager or representative, but will be required to act in the best interest of the DLLC and all of its members when engaging in actions relating to the DLLC. This duty to both entities can lead to interesting conflict of interest issues. Such dual directorship issues should be carefully considered, particularly in DLLC joint venture and strategic alliance transactions. In addition to addressing the fiduciary duties of members and managers and other persons managing the DLLC, depending upon the particular DLLC transaction, it may be advisable to address the fiduciary duties, if any, of affiliates of members and managers, such as the directors, officers and stockholders of a corporate member that is in a position of control of a DLLC, as well as agents, employees, officers and representatives of the DLLC. In addition, to the extent members appoint representatives of members to manage the DLLC, it is prudent to specify to whom such representatives owe their duty, i.e., the DLLC and all members equally or the member that appointed them. Due to the language of Section 18-1101(c) of the DLLC Act, compliance with a DLLC Agreement should help protect a member, manager or other person controlling a DLLC from liability for breach of fiduciary duty. In the event that the terms of a DLLC Agreement do not define the fiduciary duty of a member, manager or other person controlling a DLLC, such duty and liability for breach of such duty will be left for the courts to define. Whether the courts will look to corporate law, limited partnership law, general partnership law or trust law is unclear and may depend on the specific circumstances presented. E. Indemnification of Members, Managers and Other Persons. Another example of contractual flexibility afforded members and managers of a DLLC is with respect to their right to indemnification. Section 18-108 of the DLLC Act provides that, "A DLLC shall have the power to indemnify and hold harmless any member or manager of a DLLC or other person from and against any and all claims and demands whatsoever, subject to such standards and restrictions, if any, as are set forth in a DLLC Agreement." (See § 18-108 of the DLLC Act (emphasis added).) Thus, members and managers have a great deal of contractual flexibility in drafting indemnification provisions. To the extent members desire that the DLLC indemnify certain persons, including members and managers, such provisions should be included in the DLLC Agreement. A provision similar to Section 18-108 of the DLLC Act is found in Section 17-108 of the Delaware Revised Uniform Limited Partnership Act. In Delphi Easter Partners Limited Partnership v. Spectacular Partners, Inc., C.A. No. 12409 (Del. Ch. August 6, 1993), the Delaware Chancery Court quoted Section 17-108 of the Delaware Revised Uniform Limited Partnership Act and expressly acknowledged that Section 17-108 is "broadly enabling." The Court then recognized that Section 17-108 permits contractual indemnification in a greater number of circumstances than do the Delaware Uniform Partnership Law's (the statute that governed Delaware general partnerships at the time such case was decided) statutory right to indemnification (6 Del.C. § 1518(2)), and the Delaware General Corporation Law's statutory right to indemnification (8 Del.C. § 145). "In fact, Section 17-108 defers completely to the contracting parties to create and to limit rights and obligations with respect to indemnification and advancement of expenses." Id., slip op. at 3. There is no reason to believe that the indemnification provisions of the DLLC Act will not also be interpreted as broadly enabling. VI. Transfers of Limited Liability Company Interests A. Assignee Rights. The term "limited liability company interest" means "a member's share of the profits and losses of a DLLC and a member's right to receive distributions of the DLLC's assets." (See § 18-101(8) of the DLLC Act.) Pursuant to Section 18-702 of the DLLC Act, a limited liability company interest is assignable in whole or in part except as provided in a DLLC Agreement. Section 18-702 also provides that,
Thus, the assignee of the limited liability company interest does not have management rights unless otherwise provided in the DLLC Agreement. B. Admission of Assignee as a Member. The "default rule" in the DLLC Act permits limited liability company interests to be freely assignable but does not permit the assignee to be admitted as a substituted member of the DLLC without the consent of all of the members. The approval of all remaining members is required to permit an assignee to be admitted as a member of the DLLC, unless otherwise provided in the DLLC Agreement. (See § 18-704 of the DLLC Act.) The "default rule" in the DLLC Act requiring the approval of all the members of a DLLC other than the member assigning his limited liability company interest in order for the assignee to be admitted as a member of the DLLC may be modified in whole or in part by provisions in the DLLC Agreement. Under the DLLC Act, members may provide in a DLLC Agreement that limited liability company interests are not assignable prior to the dissolution and winding up of the DLLC. (See § 18-603 and § 18-702 of the DLLC Act.) Generally, restraints on alienation are permitted and enforceable under the DLLC Act. Section 18-603 provides in pertinent part that, "A member may resign from a [DLLC] only at the time or upon the happening of events specified in a [DLLC Agreement] and in accordance with the [DLLC Agreement]. Notwithstanding anything to the contrary under applicable law, unless a [DLLC Agreement] provides otherwise, a member may not resign from a DLLC prior to the dissolution and winding up of the [DLLC]. Thus, if it is desirable to permit a member to resign, such provision should be set forth in the DLLC Agreement. C. Rights of a Judgment Creditor of a Member. Section 18-703 of the DLLC Act deals with the rights of a judgment creditor of a member of a DLLC. Under Section 18-701, a limited liability company interest is personal property and a member has no interest in specific DLLC property. Section 18-703 of the DLLC Act provides that, "on application to a court of competent jurisdiction by any judgment creditor of a member [of a DLLC], the court may charge the limited liability company interest of the member [of the DLLC] with payment of the unsatisfied amount of the judgment with interest." Section 18-703 further provides that, "to the extent so charged, the judgment creditor [of a member of a DLLC] has only the rights of an assignee of the limited liability company interest." Thus, under the DLLC Act, a judgment creditor of a member of a DLLC may not satisfy its claims against the member by asserting a claim against the assets of the DLLC. VII. Merger and Consolidation of DLLCs, Domestication and Conversion of DLLCs The DLLC Act authorizes a DLLC to merge or consolidate with or into another DLLC. The DLLC Act also permits a DLLC to merge or consolidate with or into other business entities. Section 18-209(a) of the DLLC Act defines "other business entity" to mean a corporation, or a business trust, or association, a real estate investment trust, a common law trust, or any other unincorporated business, including a partnership (whether general (including a registered limited liability partnership) or limited (including a registered limited liability limited partnership)), and a foreign limited liability company. When working on a merger involving a DLLC merging with or into another entity, the law of the jurisdiction of formation or organization of the other entity needs to be considered in determining whether or not that entity can merge or consolidate with or into a DLLC. In order for a DLLC to merge or consolidate, there should be an agreement of merger or consolidation. The DLLC Act provides that a merger or consolidation of a DLLC with or into another entity must be approved, unless otherwise provided in the DLLC Agreement, by members who own more than 50% of the then current percentage or other interest in the profits of the DLLC owned by all of the members or by the members in each class or group, as appropriate. (See § 18-209 of the DLLC Act.) Thus, the merger vote rule contained in the DLLC Act is a "default rule" since the members can provide in a DLLC Agreement whatever vote they desire to authorize the merger or consolidation of a DLLC with or into another DLLC or other business entity. In addition, a certificate of merger that complies with the DLLC Act is required to be filed with the Delaware Secretary of State to effectuate the merger. In addition, a non-United States business entity may become a DLLC by domesticating as a DLLC by complying with Section 18-212 of the DLLC Act. Section 18-212(b) provides that any non-United States entity may become domesticated as a DLLC by complying with subsection (g) of Section 18-212 and by filing a certificate of limited liability company domestication and a certificate of formation that complies with the DLLC Act. A non-United States entity that becomes domesticated as a DLLC shall be subject to the provisions of the DLLC Act, except that notwithstanding Section 18-201 of the DLLC Act, the existence of the DLLC shall be deemed to have commenced on the date the non-United States entity commenced its existence in the jurisdiction in which the non-United States entity was first formed, incorporated, created or otherwise came into being. When a non-United States entity has become domesticated as a DLLC pursuant to the DLLC Act, the DLLC shall, for all purposes of the laws of the State of Delaware, be deemed to be the same entity as the domesticating non-United States entity. In addition, unless otherwise agreed, or as required under applicable non-Delaware law, the domesticating non-United States entity shall not be required to wind up its affairs or pay its liabilities and distribute its assets, and the domestication shall not be deemed to constitute a dissolution of such non-United States entity and shall constitute a continuation of the existence of the domesticating non-United States entity in the form of a DLLC. Thus, it is permissible to organize a DLLC that may be subject to the laws of two jurisdictions. Another way for an existing legal entity to become a DLLC is to convert the other entity to a DLLC. It should be noted that other business entities, including, without limitation, a corporation, business trust, partnership or a foreign limited liability company may convert to a DLLC by complying with Section 18-214 of the DLLC Act. Section 18-214(b) of the DLLC Act provides that any other entity may convert to a DLLC by complying with subsection (h) of Section 18-214 of the DLLC Act and by filing a certificate of conversion to limited liability company and a certificate of formation with the office of the Secretary of State of the State of Delaware in accordance with the DLLC Act. Section 18-214(d) of the DLLC Act provides that upon the filing of a certificate of conversion and a certificate of formation in the office of the Secretary of State of the State of Delaware, the other entity shall be converted to a DLLC and the DLLC shall thereafter be subject to all the provisions of the DLLC Act, except that notwithstanding Section 18-201 of the DLLC Act, the existence of the DLLC shall be deemed to have commenced on the date the other entity commenced its existence in the jurisdiction in which the other entity was first created, formed, incorporated or otherwise came into being. Moreover, Section 18-214(g) of the DLLC Act provides that unless otherwise agreed, or as required under applicable non-Delaware law, the converting other entity shall not be required to wind up its affairs or pay its liabilities and distribute its assets, and the conversion shall not be deemed to constitute a dissolution of such other entity and shall constitute a continuation of the existence of the converting other entity in the form of a DLLC. When another entity has been converted to a DLLC pursuant to Section 18-214 of the DLLC Act, the DLLC shall, for all purposes of the laws of the State of the Delaware, be deemed to be the same entity as the converting other entity. Similar to a merger transaction, when working on a domestication transaction or a conversion transaction, the law of the jurisdiction of the domesticating entity or converting entity, as the case may be, needs to be considered in determining whether or not that entity can domesticate to a DLLC or convert to a DLLC. VIII. Dissolution of DLLCs A DLLC will have perpetual existence unless otherwise provided in the DLLC Agreement. A DLLC will dissolve at the time, or upon the happening of events, as provided in a DLLC Agreement. A DLLC may also dissolve in a manner specified in the DLLC Act. Once dissolved, similar to a Delaware limited partnership, the business of a DLLC continues only to the extent reasonably necessary to gradually settle and wind up the DLLC's affairs. A. Agreed Events Causing Dissolution. Section 18-801(a)(1) of the DLLC Act provides that
Section 18-801(a)(2) of the DLLC Act also provides that a DLLC shall be dissolved and its affairs wound up upon the happening of events specified in a DLLC Agreement. Therefore, the parties to a DLLC Agreement can set forth the time and the happening of events that will cause a DLLC to dissolve. In addition, unless otherwise provided in a DLLC Agreement, a DLLC may be dissolved by the affirmative vote or written consent of the members of the DLLC or, if there is more than one class or group of members, then by each class or group of members, in either case, by members who own more than two-thirds of the then-current percentage or other interest in the profits of the DLLC owned by all of the members or by the members in each class or group, as appropriate. (See § 18-801(a)(3) of the DLLC Act.) B. At Any Time There Are No Members. Section 18-801(a)(4) provides that a DLLC is dissolved and its affairs should be wound up at any time there are no members, provided that a DLLC is not dissolved and is not required to be wound up if (i) within 90 days or such other period as provided in the DLLC Agreement after the occurrence of the event that terminated the continued membership of the last remaining member, the personal representative of the last remaining member agrees in writing to continue the DLLC and to the admission of the personal representative of such member or its nominee or designee to the DLLC as a member, effective as of the occurrence of the event that terminated the continued membership of the last remaining member or (ii) a member is admitted to the DLLC in a manner provided for in the DLLC Agreement, effective as of the occurrence of the event that terminated the membership of the last remaining member, within 90 days or such other period as is provided for in the DLLC Agreement after the occurrence of the event that terminated the continued membership of the last remaining member, pursuant to a provision in a DLLC Agreement that specifically provides for the admission of a member to the DLLC after there is no longer a remaining member of the DLLC. It is also permissible to include a provision in a DLLC Agreement that provides that the personal representative of the last remaining member shall be obligated to agree in writing to continue the DLLC and to the admission of the personal representative of such member or a nominee or designee to the DLLC as a member, effective as of the occurrence of the event that terminated the continued membership of the last remaining member. It should be noted that the term "personal representative" is defined in Section 18-101(13) of the DLLC Act to mean, as to a natural person, the executor, administrator, guardian, conservator or other legal representative thereof and, as to a person other than a natural person, the legal representative or successor thereof. Thus, the DLLC Act provides the flexibility to continue a DLLC without dissolution upon the occurrence of an event that causes the last remaining member to cease to be a member of the DLLC. Section 18-801(a)(4) has been deemed to be a significant advantage of a DLLC when structuring a bankruptcy remote DLLC. In addition, it is permissible to provide in a DLLC Agreement that a person may be admitted as a member of a DLLC without acquiring a limited liability company interest or without being required to make a contribution to a DLLC effective upon the occurrence of an event that causes the last remaining member to cease to be a member of a DLLC. Thus, springing members are permitted under the DLLC Act. Another issue to consider when forming a bankruptcy remote DLLC is whether the bankruptcy of a member will cause the member to cease to be a member of the DLLC. Section 18-304 does provide that a person ceases to be a member of a DLLC upon the bankruptcy of a member unless otherwise provided in a DLLC Agreement, or with the written consent of all members. In structuring a bankruptcy remote DLLC, it is often advisable to provide that the bankruptcy of a member or the occurrence of any other event set forth in Section 18-304(a) or 18-304(b) of the DLLC Act, will not cause a member to cease to be a member of the DLLC, and the business of the DLLC shall be continued without dissolution upon the occurrence of such an event. A very important provision of the DLLC Act relating to dissolution of a DLLC is Section 18-801(b) which provides that, "unless otherwise provided in a [DLLC Agreement], the death, retirement, resignation, expulsion, bankruptcy or dissolution of any member or the occurrence of any other event that terminates the continued membership of any member shall not cause the DLLC to be dissolved or its affairs to be wound up, and upon the occurrence of any such event, the DLLC shall be continued without dissolution. Thus, if a DLLC Agreement is properly drafted, under Delaware law, the bankruptcy or dissolution of a member, even the last remaining member, will not, by itself, cause the DLLC to be dissolved or its affairs wound up. C. Judicial Dissolution. The Delaware Court of Chancery may decree a judicial dissolution of a DLLC whenever it is not reasonably practicable to carry on the business in conformity with the DLLC Agreement. (See § 18-801(5) and § 18-802 of the DLLC Act.) For example, a member may be able to petition successfully the Delaware Court of Chancery to enter a decree of judicial dissolution if the purpose of the DLLC may not be achieved based upon the facts of the case. See PC Tower Ctr., Inc. v. Tower Ctr. Dev. Assocs. Limited Partnership, C.A. No. 10788 (Del. Ch. June 8, 1989), Red Sail Easter Limited Partners, L.P. v. Radio City Music Hall Productions, Inc., 1993 WL 287620 (Del. Ch. 1993) and Cincinnati Bell Cellular Systems Company v. Ameritech Mobile Phone Service of Cincinnati, Inc., 1996 WL 506906 (Del. Ch. 1996) (concerns the interpretations of an analogous provision to Section 18-802 of the DLLC Act found in Section 17-802 of the Delaware Revised Uniform Limited Partnership Act). The focal point of Section 18-802, therefore, is the purpose of the DLLC as described in the DLLC Agreement, and a member may be able to petition successfully for a decree of judicial dissolution if the DLLC's purpose may not be achieved based upon the facts of the case. The Delaware Court of Chancery has noted that its power to order the dissolution of a Delaware limited partnership pursuant to Section 17-802 of the Delaware Revised Uniform Limited Partnership Act is "narrow and limited." The Delaware Court of Chancery has stated that, "when considering the entry of a decree of judicial dissolution it is necessary to determine the business of the [DLLC] and the ability of the [DLLC] to achieve that purpose within the dictates of its [DLLC Agreement]." A question that remains unanswered, however, is whether or not a member can waive its right to seek the entry of a decree of judicial dissolution under Section 18-802 of the DLLC Act by so providing in a DLLC Agreement. The answer to this issue remains to be seen and may be dependent upon the facts of a particular case. C. Winding Up of a DLLC. When drafting a DLLC Agreement, it is very important to focus upon the winding up provisions. For example, such issues as who will wind up the affairs of the DLLC, how assets of the DLLC should be distributed to members upon dissolution after satisfaction of creditors' claims (whether by payment or the making of reasonable provision for payment thereof), whether assets may be distributed in kind to the members upon dissolution, the period of time allowed for the winding up of the DLLC, and other matters relating to the winding up of the DLLC, should be addressed in the DLLC Agreement. (See § 18-803 and § 18-804 of the DLLC Act.) IX. Conclusion The ability to form a legal entity that provides for limited liability for all its members regardless of their participation in such entity's management and that may be treated as a partnership or a branch or division of a member (single member DLLCs) for federal income tax purposes makes the DLLC a very attractive type of business organization. In many cases, the use of a DLLC will provide a competitive business advantage to clients. The contractual freedom relating to, inter alia, flexibility in structuring management, voting rights, economic rights, fiduciary duties, liability of members and managers to the DLLC and other members and managers, and indemnification enhance the attractiveness of the DLLC. The DLLC Act expressly provides in Section 18-1101(b) that, "It is the policy of this chapter to give maximum effect to the principle of freedom of contract and to the enforceability of DLLC Agreements." In addition to the advantages of the DLLC Act set forth herein, Delaware has the unique advantage that the Delaware Court of Chancery may have jurisdiction over disputes that could arise involving members and managers of a DLLC with appeal rights to the Supreme Court of the State of Delaware. Section 18-111 of the DLLC Act confirms that any action to interpret, apply or enforce the provisions of a DLLC Agreement may be brought in the Court of Chancery. The Court of Chancery and the Supreme Court of the State of Delaware are the same courts that often handle Delaware corporate, limited partnership and business trust litigation and thus have substantial experience in resolving business disputes. The Delaware courts have recognized, for example, that many partnership agreements are drafted by sophisticated commercial practitioners and the Delaware courts attempt to give effect to the words used in the partnership agreement. It is likely that Delaware courts will take a similar view when interpreting DLLC Agreements and the rights and duties of members and managers thereunder. The DLLC Act also fosters a policy of promoting arbitration as a dispute resolution forum if arbitration is provided for in a DLLC Agreement. (See § 18-109(d) of the DLLC Act.) In light of the many advantages of DLLCs, the entity has been received with great enthusiasm by the business community. Since October 1, 1992, approximately 95,000 DLLCs have been formed in Delaware. In most instances, such DLLCs are not conducting business in the State of Delaware and have no assets or activities in the State of Delaware (other than the maintenance of a registered agent and office), but are being formed as DLLCs in order to obtain the benefits and advantages of Delaware's laws and courts.
By:
James G. Leyden, Jr.,(e-mail:
leyden@rlf.com)
Richards, Layton & Finger,
Jan. 2000
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