The limited liability company (referred to as LLC) was first introduced in the United States in 1977 in the state of Wyoming. Although the LLC was a new form of business entity in the United States, most jurisdictions with a civil law tradition, such as continental Europe and South America, have had LLCs since the 19th century. Other states were reluctant to enact LLC Acts primarily because the Internal Revenue Service (IRS) could not decide whether a noncorporate entity, which afforded limited liability to its owners, would be classified as a corporation or an association for tax purposes.

In 1988, the IRS ruled the tax classification of an LLC would be determined based on whether the LLC had a predominance of corporate attributes, and that limited liability was just one attribute to be considered but not a dispositive attribute.[1] In 1997, the IRS eliminated the tax classification issue by enabling any noncorporate entity to “self-classify,” i.e., choose whether to be taxed as a corporation or as a partnership.[2] The National Conference of Commissioners on Uniform State Laws (NCCUSL) adopted and recommended for enactment the Uniform Limited Liability Company Act (ULLCA) in 1994. By that time, almost all jurisdictions had enacted an LLC Act. In 1996, the NCCUSL revised certain provisions of ULLCA to comport with the anticipated self-classification regulations of the IRS.

As of 1997, each of the 50 states and the District of Columbia has enacted an LLC Act. By many measures, LLCs have become the single most popular form of business entity in the United States. The LLC Acts throughout the states are based on a common fundamental legal theory. However, the LLC Acts differ significantly from one another on certain functional concepts such that the LLC Acts are not uniform. It is unclear whether and the extent to which the lack of uniformity has adversely affected the development and operation of LLCs. Nevertheless, the NCCUSL astutely resolved to examine the practices and innovations implemented by the states and advocated by the legal commentary as well as the nearly 20 years of experience during which LLCs have been operating. The result of this examination is the Revised Uniform Limited Liability Company Act (RULLCA), which NCCUSL adopted and recommended for enactment by the states in July 2006. As of December 1, 2007, RULLCA had not been introduced in any state legislature nor adopted by any state.

The Limited Liability Company in Perspective[3]
The limited liability company combines the advantages of a corporation with the advantages of a partnership. A properly formed LLC can possess both the limited liability of a corporation and the passthrough tax treatment of a partnership. The LLC effectively eliminates the traditional “Hobson’s” choice between possessing limited liability and possessing the passthrough tax treatment of a partnership.

The LLC is a creation of statute. An LLC can be formed and exist as a matter of law only under a state statute that enables the creation of LLCs. Unlike a partnership, an LLC can neither be implied at law nor exist by estoppel. An LLC is an unincorporated association that is a separate legal entity distinct from the “owners” or members and is not merely an aggregation of the members. An LLC may have perpetual duration. A member can be a natural person, a corporation, a partnership, a foreign person/entity, or another LLC. An LLC can sue or be sued in its own name, enter into contracts in its own name, and hold title to property in its own name.

An LLC can be formed for any business purpose as long as the purpose is a lawful one. The members may limit the powers of the LLC or restrict how the powers are exercised as long as the limit or restriction is contained in the articles of organization. If no such limit or restriction is contained in the articles of organization, then the LLC may possess and exercise all powers that are necessary or convenient to carry out the business purpose of the LLC. The doctrine of limited liability applies to LLCs, just as it applies to corporations. A member of an LLC is not a proper party to a cause of action by a third party against the LLC, nor can the personal assets of a member be used to satisfy a judgment against the LLC solely because that person is a member of the LLC. An LLC will be classified as an association and taxed as a partnership unless the LLC elects to be taxed as a corporation under the Self-Classification Regulations of the IRS.

Like corporations and partnerships, LLCs have a terminology that is specific to LLCs:

Overview of RULLCA[5]
The drafters of the RULLCA made their primary revisions to the concepts of the operating agreement, fiduciary duties, indemnification, initially forming an LLC without a member, rights of oppressed minority members, default rules on management structure, and creditor charging orders.[6] The drafters also made a significant “nonrevision.” They chose not to enable LLCs to form discrete series of membership interests, each of which would afford the members and assets of each such series limited liability and protect the members and assets of the LLC and each other series of membership interests from the creditors of a particular series.

The Operating Agreement
The Writing Requirement
Like the District of Columbia (D.C.) LLC Act, the RULLCA is a default statute. If the members have not agreed on an issue, then the RULLCA governs any such issue.[7] Under the RULLCA, the agreement can be oral, in a record, or implied, or any combination of oral, recorded, or implied elements.[8] The RULLCA does not use the term “writing” but uses the broader term “record,” which is defined as information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form.[9]

The absence of a writing requirement in RULLCA is a fundamental difference between the D.C. LLC Act and the RULLCA, along with most other jurisdictions. Only the D.C., Minnesota, and Wisconsin LLC Acts require that an operating agreement must be in writing to be enforceable.[10] Even though neither the RULLCA nor most state LLC Acts requires a writing, the Statute of Frauds still may require that an operating agreement be in writing to the same extent to which the Statute of Frauds requires any other contract to be in writing.

The primary benefits of a writing requirement are that the terms of the agreement are memorialized and there is a time certain when the agreement was made. It is commonly assumed that an operating agreement is made and binding only after the LLC is formed and after the persons become members and manifest agreement to the terms of an operating agreement. However, any agreements to agree or even any discussions that occur before the LLC is formed, and which could be construed as a meeting of the minds under common law contract principles, can become binding immediately after the LLC is formed without further deliberation or negotiation. Consequently, persons who become members when the LLC is formed may find themselves to be legally bound to terms which they believed were still in negotiation. The D.C. LLC Act effectively eliminates this possibility by requiring that all of the then members of an LLC must agree to any initial operating agreement.[11]

Mandatory Provisions
All LLC Acts contain mandatory provisions and default provisions. Mandatory provisions contain rules or requirements that the members cannot vary or eliminate by agreement. Mandatory provisions almost always contain the connector “shall” or “must” in the language of the provision. Default provisions contain rules or requirements that will govern the legal relationship of the members with respect to matters covered by the default provisions unless the members otherwise agree. Default provisions usually contain the clause “unless otherwise agreed by the [members]” or “in the absence of agreement by the [members].”

The RULLCA sets forth certain mandatory provisions but distinguishes between items that the members cannot either vary or eliminate, items that the members can vary but not eliminate, items that the members cannot restrict, and items the members cannot unreasonably restrict.

Items the Members Cannot Vary
The members cannot vary any of the following:

Items Members Cannot Eliminate But May Vary
The members cannot eliminate, but may vary, in a manner consistent with the RULLCA any of the following:

Items Members Cannot Restrict
The members cannot restrict any of the following:

Items Members Cannot Unreasonably Restrict
The members cannot unreasonably restrict either of the following:

The D.C. LLC Act does not make the foregoing distinctions among the mandatory provisions. The D.C. LLC Act simply enables members to enter into an operating agreement to regulate or establish the affairs of the LLC, conduct the business of the LLC and the relations of the members as long as no provision of any such agreement is inconsistent with D.C. laws or the articles of organization.[22]

Fiduciary Duties
Because an LLC has the attributes of both a corporation and a partnership, whether and the extent to which fiduciary duties should apply to, or be imposed on, members of an LLC has been a matter of controversy since Wyoming enacted the first LLC statute in 1977. As between and among members, the RULLCA maintains the principle that there are no fiduciary duties unless the members agree to impose fiduciary duties. As between or among members in a member-managed LLC, the RULLCA takes a middle ground by enabling members in a member-managed LLC to restrict or even eliminate fiduciary duties as long as any such restriction or elimination is not manifestly unreasonable.[23] The RULLCA purports to provide guidance to the courts as to when a restriction or elimination is “manifestly unreasonable”.[24]

Member–to–Member Fiduciary Duties and Implied Contractual Obligation
A member does not have any fiduciary duty to the LLC or to any other member solely by reason of being a member.[25] The members must agree to impose the fiduciary duties on the members. Although not a fiduciary duty, each member owes to each other member and the LLC the implied contractual obligation to discharge its obligations and exercise its rights in good faith and consistent with fair dealing.[26]

Member Fiduciary Duties in a Member-Managed LLC
A member of a member-managed LLC owes to the LLC, and each other member, the fiduciary duties of loyalty and care.[27] The duty of loyalty is defined to include the duty to account to the LLC and to hold as trustee for the LLC any property, profit, or benefit derived by the member; to refrain from dealing with the LLC, as or on behalf of, a person having an interest adverse to the LLC; and to refrain from competing with the LLC before the dissolution of the LLC.

Subject to the business-judgment rule, the duty of care of a member in the conduct and winding up of the LLC activities is to act with the care that a person in a like position would reasonably exercise under similar circumstances and in a manner the member reasonably believes to be in the best interest of the LLC. In discharging this duty, a member may rely in good faith upon opinions, reports, statements, or other information provided by another person that the member reasonably believes is a competent and a reliable source of the information.[28]

As a general proposition, and except for certain limitations, the members may restrict or eliminate the duty of loyalty or the duty of care in the operating agreement as long as such restriction or elimination is not manifestly unreasonable.[29] The guidance RULLCA offers to courts on the meaning of “manifestly unreasonable” is essentially tautological, because it states that any such restriction or elimination is not manifestly unreasonable if it is reasonable.[30]

The D.C. LLC Act does not address the issue of fiduciary duties. If the members desire that either members or managers be subject to fiduciary duties, they must agree to impose fiduciary duties in the operating agreement. If the members have not addressed the issue, a manager, but not a member, can be removed with or without cause by members holding a majority of the interests in the LLC.[31]

Indemnification
An LLC must reimburse and indemnify a member for any payment, debt, obligation, or other liability incurred by a member of a member-managed company or the manager of a manager-managed company in the course of the member’s or manager’s activities on behalf of the LLC, as long as the act of any such member or manager was not an improper distribution or did not violate the standards of conduct for members and managers under RULLCA.[32]

The members may agree to alter or eliminate the foregoing indemnification obligation as long as the act of the member or manager is not any of the following:

The D.C. LLC Act simply enables members to agree to limit or restrict the liability of a member or manager in any action brought by, or on behalf of, the LLC or the members unless the action is premised on willful misconduct.[34]

Rights of Oppressed Minority Members
Like the D.C. LLC Act, the RULLCA enables a member of an LLC to seek judicial dissolution of the LLC on the grounds that it is not reasonably practical to carry on the business of the LLC as set forth in the articles or any operating agreement.[35] The RULLCA adds as an additional ground that the managers or controlling member(s) are acting illegally or fraudulently or engaging in conduct that is oppressive and directly harmful to the applicant-member.[36] The RULLCA also empowers a court to fashion a remedy other than dissolution.[37]

Series of Membership Interests
Probably the most controversial development in the law of LLCs is the concept of series of membership interests.[38] The concept has been part of the Delaware LLC Act since 1996. Illinois, Iowa, Nevada, Oklahoma, Tennessee, and Utah enacted series provisions in 2004 and 2005.[39] Under the foregoing LLC Acts, an LLC can create discrete series membership, each of which may have its own discrete assets or investment objectives, and each of which has its own limited liability. A series of an LLC is afforded its own limited liability. A series can incur obligations to third persons, and those obligations can be enforced only against the assets of that series and not against the assets of any other series or the assets of the LLC.[40]

For a series to be entitled to the limited liability protection, each of the foregoing LLC Acts requires the following: