Apr 122015

Introduction to Limited Liability Companies

The responses to my series on mechanics liens have been very positive. A large number of you have expressed that you find the information helpful and that it gives you a deeper and clearer understanding of the complex world of mechanics liens.

Many of you have also asked that I do a similar series for other subjects, such as corporations and other business entities. After giving it some thought, I believe an introduction to limited liability companies could be very useful. Many people form them, but relatively few know the basic elements of LLCs or how they are operated. As a result, many, if not most, LLCs are seriously mis-managed, which creates a host of problems for the LLC and its members and managers, including potential legal liability and penalties.

The following is the first in a series of articles that will present a general introduction to LLCs. The articles are intended to provide an explanation of the basic elements of LLCs, how they are managed, and the roles of the following:

  • the owners of the LLC (called “members”);
  • the managers elected by the members to operate the LLC business (the “managers”); and
  • the governing agreement for the LLC (called the “operating agreement”).

I hope you find this information helpful and easy to understand.


PART 1 – Basic Structure of an LLC

An LLC is formed when its Articles of Organization have been executed and filed with the California Secretary of State’s office. An LLC may have one or more members at the time of formation and its members are required, either before or after filing the Articles of Organization, to enter into an operating agreement. This is the instrument that governs the LLC and it will typically contain pro-visions specifying capital contributions, profit sharing percentages, management and control, admission of new members, restrictions on transfers of membership interests, and perhaps special tax provisions such as specific allocations of gains and losses.

LLCs are but one of a number of forms of organization in which one or more persons can join together to conduct a business. The LLC is owned by the members who can either (i) manage the business of the LLC themselves, in which case the LLC would be a “member-managed LLC,” or (ii) elect a manager or managers to manage the business of the LLC, in which case the LLC would be a “manager-managed LLC.” One of the most important differences between a member-managed LLC and a manager-managed LLC concerns the authority of the members to bind the LLC to LLC obligations:

  • In a member-managed LLC, each member has the power to bind the member-managed LLC (like general partners in a partnership).
  • In a manager-managed LLC, no member has the power to bind the LLC (just as no shareholder of a corporation can bind the corporation); only a manager or authorized officer of the LLC can bind the manager-managed LLC.

Management duties include decisions about key policies, LLC transactions, and the establishment of guidelines within which the business of the LLC will be conducted. The managers can hire officers and employees to perform the LLC’s day-to-day business.

The principal distinguishing feature of an LLC is the limitation of liability the members of the LLC enjoy (like a corporation), as well as the pass-through income tax treatment enjoyed by the LLC and members (like a partnership). So long as the LLC is properly formed and in existence, and is properly operated, the members will not be personally liable for the LLC’s debts, obligations, and liabilities. In other words, if the LLC’s debts exceed the value of the LLC’s assets, the LLC’s creditors should not be entitled to seek repayment from the members’ personal assets.

Of course, a personal guarantee by an LLC member of an LLC obligation would give rise to personal liability of that member to the extent specified in the guarantee (as it would for a shareholder in a corporation). Failure by a member to remit employee with-holding taxes can provide another basis for personal liability of a member (as it would for a shareholder in a corporation). Liability based on the personal tortious behavior of a member would also provide the basis for personal tort liability of that member (as it would for a shareholder in a corporation). But generally the LLC liability shield, like the corporation’s liability shield, should protect individual members from LLC debts, obligations, and liabilities.

The information provided herein is not intended as legal advice and should not be acted upon. If you have additional questions about this subject matter or would like to consult with an attorney about this or related subject matters, please call or email Josef Cowan at the Cowan Law Group (949) 333-0919 or at jcowan@cowanlawgroup.com.

Filed by Joe Cowan, April 12, 2015