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Why LLCs are Now the Entity of Choice in Pennsylvania
Webinar Noon-1 p.m. June 1, 2016
Wendi Kotzen, Partner
Ballard Spahr, Philadelphia
William H. Clark Jr., Partner
Drinker, Biddle and Reath,
Philadelphia
Saba Ashraf, Partner
Ballard Spahr, Philadelphia
A Brief Review of Entity Law Basics Relating to
Choice of Entity
William H. Clark, Jr. Drinker Biddle & Reath LLP
One Logan Square Philadelphia, PA 19103
(215) 988-2804 [email protected]
general approach on choice of entity
always:
• reduce taxes
• limit the liability of the owners
and usually:
• protect the people in charge
while:
• implementing the governance arrangement desired by the owners
liability of owners corporation good
– shareholders protected
general partnership bad – partners jointly and severally liable
LLP – PA partial shield – DE full shield
limited partnership mixed – general partners liable
LLLP – full or partial shield for general partners
limited liability company good – members protected
business trust good – beneficial owners protected
protection of those in charge • exoneration
– authorized by statute for corporations (and indirectly for some limited liability companies)
– available by contract for other types of entities
• indemnification – authorized by statute for corporations, limited
partnerships, and limited liability companies – available by contract for other types of entities
• advancement of expenses – authorized by statute for corporations, limited
partnerships, and limited liability companies – available by contract for other types of entities
• variation of duties – available in Delaware, but currently not in Pennsylvania
governance arrangements
• there are three basic governance paradigms: 1. corporation
board with overall responsibility and officers
2. general partnership all owners actively participate in management
3. limited partnership one or more managers locked into position
• the three paradigms largely may be replicated in any type of entity organized under Pennsylvania law – this is true even for corporations because of the
validation of freedom of contract in 15 Pa.C.S. § 1306(a)(8)(ii) and (b)
ENTITY COMPARISON CHART
By
William H. Clark, Jr. Drinker, Biddle &
Reath
Wendi L. Kotzen Saba Ashraf
Ballard Spahr LLP
May 2016
TAX C CORP S CORP LIMITED
PARTNERSHIP LIMITED LIABILITY
PARTNERSHIP GENERAL
PARTNERSHIP LIMITED LIABILITY
COMPANY BUSINESS TRUST
ORGANIZE TAX FREE GENERALLY YES GENERALLY YES GENERALLY YES GENERALLY YES GENERALLY YES GENERALLY YES GENERALLY YES
TAX FREE CONTRIBUTION OF PROPERTY AFTER FORMATION
GENERALLY NO GENERALLY NO YES YES YES YES YES
TAX ON DEBT IN EXCESS OF BASIS OF CONTRIBUTED PROP
YES YES POSSIBLY POSSIBLY POSSIBLY POSSIBLY POSSIBLY
CAN HAVE CORPORATE OWNER
YES NO (EXEMPT ORG CORPORATE OWNERS WILL NOT CAUSE LOSS OF S STATUS)
YES YES YES YES YES
NEED TWO OWNERS NO NO YES YES YES NO, BUT IF ONE OWNER, WILL BE DISREGARDED FOR FIT AND PA INCOME TAX PURPOSES
NO, BUT IF ONE OWNER, WILL BE DISREGARDED FOR FIT AND PA INCOME TAX PURPOSES
MAXIMUM NUMBER OF OWNERS
NO 100 NO NO NO NO NO
This chart assumes that each entity that is not a state law corporation does not elect to be treated as a corporation and is not publicly traded.
7
TAX C CORP S CORP LIMITED PARTNERSHIP LIMITED LIABILITY
PARTNERSHIP GENERAL
PARTNERSHIP LIMITED LIABILITY
COMPANY BUSINESS TRUST
PASS THROUGH FED
NO YES YES YES YES YES YES
PASS THROUGH PA INC TAX
NO YES, EXCEPT INCOME SUBJECT TO FIT (e.g., BUILT-IN GAINS) - SUBJECT TO CNIT
REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL SHAREHOLDERS
FOR TAX YEARS BEGINNING AFTER 12/31/2014, S CORPS WITH 11 OR MORE SHAREHOLDERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE SHAREHOLDERS’ ACTUAL TAX LIABILITY
YES
PARTNERSHIP REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL PARTNERS AND CNIT FROM CORPORATE PARTNERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR PARTNERS’ TAX UPON FAILURE TO WITHHOLD
FOR TAX YEARS BEGINNING AFTER 12/31/2014, PARTNERSHIPS WITH ENTITY PARTNERS OR WITH 11 OR MORE PARTNERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE PARTNERS’ ACTUAL TAX LIABILITY
YES
PARTNERSHIP REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL PARTNERS AND CNIT FROM CORPORATE PARTNERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR PARTNERS’ TAX UPON FAILURE TO WITHHOLD
FOR TAX YEARS BEGINNING AFTER 12/31/2014, PARTNERSHIPS WITH ENTITY PARTNERS OR WITH 11 OR MORE PARTNERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE PARTNERS’ ACTUAL TAX LIABILITY
YES
PARTNERSHIP REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL PARTNERS AND CNIT FROM CORPORATE PARTNERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR PARTNERS’ TAX UPON FAILURE TO WITHHOLD
FOR TAX YEARS BEGINNING AFTER 12/31/2014, PARTNERSHIPS WITH ENTITY PARTNERS OR WITH 11 OR MORE PARTNERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE PARTNERS’ ACTUAL TAX LIABILITY
YES
REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL OWNERS AND CNIT FROM CORPORATE MEMBERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR MEMBERS’ TAX UPON FAILURE TO WITHHOLD
FOR TAX YEARS BEGINNING AFTER 12/31/2014, LLCS WITH ENTITY MEMBERS OR WITH 11 OR MORE MEMBERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE MEMBERS’ ACTUAL TAX LIABILITY
YES
REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL OWNERS AND CNIT FROM CORPORATE MEMBERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR MEMBERS’ TAX UPON FAILURE TO WITHHOLD
FOR TAX YEARS BEGINNING AFTER 12/31/2014, LLCS WITH ENTITY MEMBERS OR WITH 11 OR MORE MEMBERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE MEMBERS’ ACTUAL TAX LIABILITY
8
TAX C CORP S CORP LIMITED PARTNERSHIP LIMITED LIABILITY
PARTNERSHIP GENERAL
PARTNERSHIP LIMITED LIABILITY
COMPANY BUSINESS TRUST
ELECTION REQUIRED FOR FEDERAL, PA
NO YES
PA FOLLOWS FEDERAL (UNLESS ELECTION TO OPT OUT)
NO NO NO NO NO
PA CAPITAL STOCK TAX PHASED OUT EFFECTIVE 1/1/16
N/A N/A N/A N/A N/A N/A N/A
OWNER GETS BASIS FOR ENTITY’S DEBT
NO NO YES YES YES YES YES
CALENDAR OR BUSINESS YEAR REQUIRED
NO YES YES YES YES, WITH CERTAIN EXCEPTIONS
YES YES
CAN HAVE SUBSIDIARIES
YES YES YES YES YES YES YES
CAN BE DISREGARDED FOR FIT PURPOSES
NO NO YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED
CITY OF PHILADELPHIA TAXES
(GENERALLY NO PASS-THROUGH ENTITIES)
BUSINESS INCOME AND RECEIPTS TAX (FORMERLY BUSINESS PRIVILEGE TAX)
BUSINESS INCOME AND RECEIPTS TAX
QSSS NOT TREATED AS SEPARATE ENTITY BUT S CORP. PARENT AND QSSS TREATED AS ONE ENTITY AND SUBJECT TO BPT.
BUSINESS INCOME AND RECEIPTS TAX
NET PROFITS TAX
BUSINESS INCOME AND RECEIPTS TAX
NET PROFITS TAX
BUSINESS INCOME AND RECEIPTS TAX
NET PROFITS TAX
FOLLOWS FIT
BUSINESS INCOME AND RECEIPTS TAX (IF DRE, THEN OWNER SUBJECT TO BIRT AND - IF APPLICABLE - NPT)
BUSINESS INCOME AND RECEIPTS TAX
NET PROFITS TAX
9
TAX C CORP S CORP LIMITED
PARTNERSHIP LIMITED LIABILITY
PARTNERSHIP GENERAL
PARTNERSHIP LIMITED LIABILITY
COMPANY BUSINESS TRUST
SUBJECT TO AT
RISK RULES
NO, UNLESS
CLOSELY HELD
YES YES YES YES YES YES
SUBJECT TO
PASSIVE
ACTIVITY LOSS
RULES
NO, UNLESS
CLOSELY HELD
YES YES YES YES YES YES
ACCRUAL
METHOD
REQUIRED
YES, UNLESS
QPSC OR GR
NO, UNLESS IT
HAS INVENTORY
YES IF C CORP
PARTNER OR TAX
SHELTER,
UNLESS GR AND
UNLESS IT
CHECKS THE BOX,
OR IT HAS
INVENTORY
YES IF C CORP
PARTNER OR
TAX SHELTER,
UNLESS GR AND
UNLESS IT
CHECKS THE
BOX, OR IT HAS
INVENTORY
YES IF C CORP
PARTNER OR
TAX SHELTER,
UNLESS GR AND
UNLESS IT
CHECKS THE
BOX, OR IT HAS
INVENTORY
YES IF C CORP
MEMBER OR
TAX SHELTER
UNLESS GR AND
UNLESS IT
CHECKS THE
BOX, OR IT HAS
INVENTORY
YES IF C CORP
MEMBER OR TAX
SHELTER UNLESS
GR AND UNLESS IT
CHECKS THE BOX,
OR IT HAS
INVENTORY
EMPLOYMENT
TAX/ SELF-
EMPLOYMENT
TAX
NOT ON
DIVIDENDS
ISSUES EXIST
FOR OE
GUARANTEED
PAYMENTS FOR
SERVICE YOU
RENDERED THE
PARTNERSHIP
ARE NET
EARNINGS FOR
SELF-
EMPLOYMENT
TAX.
GUARANTEED
PAYMENTS FOR
SERVICE YOU
RENDERED THE
PARTNERSHIP
ARE NET
EARNINGS FOR
SELF-
EMPLOYMENT
TAX.
GENERAL
PARTNER'S
EARNINGS
FROM SELF-
EMPLOYMENT
INCLUDE
DISTRIBUTIVE
SHARE OF
INCOME OR
LOSS AND
GUARANTEED
PAYMENTS FOR
SERVICES
RENDERED.
LIMITED
PARTNERS
ONLY
INLUCLUDE
GUARANTEED
PAYMENTS.
GUARANTEED
PAYMENTS FOR
SERVICE YOU
RENDERED THE
PARTNERSHIP
ARE NET
EARNINGS FOR
SELF-
EMPLOYMENT
TAX.
YES ON
ALLOCABLE SHARE
OF INCOME IF
MEMBER HAS
PERSONAL
LIABILITY FOR
DEBT OR CLAIMS
VS. ENTITY,
AUTHORITY TO
CONTRACT ON
BEHALF OF THE
BUSINESS TRUST
OR PARTICIPATES
IN THE BUSINESS
TRUST’S TRADE OR
BUSINESS FOR
MORE THAN 500
HOURS DURING
THE BUSINESS
TRUST’S TAX YEAR;
IF MEMBER IS
SERVICE MEMBER
10
11
TAX C CORP S CORP LIMITED
PARTNERSHIP LIMITED LIABILITY
PARTNERSHIP GENERAL
PARTNERSHIP LIMITED LIABILITY
COMPANY BUSINESS TRUST
3.8% NET
INVESTMENT
INCOME TAX
MAY BE
IMPOSED ON
GAIN FROM
SALES OF
STOCK AND
DIVIDENDS
EARNED BY
INDIVIDUAL
SHAREHOLDERS
MAY BE
IMPOSED ON
GAIN FROM
SALES OF
STOCK AND
OTHER INCOME
EARNED BY
INDIVIDUAL
SHAREHOLDERS
IF OWNERSHIP
IS A PASSIVE
ACTIVITY
MAY BE IMPOSED
ON GAIN FROM
SALES OF
PARTNERSHIP
INTERESTS AND
OTHER INCOME
EARNED BY
INDIVIDUAL
PARTNERS IF
OWNERSHIP IS A
PASSIVE ACTIVITY
MAY BE
IMPOSED ON
GAIN FROM
SALES OF
PARTNERSHIP
INTERESTS AND
OTHER INCOME
EARNED BY
INDIVIDUAL
PARTNERS IF
OWNERSHIP IS A
PASSIVE
ACTIVITY
MAY BE
IMPOSED ON
GAIN FROM
SALES OF
PARTNERSHIP
INTERESTS AND
OTHER INCOME
EARNED BY
INDIVIDUAL
PARTNERS IF
OWNERSHIP IS A
PASSIVE
ACTIVITY
MAY BE
IMPOSED ON
GAIN FROM
SALES OF
MEMBERSHIP
INTERESTS AND
OTHER INCOME
EARNED BY
INDIVIDUAL
MEMBERS IF
OWNERSHIP IS A
PASSIVE
ACTIVITY
MAY BE IMPOSED
ON GAIN FROM
SALES OF
INTERESTS AND
OTHER INCOME
EARNED BY
INDIVIDUAL IF
OWNERSHIP IS A
PASSIVE ACTIVITY
DOUBLE TAX ON
SALE OF
ASSETS
YES NO, UNLESS TAX
ON BUILT IN
GAIN
NO NO NO NO NO
CAN RECEIVE
STOCK TAX
FREE IN A
MERGER
YES YES NO NO NO NO NO
ENTITY ASSET
BASIS STEP UP
ON TRANSFER
BY OWNER BY
SALE OR DEATH
NO NO YES WITH 754
ELECTION
YES WITH 754
ELECTION
YES WITH 754
ELECTION
YES WITH 754
ELECTION
YES WITH 754
ELECTION
QPSC = QUALIFIED PERSONAL SERVICE CORP. GR = GROSS RECEIPTS UNDER $10,000,000 OE = OWNER EMPLOYEE QSSS = QUALIFIED SUBCHAPTER S SUBSIDIARY
BUSINESS C CORP S CORP LIMITED
PARTNERSHIP LIMITED LIABILITY
PARTNERSHIP GENERAL
PARTNERSHIP LIMITED LIABILITY
COMPANY BUSINESS TRUST
LIMITED LIABILITY FOR OWNERS
YES YES YES FOR LIMITED PARTNERS
DEPENDS ON STATE STATUTE. DELAWARE OFFERS FULL SHIELD. PENNSYLVANIA—PARTNERS ARE NOT LIABLE FOR MISCONDUCT OF OTHER PARTNERS BUT ARE LIABLE FOR OBLIGATIONS OF THE COMPANY.
NO YES YES
LIMITED LIABILITY OF DIRECTORS/ MANAGERS/ OFFICERS
YES YES NO, FOR GENERAL PARTNER
SOME FOR GENERAL PARTNER
NO DEPENDS ON STATUTE
DEPENDS ON STATUTE
IMPACT OF DEATH OF AN OWNER ON THE BUSINESS
(PARTNERSHIP / LLC AGREEMENTS MAY PROVIDE OTHERWISE)
NONE NONE STATUTORY DISSOLUTION IF GENERAL PARTNER DIES OTHERWISE, NONE
STATUTORY DISSOLUTION IF GENERAL PARTNER DIES OTHERWISE, NONE
STATUTORY DISSOLUTION
DEPENDS ON STATUTE, MOST ARE THE SAME AS FOR A LIMITED PARTNERSHIP
NONE
TRANSFERABILITY OF INTERESTS IN ENTITY
YES YES, BUT RESTRICTIONS DESIRABLE
YES, BUT OFTEN RESTRICTED
YES, BUT OFTEN RESTRICTED
YES, BUT OFTEN RESTRICTED
YES, BUT OFTEN RESTRICTED
YES, BUT OFTEN RESTRICTED
ARE ANNUAL ELECTIONS OF DIRECTORS, MANAGERS, AND OFFICERS REQUIRED
YES YES NO NO NO NO NO
12
LP TO LLC AND LLC TO LP
LP TO LLC
GENERALLY A CONVERSION FROM AN LP TO AN LLC WILL NOT BE TAXABLE TO THE LIMITED PARTNERS. LIMITED PARTNERS WILL HAVE A TAX BASIS FOR THEIR MEMBERSHIP INTERESTS EQUAL TO THEIR BASIS FOR THEIR PARTNERSHIP INTERESTS, PLUS THEIR SHARE OF THE LLC’S RECOURSE DEBT. THE GENERAL PARTNER’S BASIS FOR ITS MEMBERSHIP INTEREST WILL DECREASE BY THE OTHER MEMBER’S SHARE OF THE LLC’S RECOURSE DEBT. THE GENERAL PARTNER COULD RECOGNIZE GAIN IF THERE IS A DECREASE IN ITS SHARE OF LIABILITIES AND THE DECREASE EXCEEDS THE PARTNER'S BASIS FOR ITS PARTNERSHIP INTEREST. THE LLC'S BASIS FOR ITS ASSETS WILL BE THE SAME AS THE BASIS THE LP HAD FOR THE ASSETS PLUS ANY GAIN RECOGNIZED BY THE PARTNERS. THE PENNSYLVANIA TAX CONSEQUENCES SHOULD BE THE SAME AS THE FEDERAL TAX CONSEQUENCES.
LLC TO LP – WILL BE VERY RARE
GENERALLY CONVERSION FROM AN LLC TO AN LP WILL NOT BE TAXABLE TO THE LLC MEMBERS. THE LIMITED PARTNERS WILL HAVE A BASIS FOR THEIR LIMITED PARTNERSHIP INTERESTS EQUAL TO THEIR BASIS FOR THEIR MEMBERSHIP INTERESTS LESS THEIR SHARE OF THE LP’S RECOURSE DEBT. THE GENERAL PARTNER WILL HAVE A BASIS FOR ITS GENERAL PARTNERSHIP INTEREST EQUAL TO ITS BASIS FOR ITS MEMBERSHIP INTEREST PLUS THE OTHER MEMBER’S SHARE OF THE RECOURSE DEBT. THE LP'S BASIS FOR ITS ASSETS WILL BE THE SAME AS THE BASIS THE LLC HAD FOR THE ASSETS PLUS ANY GAIN RECOGNIZED BY THE MEMBERS. THE PENNSYLVANIA TAX CONSEQUENCES SHOULD BE THE SAME AS THE FEDERAL TAX CONSEQUENCES.
CORPORATION TO LLC AND LLC TO CORPORATION
CORPORATION TO LLC – WILL BE VERY RARE
THERE WILL BE DOUBLE TAX. THE CORPORATION IS TREATED AS IF IT SOLD ITS ASSETS FOR THEIR FAIR MARKET VALUE. GAIN OR LOSS IS RECOGNIZED BY THE CORPORATION IN THE AMOUNT OF THE DIFFERENCE BETWEEN THE FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS. ALSO THE SHAREHOLDERS ARE TAXED ON THE EXCESS OF THE FAIR MARKET VALUE OF THE ASSETS OVER THEIR TAX BASIS FOR THEIR SHARES. THE MEMBERS WILL HAVE A FAIR MARKET VALUE BASIS FOR THEIR MEMBERSHIP INTERESTS. THE LLC WILL HAVE A FAIR MARKET VALUE BASIS FOR ITS ASSETS. FOR S-CORPS, THE GAIN OR LOSS RECOGNIZED BY THE CORPORATION ON THE DIFFERENCE BETWEEN THE FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS WILL BE PASSED THROUGH TO THE S-CORP SHAREHOLDERS.
LLC TO CORPORATION
THE CONVERSION WILL BE TAX-FREE UNLESS THE LLC’S ASSETS ARE ENCUMBERED BY DEBT THAT EXCEEDS THEIR BASIS. THE CORPORATION’S TAX BASIS FOR THE ASSETS WILL BE THE BASIS THAT THE LLC HAD FOR THOSE ASSETS PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS BASIS FOR THEIR STOCK WILL BE THEIR BASIS FOR THEIR MEMBERSHIP INTERESTS LESS THEIR SHARE OF THE LLC’S DEBT PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS WILL RECOGNIZE GAIN TO THE EXTENT THAT THEIR SHARE OF THE LLC’S DEBT EXCEEDS THEIR BASIS FOR THEIR MEMBERSHIP INTEREST.
FEDERAL AND PENNSYLVANIA INCOME TAX CONSEQUENCES OF STATE ENTITY CONVERSIONS
13
CORPORATION TO LP AND LP TO CORPORATION
CORPORATION TO LP – WILL BE VERY RARE
THERE WILL BE DOUBLE TAX. THE CORPORATION IS TREATED AS IF IT SOLD ITS ASSETS FOR THEIR FAIR MARKET VALUE. GAIN OR LOSS IS RECOGNIZED BY THE CORPORATION IN THE AMOUNT OF THE DIFFERENCE BETWEEN FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS. ALSO THE SHAREHOLDERS ARE TAXED ON THE EXCESS OF THE FAIR MARKET VALUE OF THE ASSETS OVER THEIR TAX BASIS FOR THEIR SHARES. THE PARTNERS WILL HAVE A FAIR MARKET VALUE BASIS FOR THEIR PARTNERSHIP INTERESTS PLUS THEIR SHARE OF THE PARTNERSHIP’S NON RECOURSE DEBT. THE PARTNERSHIP WILL HAVE A BASIS FOR ITS ASSETS EQUAL TO THE FAIR MARKET VALUE OF THE ASSETS FOR S-CORPS, THE GAIN OR LOSS RECOGNIZED BY THE CORPORATION ON THE DIFFERENCE BETWEEN THE FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS WILL BE PASSED THROUGH TO THE S-CORP SHAREHOLDERS.
LP TO CORPORATION
THE CONVERSION WILL BE TAX-FREE UNLESS THE PARTNERSHIP’S ASSETS ARE ENCUMBERED BY DEBT THAT EXCEEDS THEIR BASIS. THE PARTNERSHIP’S TAX BASIS FOR THE ASSETS WILL BE THE BASIS THAT THE PARTNERSHIP HAD FOR THOSE ASSETS PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS BASIS FOR THEIR STOCK WILL BE THEIR BASIS FOR THEIR PARTNERSHIP INTERESTS LESS THEIR SHARE OF THE PARTNERSHIP’S DEBT PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS WILL RECOGNIZE GAIN TO THE EXTENT THAT THEIR SHARE OF THE PARTNERSHIP’S DEBT EXCEEDS THEIR BASIS FOR THEIR PARTNERSHIP INTEREST.
14
Conversion of Entities under Pennsylvania Law
William H. Clark, Jr. Drinker Biddle & Reath LLP
One Logan Square Philadelphia, PA 19103
(215) 988-2804 [email protected]
15
16
• Since July 1, 2015, Pennsylvania has authorized the conversion of entities from one form to another.
• The conversion provisions are found in 15 Pa.C.S. Subch. 3E and are part of a complete set of inter-entity transaction provisions.
• The provisions of 15 Pa.C.S. Ch. 3 apply to transactions involving only Pennsylvania entities and also those involving an entity organized under the law of a foreign jurisdiction that permits inter-entity transactions.
16
17
conversion (I) (single state)
L.P. A
(PA)
LLC A
(PA)
18
conversion (II) (multi-state)
L.P. A
(DE)
LLC A
(PA)
19
The only trick to using the new provisions is
learning a new vocabulary:
– governor
– interest
– interest holder
– organic law
– organic rules
– private organic rules
– public organic record
– “entity” v. “association”
19
20
– Governor: a person by or under whose authority
the powers of an association are exercised and
under whose direction the activities and affairs of
the association are managed pursuant to the organic
law and organic rules of the association. For
example:
• director of a business corporation
• manager of a manager-managed LLC
• member of a member-managed LLC
20
21
– Interest: a share in a corporation for profit, a
membership or share in a corporation not-for-profit,
a governance interest, or a distributional interest.
For example:
• share in a business corporation
• membership interest in an LLC
– Interest holder: a direct or record holder of an
interest. For example:
• shareholder of a business corporation
• member of an LLC
21
22
– Organic law: the law of the jurisdiction of formation of an association governing its internal affairs. For example:
• the Business Corporation Law of 1988
• the Limited Liability Company Law of 1994
– Organic rules: the public organic record and private organic rules of an association. For example:
• articles and bylaws of a business corporation
• certificate of formation and operating agreement of an LLC
22
23
– Private organic rules: the rules that govern the
internal affairs of an association, are binding on all
its interest holders and are not part of its public
organic record, if any. For example
• bylaws of a business corporation
• operating agreement of an LLC
– Public organic record: the document the public
filing of which by the department or a similar
agency in another jurisdiction is required to form an
association. For example:
• articles of a business corporation
• certificate of formation of an LLC
23
24
• An “entity” is a domestic or foreign organization of a type whose organic law is found in Title 15.
• In contrast, “association” is a broader term that includes any type of private organization, whether domestic or foreign.
– A banking institution is an association but not an entity.
“entity” v. “association”
association entity
25
• The definitions just discussed are found in 15 Pa.C.S. § 102.
– Thus, they apply to all of Title 15 and all of the Pennsylvania business entity laws.
• Definitions applicable just to Chapter 3 relating to fundamental transactions appear in 15 Pa.C.S. § 312.
– These definitions are mostly unremarkable and simply facilitate the wording of Chapter 3.
– Three definitions are worth noting and will be discussed later:
• “interest holder liability”
• “protected agreement”
• “protected governance agreement”
25
26
procedures generally
• The statutory provisions for conversions parallel the provisions for other types of transactions under Ch. 3: – authorization of the transaction
– preparation of a plan
– approval of the plan by the governors and interest holders
– amendment or abandonment of the plan
– filing and effectiveness
– effect of the transaction
• Substantive approval requirements under current law continue unchanged. – These are collected in a separate Subchapter 3B and
organized by type of entity.
26
27
• Note that the general rule in Pennsylvania is that approval of a fundamental transaction requires the affirmative vote of a majority of the votes cast (which excludes abstentions) at a meeting at which a quorum is present.
• This is in marked contrast to Delaware where approval requires the affirmative vote of a majority of the outstanding interests.
27
28
• Dissenters rights are available for shareholders
on a conversion.
• Statutory dissenters rights are not available for
interest holders in entities that are not business
corporations.
• Contractual dissenter rights are available for
interest holders in entities that are not business
corporations. See 15 Pa.C.S. § 317.
dissenters rights
28
29
• 15 Pa.C.S. § 329 permits a plan to classify interest holders into groups on a basis other than the class or series of interest that they hold and provide mandatory treatment for members of the group.
• This “special treatment” will be respected if either:
1. the interest holders receiving special treatment have either:
• a class vote, or
• dissenters rights
2. a court of competent jurisdiction finds that the special treatment was undertaken in good faith, after reasonable deliberation and was in the best interest of the association.
special treatment
30
• The concept of a “protected agreement” or “protected governance agreement” provides transitional protection.
• These concepts are defined in 15 Pa.C.S. § 312 as follows:
“Protected agreement.” Either of the following:
(1) A record evidencing indebtedness and any related agreement in effect on July 1, 2015.
(2) A protected governance agreement.
“Protected governance agreement.” Either of the following:
(1) The organic rules of a domestic entity or foreign association in effect on July 1, 2015.
(2) An agreement that is binding on any of the governors or interest holders of a domestic entity or foreign association on July 1, 2015.
protected agreements
31
• If such an agreement deals with a merger, the agreement is deemed to apply to a conversion.
• The notion is that, if people contracted for special rules or protections in the event of a merger at a time when conversions were not authorized, they are deemed to have wanted the same special arrangements for a conversion.
– Underlying the concept is a recognition that a conversion could previously have been accomplished by using a merger.
32
interest holder liability
• Interest holder liability is defined in 15 Pa.C.S.
§ 312 and is personal liability for either:
– a liability of an association as a result of being an
interest holder; or
– an obligation to contribute to the association
imposed by the organic rules.
• A transaction must be approved by any person
that will have interest holder liability following
the transaction.
32
33
33
General Partnership
Corporation
General Partnership
General Partnership
Corporation
Corporation
A B
B A
A B
B A
Thank you for attending
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