THE CORPORATION

VS. THE LLC

PRESENTED BY:

Lori Ann Fox, Esq.

Corporation vs. LLC

SEMINAR OVERVIEW

•Entity characteristics

•Non-tax advantages

•Formation requirements

•Doing business in foreign states

•Management & ownership

•Compliance issues

Corporation vs. LLC

ENTITY CHARACTERISTICS

Corporation vs. LLC

ENTITY CHARACTERISTICS

•Liability

•Control

•Transferability of interests

•Continuity of existence

•Taxation

Corporation vs. LLC

LIABILITY

•Personal liability of the owners?

•Both provide limited liability

Key similarity

Corporation vs. LLC

CONTROL

•Who manages? Owners or management group?

•Corporation

– board of directors

– officers

– not shareholders

•LLC

– either members or managers

– partnership or corporation structure

Corporation vs. LLC

TRANSFERABILITY OF INTERESTS

•Right to sell or transfer interest to a third party

• Interest = financial rights + management rights

•Free transferability - buyer receives all rights of seller

– Corporation

• free transferability

• buyer becomes shareholder

• buyer has all rights of seller

– LLC

• restricted transferability

• buyer becomes assignee - not member

• buyer has only financial rights of seller

Corporation vs. LLC

CONTINUITY OF EXISTENCE

•Affect of change in owners

•Continuity means entity does not dissolve upon change

•Corporation?

•LLC?

Corporation vs. LLC

POLLING QUESTION #1

Have you ever been asked to form an “S” corporation?

A. Yes

B. No

Corporation vs. LLC

TAXATION

•Pass-through vs. separate entity (federal income tax purposes)

•Corporation

– Default

– Election

•LLC

– Default

– Election

Key difference

Corporation vs. LLC

TAXATION OF C CORPORATION

•Corporation taxed on income

•Shareholders taxed on dividends & final distributions

•State taxes

Corporation vs. LLC

ADVANTAGES OF C CORPORATION TAXATION

•Deduct fringe benefits

•Qualified pension and ISO

•Tax free reorganization

•Adopt any tax year

•Passive loss

Corporation vs. LLC

S CORPORATION

•Permitted by federal income tax laws

•Alternative to C corporation

•Pass-through taxation

•State tax treatment

•Restrictions

Corporation vs. LLC

TAXATION OF LLC

•Pass-through entity

•One member LLC - disregarded as entity

•Two or more member LLC - taxed as partnership

•Options: C or S corporation taxation

Corporation vs. LLC

NON-TAX ADVANTAGES

Corporation vs. LLC

NON-TAX ADVANTAGES – CORPORATIONS

•Public companies prefer

•Status symbol

•Familiarity

– investors and lenders

– lawyers, judges, other professionals

•Stock options & bonuses

•Legal treatment

– More case law

– Statutes well developed

– Statutory treatment known

– Laws governing solely owned corporations clearer than those

governing single member LLCs

Corporation vs. LLC

DIVERSITY JURISDICTION

•Multi-state entities often prefer to have litigation heard in federal

court

•Two ways to federal court

– federal question

– diversity of citizenship

•Corporation and LLC treated differently

– Corp is citizen of state of incorporation & state of ppb

• S.Ct in 2010 case: ppb is location of “nerve center”

– LLC is citizen of every state its members are citizens

•Easier for corporation with shareholders located throughout US to

have access to federal court

Corporation vs. LLC

LLC TREATMENT IN FLUX: HSR EXPERIENCE

•Hart-Scott-Rodino Act

– Federal law requiring pre-merger notification filing

– 1976 law – refers to corporations & partnerships only as LLCs did not exist

•At first FTC decided to treat LLCs the same as corporations

1994 - rule change to treat LLC like corporation or

partnership on case by case basis

1999 – new rules applicable to LLCs

• Fewer filings required than for corporations

2005 – rules changed again

• LLC treatment made consistent with corporation

Corporation vs. LLC

UNCERTAIN TREATMENT – AN EXAMPLE

Cortez v. NACCO Materials Handling Group, Inc., 274 P.3d 202 (Or. App. 2012)

•Facts:

– Pl employed by LLC; injured on job; receives workers comp award from LLC

– Pl sues LLC’s member for damages

– Member argues it is exempt under Sec. 656.018

– Ore. Workers Comp. L., Sec. 656.018 – states that workers comp provides exclusive remedy for employer and its officers and directors

•Court:

– Because statute does not list LLC members it does not apply to members

– Legislature could have amended section if it wanted it to apply to LLC members

Corporation vs. LLC

NON-TAX ADVANTAGES - LLC

•Few mandatory provisions - dissenter’s rights, indemnification, etc.

•Fewer management formalities - meetings, notice, minute keeping, etc.

•Management alternatives - member or manager

•Flexibility in splitting financial interests

•Governing provisions remain private

•Creditor generally limited to charging order

•Separation of assets from liabilities thru Series LLC

Corporation vs. LLC

CHARGING ORDER

•LLC protects entity from owner’s debts

•Limits remedy of judgment creditor of member to charging order

•Court order requiring LLC to pay member’s distributions to creditor

•Lien on economic interest only

•Creditor cannot obtain membership interest or management rights

•Corporation statutes do not limit remedy

– shareholder’s creditor may attach stock itself

– creditor obtains stock, voting and other rights

– may be able to force liquidation

Corporation vs. LLC

CHARGING ORDER - EXCEPTIONS

•Check statute to be sure it eliminates foreclosure as remedy

– Some say “court may charge LLC interest of member”

– Could be interpreted as allowing other remedies

•States are amending LLC law to clarify that charging order is only

remedy

•Example:

– Ohio Sec. 1705.19 as amended by HB 48, eff. 5/4/2012

– “An order charging the membership interest of a LLC is the sole and

exclusive remedy that a judgment creditor may seek to satisfy a

judgment against the membership interest of a member or a member’s

assignee.”

Corporation vs. LLC

CHARGING ORDER - EXCEPTIONS

•Limitation to charging order may not apply to SMLLC

•Reason – limitation intended to protect other members

•Olmstead v. FTC, 44 So.3d 76 (Fla. 2010)

– FL SCt rules that charging order provision of FL LLC act permits court to

order a judgment debtor to surrender all rights, title, interest in

debtor’s SMLLC to satisfy judgment

– Legislative response in 2011 clarifies that charging order applies to

SMLLC unless creditor proves to court distribution will not satisfy

judgment

•States are amending laws to clarify that charging order provision

applies to single member LLCs

– Ex. – South Dakota HB 1192, eff. July 1, 2012 adds subsection(g) to

charging order section

– “This section [which states that charging order is exclusive remedy]

applies to SMLLCs in addition to LLCs with more than one member.”

Corporation vs. LLC

WEDDELL V. H2O, INC., 271 P.3D 743 (NEV. 2012)

•Facts:

– Weddell, Stewart – members and managers of NV LLC

– Judgment creditor of Weddell obtains charging order

– Relationship deteriorates; they sue each other

•Trial ct:

– rules for Stewart

– holds that charging order divested Weddell of managerial rights so

Stewart sole manager

•NV S.Ct. reverses; charging order resulted in following:

– Weddell has no right to distributions but retains other rights including

managerial rights

– Judgment creditor only receives economic interests

– Reflects principle that LLC members should be able to choose members

with whom to associate

Corporation vs. LLC

POLLING QUESTION # 2

Are you familiar with the Series LLC?

A. Yes

B. No

Corporation vs. LLC

SERIES LLC - DIAGRAM

Corporation vs. LLC

SERIES LLC

•An LLC that is divided into separate series

•Each series functions like a separate LLC

• If properly formed and maintained, debts of a series can be

satisfied from that series only

•Delaware was first state to authorize

•Other states include AL (1/1/15), DC, IL, IA, KS, MO, MT, NV, OK,

TN,TX, UT

Corporation vs. LLC

SERIES LLC

Questions surrounding Series LLCs

– How will Series LLC and series be taxed?

• PLR 200803004 – IRS treated each series separately

– Will foreign state that does not provide for Series LLC respect separation

of liabilities?

– Can series, in its own name, enter into contracts, sue or be sued, own

legal title to real estate?

– Can series file for bankruptcy or register under securities laws?

Corporation vs. LLC

FORMATION

Corporation vs. LLC

CHOOSING FORMATION STATE

•More critical for corporations

•Normally where entity located

•Avoid quirks

• If not where located then in Delaware

Corporation vs. LLC

WHY SELECT DELAWARE?

•Statutes provide efficiency

•Annual review of statutes

•Court of Chancery

•Substantial body of case law

•Up-to-date filing office

Corporation vs. LLC

NAME ISSUES

•Entity indicator

•Name availability

•Name reservation

•Name registration

•Trademark search

•Assumed name

Corporation vs. LLC

FORMATION DOCUMENT - CORPORATION

•Articles of Incorporation

– name, shares, registered agent and office, incorporators

•Notice function plus

– management rules

– director and shareholder rights

•Review default provisions

Corporation vs. LLC

POLLING QUESTION #3

Do you include optional provisions in your corporation’s articles of

incorporation?

A. Include Optional Provisions

B. Do Not Include Optional Provisions

Corporation vs. LLC

OPTIONAL PROVISIONS

•Shield directors from personal liability

•Shareholders cumulate votes

•Qualifications for directors

•Staggered terms for directors

•Directors to change bylaws

•Creating classes and series of shares

•Fix terms of class of shares

•Voting rights

•Supermajority voting

Corporation vs. LLC

FORMATION DOCUMENT - LLC

•Articles of Organization

– only a notice function

– name

– principal office address

– registered agent/office

– management structure

•Not used to opt out of default provision

•Optional provision for public notice

Corporation vs. LLC

GOVERNING DOCUMENT - CORPORATION

•Bylaws

– location of offices

– director and shareholder meetings

– officers

– election and removal of directors

– committees

•Subordinate to Articles of Incorporation and state law

Corporation vs. LLC

GOVERNING DOCUMENT - LLC

•Operating agreement

– Who will manage

– Powers of members or managers

– Who can sign documents

– Meeting requirements

– Indemnification

– Member names, adding new

members

– Contributions and percent

interest

– Allocation of profits, losses,

distributions

– Subordinate to articles of

organization and state law

•Combination of corporation’s bylaws, Articles of Incorporation

and shareholder agreements

•Used to opt out

•Used to fill in gaps (Delaware)

Corporation vs. LLC

PURPOSES

•Corporation

– Statutes – any lawful business or purpose

– For profit entity

– Non profits generally incorporate under separate statute

•LLC

– Statutes – any lawful business or purpose

• banking or insurance may be prohibited

– For profit and non profit generally form under same statute

Corporation vs. LLC

ORGANIZATIONAL MEETING

•Required by corporation law

– completes organization

– consent in lieu of meeting

• Incorporators’ meeting

– elect directors

– bylaw adoption

•Directors’ meeting

– elect officers

– other actions

Difference: not required by LLC statutes

Corporation vs. LLC

DOING BUSINESS IN FOREIGN STATES

Corporation vs. LLC

CONSEQUENCES OF DOING BUSINESS

•Foreign state - any state other than formation state

•Can corporations and LLCs do business in foreign states?

•Not all activities are “doing business”

•First step - find out all activities and contacts

Corporation vs. LLC

WHAT CONSTITUTES DOING BUSINESS?

•Must determine whether activities constitute “doing business” in

state

•First check statutory list

– maintaining, defending suits

– shareholder, director, member, manager meeting

– bank accounts

– isolated transactions

– interstate commerce

•Then check case law

Corporation vs. LLC

QUALIFICATION

•File application for authority/registration

– name

– state and date of formation

– principal office

– registered agent and office

– name of directors, officers, managers

•Supporting document

•Fees

•Conflict name

Corporation vs. LLC

RISKS OF FAILURE TO QUALIFY

•Denied access to courts

•Fines

– against corporation or LLC

– against individuals

Corporation vs. LLC

MANAGEMENT

Corporation vs. LLC

SOME MANAGEMENT DIFFERENCES

Corporation LLC

Individual directors Entity managers

No meeting –

unanimous consent

No meeting –

unanimous/majority

No vote by proxy Vote by proxy

Appoint officers

Limits on committee actions

Officers optional

No limits on committee actions

Corporation vs. LLC

CORPORATION - BASIC STRUCTURE

•Managed by board of directors

– use of committees

•Directors elected by shareholders

– plurality vote unless otherwise provided

– recent statutory trend: permit bylaw whereby nominee in public

corporation cannot serve if more “against” votes than “for” votes are

received

•Officers

– may be required by statute

•Shareholders

– do not manage

Corporation vs. LLC

MANAGEMENT FORMALITIES

•Corporations managed formally

•Meetings required

•Notice must be given

•Quorum required to act

• Inspectors of election

Corporation vs. LLC

STATUTORY CLOSE CORPORATION

•Limited number of shareholders

•Stock transfer restricted

•No public offering

•Can dispense with board

•Shareholders have same powers as directors

• Issues

– Not all states permit

– Unanimous consent

Corporation vs. LLC

LLC - BASIC STRUCTURE

•Default rule - members manage

•May have managers instead

– corporation structure

– managers chosen pursuant to operating agreement

•Can be managed informally

Corporation vs. LLC

FIDUCIARY DUTIES - CORPORATIONS

•Statutory standard: business judgment standard

•Common law

– duty of loyalty

– duty of care (including oversight)

•Limit on interested transactions

Corporation vs. LLC

DUTY OF LOYALTY: GUTH V. LOFT, INC

•Delaware case creating “corporate opportunity doctrine”

•Facts:

– Corporation looking for cheaper syrup

– Director/president learns of bankrupt syrup company

– Buys syrup formula and trademark for himself

– Uses corporate assets and employees to develop syrup

•Delaware Supreme Court holds director liable for breach of duty of

loyalty

Corporation vs. LLC

DUTY OF CARE: SMITH V. VAN GORKOM

•Rare DE case where directors found to violate duty of care

•Facts:

– Chairman/CEO decided to sell company and found buyer

– Called director meeting on one day notice without telling purpose

– Directors approve after two hour meeting

– No fairness opinion or valuation report

•Court:

– Directors held liable

– 12(b)(7)

Corporation vs. LLC

FIDUCIARY DUTIES - LLC

•Three approaches

– corporate standard

– partnership standard

– let operating agreement govern

•Duties less certain than corporations

Corporation vs. LLC

LLC FIDUCIARY DUTIES IN DELAWARE

•Auriga Capital Corp. v. Gatz Properties, LLC, C.A. No. 4390, Ch.Ct.

(1/27/2012)

•Background: no statutory standard of conduct in DE

•Facts:

– Minority members sued manager alleging breach of fiduciary duties after

he bought them out for price well below market value

– Manager argues he did not owe fiduciary duties in absence of LLC

agreement provision specifying such duties

• Issue – Do default fiduciary duties exist where they have not been

eliminated or modified in LLC agreement?

•Holding - Yes

Corporation vs. LLC

LLC FIDUCIARY DUTIES IN DELAWARE: AURIGA CAPITAL V. GATZ PROPERTIES (CONT.)

•Ch. Ct.’s reasoning:

– LLC act explicitly states that rules of equity govern unless otherwise

provided for

– Default fiduciary duties apply to managers of alternative entities

– LLC act was amended to provide that fiduciary duties may be eliminated

in the LLC agreement; why would General Assembly eliminate something

unless it existed

•Manager breached his fiduciary duties

– Refused to explore strategic options

– Refused to consider credible offer to buy LLC from 3rd party

– Made low ball offer to members

– Conducted a sham auction for the LLC

Corporation vs. LLC

LIMITING LIABILITY

•Corporations

– duty of care only

– only in articles of incorporation

•LLC

– any fiduciary duty

– in operating agreement

– public policy limit

Corporation vs. LLC

SHAREHOLDERS VS. MEMBERS

Corporation vs. LLC

WHAT DO INVESTORS GET?

•Corporation

– shares of stock

– may be represented by certificate

•LLC

– percentage interest

– generally, no certificate

•Privileges

•Rights

•Duties

•Liability

Corporation vs. LLC

PRIVILEGE OF OWNERSHIP

•Limited liability

•Exceptions

– consent to liability

– liable for own tortious conduct

– piercing the veil

Corporation vs. LLC

PIERCING THE VEIL

•Corporations: alter ego test

– Undercapitalization

– Management formalities

– Corporation maintained books and accounts

– Used for personal purposes

– Test of inequity

•LLCs

– State courts have applied the theory to LLCs

– Policy - liability shield may not be used fraudulently

– Only a few states expressly provide for piercing the LLC veil in the

enabling statute

– Less weight on formalities

Corporation vs. LLC

SAMPLE LLC STATUTE: WASHINGTON

•WA § 25.15.060 Piercing the veil

•“Members of a limited liability company shall be personally liable for

any act, debt, obligation, or liability of the limited liability company

to the extent that shareholders of a Washington business corporation

would be liable in analogous circumstances.”

•Court - Consider corporate case law

Corporation vs. LLC

LLC VEIL PIERCING: MARTIN V. FREEMAN

•272 P.3d 1182 (Colo. App. 2012)

•Facts:

– Pl obtained judgment against SMLLC

– While suit pending LLC sold airplane that was only significant asset

•Court pierced veil to hold member liable for judgment

– Main factor – proceeds from airplane sale were diverted to member’s

personal account

– Courts do not have to consider that LLCs have fewer restrictions than

corporations in observing formalities

– Wrongful intent or bad faith need not be shown

Corporation vs. LLC

DIVIDENDS AND DISTRIBUTIONS

Corporation LLC

Dividend Interim distribution

Declared by board Decided by members

Apportioned in accordance

with stock ownership Members allocate

Corporation vs. LLC

PROFITS & LOSSES

•Members share P & L

•S corporation shareholders share P & L

•C corporation shareholders do not

•Profit vs. distribution

•LLC can have special allocations

•S corporation shareholders share based on stock ownership

Corporation vs. LLC

MANAGEMENT RIGHTS

•Right to vote for directors & managers

•Right to vote for major changes

•Member-managed LLC

– make business decisions

– bind LLC

Corporation vs. LLC

INSPECTION AND DISSENTERS’ RIGHTS

• Inspect books and records

– provided by statute

– corporations cannot restrict right

– LLCs can restrict

•Dissenters’ rights

– corporation - required by statute

– LLC - may or may not be required

Corporation vs. LLC

MORE ON MANAGEMENT RIGHTS

•Right to transfer

– shareholder - yes

– member - with consent

•Derivative suit

•Affect on choice?

Corporation vs. LLC

DUTIES & LIABILITIES

Shareholder Member

Pay for shares Pay for interests

Failure to pay – breach of

contract

Failure to pay – breach of

contract or more

No fiduciary duties owed

Fiduciary duties owed to

members, LLC (member

managed LLC )

Corporation vs. LLC

COMPLIANCE ISSUES

Corporation vs. LLC

CHANGES TO FORMATION DOCUMENT

•Amendments

•Corrections

•Restatement

Corporation vs. LLC

REGISTERED AGENT & OFFICE

•Registered agent - agent authorized to receive service of process

•Registered office - location in state of registered agent

•Noncompliance - grounds for administrative dissolution

•MoRAA

Corporation vs. LLC

ANNUAL REPORT & FRANCHISE TAX

•Annual report

– information on file with filing office

– mandatory for corporations and LLCs

– failure to file is grounds for administrative dissolution

•Franchise tax

– state’s fee for providing franchise

– base may be income, shares, capital, flat fee

– failure to pay is grounds for administrative dissolution

Corporation vs. LLC

RECORDING KEEPING & ANNUAL MEETING

•Corporation’s recording keeping

– required to maintain records

– ex. - articles, bylaws, list of shareholders, directors, and officers

•LLC’s recording keeping

– required by some laws

– operating agreement

•Annual meeting

Corporation vs. LLC

FEDERAL COMPLIANCE REQUIREMENTS

•Securities cannot be sold to the public unless seller discloses material

information

– 1933 and 1934 acts require filings

• Form S-1

• Form 10

• Form 10-K

• Form 10-Q

• Form 8-K

• Forms 3, 4, and 5

•Sarbanes-Oxley

•Dodd-Frank

Corporation vs. LLC

RECAP

•Characteristics

•Advantages

•Formation

•Doing business in foreign states

•Owners and managers

•Compliance requirements

THE CORPORATION VS. THE LLC

The Legal Professional’s First Choice

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