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August 11, 2014

LLC Veil Piercing: Required Corporate Formalities, revisited

iStock_000014425910XSmall.jpgOne of the factors for determining when the owners of an LLC (or a corporation) may be held liable for the obligations of the business is whether the required corporate formalites have been observed. A while back, we posted an article about the required corporate formalities for Indiana limited liability companies. One of them is that each Indiana LLC must maintain certain records and must make them available to members for inspection and copying. Notably, that requirement is not a default provision that can be reduced or eliminated by the operating agreement.

Last week the LLC Law Monitor blog by Doug Batey of Stoel Rives commented on a Massacusetts case, Kosanovich v. 80 Worcester Street Associates, LLC, No. 201201 CV 001748, 2014 WL 2565959 (Mass. App. Div. May 28, 2014), that imposed liability on the sole member of a Massachusetts limited liability company primarily because of the LLC's failure to maintain records. Doug described the case (correctly, in my view) as "an outlier decision on veil-piercing" for piercing the veil based on so little.

First, a quick summary of Massachusetts veil-piercing law as described in the decison by the Appellate Division of the Boston District Court. A corporate veil may be pierced only in rare circumstances and only to defeat or remedy fraud, wrong, or injustice. Massachusetts courts weigh twelve factors, but the analysis is not merely an exercise in counting factors. The twelve factors are (1) common ownership (presumably relevant when multiple entities are involved); (2) pervasive control (which is not enough, by itself, to pierce the veil); (3) confused intermingling of business assets; (4) thin capitalization; (5) nonobservance of corporate formalities; (6) absence of corporate records; (7) no payment of dividends; (8) insolvency at the time of the litigated transaction; (9) siphoning away of corporation's funds by dominant shareholder; (10) nonfunctioning of officers and directors; (11) use of the corporation for transactions of the dominant shareholders; and (12) use of the corporation in promoting fraud.

In this case, the LLC was owned and entirely controlled by one person, a construction contractor who set up a separate LLC for each of his projects. The only record the LLC produced was a copy of the articles of organization. The owner testified that some of the records might have existed at one time but that they might have been lost when his former partner left the business. There were no tax records, no checkbook, no statements from subcontractors -- none of the records that one would ordinarily expect to be created in the ordinary course of a construction contracting business. The court upheld the trial judge's decision to hold the owner liable based on only two of the twelve factors: pervasive control (which, taken alone, would be insufficient) and the absence of corporate records.

One gets the sense that the court (and almost certainly the plaintiff's lawyer) was frustrated by the absence of records because they are also the records that, if they existed, might have served as evidence of the other veil-piercing factors and of the independent prerequisites of fraud, wrong, or injustice. Nonetheless, there was no evidence of any of the ten other factors nor evidence of fraud, wrong, or injustice. Had there been proof that the owner had destroyed records, it might have justified an inference that the records destroyed would have proven enough to pierce the veil, but there was no evidence of that, either. The evidence proved was that the owner completely neglected business records, but not that he destroyed them. As Doug stated in his blog, "The court's reliance on [the owner's] inadequate record-keeping effectively placed on his shoulders the burden to prove that he was innocent of violating any of the other 12 factors."

Would the result have been the same under Indiana law? I do not believe so, or at least I do not believe that it should, based in part on a provision of the Indiana Business Flexibility Act, the statute that governs Indiana LLCs. As mentioned in the first paragraph, the statute requires Indiana LLCs to maintain certain records and to make them available to members for inspection and copying. However, Ind. Code section 23-18-4-8(e) specifies that failure to maintain those records does not constitute grounds for holding the owners personally liable for the obligations of the LLC. Even without that provision, I do not believe Indiana courts would pierce the veil of an Indiana LLC under similar circumstances, but I think that provision forecloses any possibility of the owner of an Indiana LLC (sole owner or otherwise) being held liable just because the LLC does not maintain the required records.

As Doug also pointed out, lawyers (including this one) advise their business clients to observe formalities of running a business and to maintain good records, including those required by the Indiana Business Flexibility Act, and this case, even if it is an outlier, and even if an Indiana court would not reach the same result, is an example of a business owner who paid a price for not doing so.

Continue reading "LLC Veil Piercing: Required Corporate Formalities, revisited" »

July 28, 2014

LLCs and Apparent Authority II

iStock_000007115543Small.jpgLast week I posted an article about apparent authority of a member or manager of an Indiana limited liability companies to bind the LLC, usually by signing a contract on behalf of the company, including a discussion of a 2013 decision of the Indiana Court of Appeals, Cain Family Farms vs. Shrader Real Estate & Auction, addressing the common law doctrine of apparent authority and the provisions of the Indiana Business Flexibility Act that bestow apparent authority on members and managers. Under the facts presented by the record, the court held that apparent authority existed and, in particular, "Whether we consider the question of apparent authority under the common law or the
Indiana Business Flexibility Act, the outcome is the same."

As discussed in last week's Indiana Business Law Blog post, one can imagine situations in which the statute would establish apparent authority but the common law analysis would not, and vice versa. It seems clear that a member or manager has authority to bind a limited liability company if the Indiana Business Flexibility Act says so, even if the member or manager would not have apparent authority under the common law analysis. But what if it's the other way around? Will an Indiana court enforce a contract signed by a member or manager on behalf of the LLC if the member or manager would have apparent authority under the common law but not under the Indiana Business Flexibility Act? Although the Cain Family Farm decision does directly address that question, the Court of Appeals appears to treat the two bases of apparent authority as independently viable, implying that Indiana courts will recognize the apparent authority of a member or manager under the common law even if apparent authority does not exist under the Indiana Business Flexibility Act.

Since I posted the article last week, I've corresponded with my friend John Cunningham, a New Hampshire attorney, a recognized expert on LLCs, a blogger, and co-author of Drafting Limited Liability Company Operating Agreements, my go-to reference for LLC law and operating agreements. I asked John about the question, and he pointed me to the official commentary of the Revised Uniform Limited Liability Company Act, which discusses why the RULLCA leaves the issue of apparent authority of members to the common law. See RULLCA Section 301.

After reflecting on my correspondence with John and reading the commentary to the RULLCA, I've come to believe that the path on which the Court of Appeals appears to have placed Indiana law is a good one. Note that question of apparent authority is irrelevant if the member or manager has actual authority to bind the company, and it cannot be used by another party to avoid a contract with a limited liability company over the LLCs objection. (If nothing else, the LLC can always ratify the contract.) The question arises only when an LLC tries to avoid a contract signed by a member or manager in the absence of actual authority, and the question is, who suffers the consequences -- the LLC or the other party? Although the Indiana Business Flexibility Act creates some areas of relative certainty (which I believe is superior to the intentional silence of the RULLCA), it also denies apparent authority under some circumstances in which the other party to the contract reasonably believes, based on the conduct of the LLC, that the member or manager is acting within his or her authority.

In my personal view, it is better public policy to err on the side of enforcing contracts in those situations by maintaining the common law doctrine as a viable basis for apparent authority, independent of the statutory basis. First, the LLC is in the best position to control the actions of its members or managers, and the operating agreement can provide a remedy when one of them misbehaves. Second, the LLC is also in the best position to control its own actions and to avoid conduct that cloaks its representatives with apparent authority when they lack actual authority. Third, to fail to enforce a contract that the other party entered into in good faith, based on a reasonable belief that the member or manager had authority to bind the company (or to require prospective counterparties to consult the public record before signing a contract with a limited liability company) could cause others to be overly cautious, even leery, of doing business with LLCs.

Whether Indiana courts agree with this analysis remains to be seen.

Continue reading "LLCs and Apparent Authority II" »

July 24, 2014

LLCs and Apparent Authority

iStock_000007115543Small.jpgWhether a particular person has the authority to execute a contract on behalf of another person or entity is a standard question of agency law. If the principal has expressly or impliedly authorized an agent to execute contracts on behalf of the principal, the agent is said to have actual authority. However, a person who does not have actual authority can nonetheless bind the principal if that person has apparent authority.

Common Law Standard for Apparent Authority

The common law analysis of apparent authority is well established. An agent has apparent authority when a third person reasonably believes, based on the conduct of the principal, that the agent has authority. The reason for the belief need not be an actual statement by the prinicipal but can be (and usually is) found in the circumstances in which the prinicipal places the agent, but it is essential that the third party's belief is based on the conduct of the principal; the statements or actions of the agent cannot create apparent authority. Moreover, if the third person knows that the agent has no actual authority, apparent authority does not exist.

Apparent Authority under the Indiana Business Flexibility Act

The Indiana Business Flexibility Act (Article 23-18 of the Indiana Code) contains different rules for the authority of members and managers of limited liability companies, and the rules are slightly different for LLCs formed on or before June 30, 1999 (Section 23-18-3-1), and LLCs formed after that date (Section 23-18-3-1.1).

If the LLC's articles of organization do not provide for managers (i.e., a member-managed LLC), each member is an agent of the LLC for the purpose of the LLC's business and affairs. Accordingly, the act of any member for those purposes, including the execution of a contract, binds the LLC, subject to the following exceptions:


  1. The member does not have actual authority and the person with whom the member is dealing knows that the member does not have actual authority.

  2. The act is not apparently for the purpose of carrying on the LLC's business and affairs in the usual manner, unless the member has been granted actual authority by the operating agreement or by unanimous consent of the members.

  3. For LLCs formed after June 30, 1999, the articles of organization provide that the member does not have the authority to bind the company.

If the LLC's articles of organizations provide for managers, a member acting solely in the capacity of a member is not an agent of the LLC and does not have authority to bind the LLC, except to the extent provided by the articles of organization. Instead, each manager is an agent of the company and has authority to bind the LLC, subject to the following exceptions:


  1. The manager does not have actual authority and the person with whom the manager is dealing knows that the manager does not have actual authority.

  2. The act is not apparently for the purpose of carrying on the LLC's business and affairs in the usual manner, unless the manager has been granted actual authority by the operating agreement or by unanimous consent of the members..

  3. For LLCs formed after June 30, 1999, the articles of organization provide that the manager does not have the authority to bind the company.

Although Sections 3-1 and 3-1.1 of the Indiana Business Flexibility Act speak only of authority and agency, not of apparent authority and apparent agency, it seems clear that those sections deal with apparent authority and that actual authority of managers and members is addressed elsewhere, in Section 23-18-4-1. Indeed, the only Indiana decision to address Section 3-1.1, Cain Family Farm, L.P. vs. Schrader Real Estate & Auction Company, describes that section as a source of apparent authority and not actual authority.

Comparison of Common Law and Statutory Bases for Apparent Authority

The following table summarizes the main differences between the common law basis of apparent authority and the statutory basis.

Common law analysis of apparent authority

Apparent authority of members and managers under Indiana Business Flexibility Act

Applies to any agent of the company.

Applies only to members or managers.

Apparent authority created by conduct of the company.

Apparent authority created by the articles of organization; no other conduct necessary.

The person with whom the member or manager is dealing must have a reasonable belief that the member or manager has authority based on the company's conduct.

As long as the person with whom the member or manager is dealing does not have actual knowledge that the member or manager lacks authority, that person's subjective belief is irrelevant.

No exception for acts outside the usual course of business

No authority for acts outside the apparent usual way the company does business, unless the authority is granted by the operating agreement or by unanimous consent of the members.


When we're dealing with managers of an LLC or with members in a member-managed LLC, the statute confers authority more broadly than the common law because no other conduct on the part of the LLC is necessary. However, the statutory exceptions are also broader because the common law contains no exception for acts outside the usual way the LLC does business. In addition, the statute denies authority to members of a manager-managed LLC (except to the extent the articles of organization confer authority) but the common law analysis treats the members of a manager-managed LLC no differently than any other agent. In other words, it is possible for a manager or member to have apparent authority under the statute but not under the common law, and vice versa. What happens then?

One possibility is that the statute is now the exclusive source of apparent authority for members and managers of LLCs. That would not appear to cause any problems when the statute confers apparent authority more broadly than the common law standard, but what about situations that fall into one of the broader statutory exceptions, for example when the member of a manager-managed LLC takes an action that a third party would reasonably believe, based on the conduct of the LLC, the member was authorized to take? Does the statute abrogate the common law in that situation?

It appears that it does not. In the Cain Family Farms decision mentioned above, the Court of Appeals considered the apparent authority of a member to bind a member-managed LLC. In doing so, the Court of Appeals analyzed the member's authority under both the common law and the Indiana Business Flexibility Act. Perhaps because the Court found that apparent authority existed under both analyses, it did not expressly decide which one would control in the event of a conflict. Nonetheless, the implication seems to be that both sources of apparent authority remain viable and that the LLC will be bound by the actions of a member or manager if either the common law or the Indiana Business Flexibilty Act impute that authority to the member or manager.

Continue reading "LLCs and Apparent Authority" »

June 2, 2014

Family Businesses: Succession planning for LLCs

iStock_000017700348Small.jpgOwners of Indiana LLCs (and their lawyers) can learn some lessons from a recent case involving an Alabama LLC. The case is L.B. Whitfield, III Family LLC v. Virginia Ann Whitfield, et al.

The Whitfield Case

L.B. Whitfield, III owned half of the voting stock in a business that had been in his family for generations. The other half had belonged to L.B.'s brother, who died and left the stock to a trust for the benefit of his son.

L.B. had four children, his son Louie, and three daughters. After his brother's death, L.B. became concerned that the 50/50 voting balance might be disturbed if, after he died, his stock were to be divided among his four children. To prevent that from happening, L.B. created a manager-managed Alabama limited liability company to hold his half of the voting stock. L.B. was the sole member, and he and Louie were the two managers. His will provided that his interest in the LLC would pass to his four children in four equal shares.

After L.B. died, Louie continued as manager, and the four children were treated as members of the LLC, with each of them holding 25% of the interest in the LLC. About 10 years later, a dispute arose between Louie and his sisters, and the dispute escalated into litigation. Ultimately, the litigation was resolved on a theory that was not argued in the original pleadings and apparently did not even occur to the parties' lawyers until several months into the case.

The Alabama Supreme Court noted that L.B. had been the sole member of the LLC and that, after he died, the LLC had no members. His will gave them equal shares of his econimic rights in the LLC (his "interest"), but economic rights in an LLC and membership are two different things. The Court further noted that, under the Alabama LLC statute, a limited liability company that has no members is dissolved and its affairs must be wound up, a process which includes payment of its debt and distribution of its remaining assets to the holders of interest in the LLC (who are not necessarily members). Accordingly, the Court held that the assets of the LLC should be distributed in four equal shares to Louie and his sisters.

Interestingly, the Alabama statute provides a way that L.B.'s heirs could have become members and avoided the dissolution of the LLC, but they had to do it by mutual written agreement within 90 days of L.B.'s death, and there was no such written agreement.

How does it work in Indiana?

If the Whitfield case had involved an Indiana LLC, the results might well have been the same. Unless other provisions (discussed below) have been made to avoid the result, when the single member of an LLC dies, that member will be dissociated (i.e., will cease to be a member, Ind. Code 23-18-6-5(a)(4)), the LLC will have no members, and, as a result, it will be dissolved, at least if the LLC was formed after June 30, 1999, (Ind. Code 23-18-9-1.1(c)). As a result, the member's heirs will not receive an ongoing business; instead, they will receive only the rights to receive distributions from the dissolved LLC after all obligations are satisfied -- which may be far less valuable than the business would have been as an ongoing concern.

Note that there are other scenarios that can create a similar result. Under Ind. Code 23-18-6-4.1(e) (which applies only to LLC's formed after June 30, 1999), a member who assigns her entire interest to another person ceases to be a member. If the person making the assignment is the sole member, the person who receives the interest can become a member under Ind. Code 23-18-6-4.1(b), which provides that the person who receives the interest can become a member "in accordance with the terms of an agreement between the assignor and the assignee." But what if there are no such terms? What if the agreement simply says, "Seller hereby assigns her interest in the LLC to Buyer," but doesn't mention membership? In that case (unless the operating agreement already deals with the situation some other way), the LLC will have no members, and it will be dissolved. In other words, the person who thought he bought an ongoing business may well have bought only the rights to receive distributions from a dissolved LLC.

Now, what if there are multiple members and one of them dies? In that case, the LLC is not dissolved, at least not if it was formed after June 30, 1999, but the member's heirs may not become members. Although they may inherit the deceased member's interest (i.e., rights to receive distributions), they will become members (and therefore have the right to participate in the management of the company), only if the operating agreement makes some other provisons or the other members unanimously consent.

What should you do?

If you own an LLC, or if you own part of an LLC, and these possibilities make you uncomfortable, you need a business succession plan that includes two different components. First, it should include appropriate estate planning tools to make sure that your economic interest in the LLC goes to the people you want to taken care of after your death. For example, you may want to designate a transfer-on-death beneficiary to your interest in the LLC. Second, the LLC should have an operating agreement with appropriate provisions to ensure that your heirs benefit not only from the right to receive distributions from the LLC but also the right to participate in its management, along with other rights of membership. There are different ways to do that; an attorney with experience in business succession planning, particularly with Indiana LLCs, can help you choose the best one for you.

Continue reading "Family Businesses: Succession planning for LLCs" »

April 5, 2014

Indiana Limited Liablity Companies and the Required Formalities

iStock_000034659194Small.jpgA primary reason to organize a business as a corporation or a limited liability company (LLC) is to protect the owners from personal liability for the debts of the business. Sometimes, however, a court may "pierce the corporate veil" of a business to hold the owners of the business personally liable for the company's obligations.

In deciding whether to pierce the corporate veil, Indiana courts examine and weigh several factors, including whether the owners of the business have observed the required formalities for the particular form of organization. One of the reasons we generally favor LLCs for small businesses is that there are fewer required formalities for LLCs than for corporations, which in turn means that there is not only a lower administrative burden associated with LLCs, but also fewer opportunities for business owners to miss something. However, there are a few requirements, discussed below.

1. An Indiana LLC must have written articles of organization, and the articles must be filed with the Indiana Secretary of State .

There's almost no need to mention this one because an LLC does not even exist until its articles of organization are filed with the Secretary of State, but for the sake of being complete . . .

The articles of organization must state:

  • The name of the LLC, which must include "limited liability company," "LLC," or "L.L.C."
  • The name of the LLC's registered agent and the address of its registered office (discussed in more detail below).
  • Either that the LLC will last in perpetuity or the events upon which the LLC will be dissolved.
  • Whether the LLC will be managed by its members or by managers. (Technically, the articles can remain silent on this point, in which case the LLC will be managed by its members, but the Secretary of State's forms call for a statement one way or the other.)

2. An Indiana LLC must have a registered agent and a registered office within the State of Indiana.

The purpose of this requirement is to give people who sue the LLC a way to serve the complaints and summons. The registered office must be located within Indiana, and it must have a street address. A post office box is not sufficient. The registered agent must be an individual, a corporation, an LLC, or a non-profit corporation whose business address is the same as the registered office's address.

The registered office and registered agent must be identified in the articles of incorporation and in the business entity reports (discussed below) filed every other year with the Indiana Secretary of State, but the requirement to have a registered office and registered agent applies all the time, not just when those filings are made. If the LLC's registered agent resigns, the LLC must name a new one and file a notice with the Secretary of State within 60 days.

In addition, LLCs formed after July 1, 2014, are required to file the registered agent's written consent to serve as registered agent or a representation that the registered agent has consented. That new requirement was established by Senate Bill 377, passed by the 2014 General Assembly and signed into law by the governor.

3. An Indiana LLC must keep its registered agent informed of the name, business address, and business telephone number of a natural person who is authorized to receive communications from the registered agent.

This is another new requirement contained in Senate Bill 377. It takes effect on July 1, 2014.

4. An Indiana LLC must maintain certain records at its principal place of business.

The required records are:

• A list of the names and addresses of current and former members and managers of the LCC.
• A copy of the articles of organization and all amendments.
• Copies of the LLC's tax returns and financial statements for the three most recent years (or, if no tax returns or statements were prepared, copies of the information that was or should have been supplied to the members so they could file their tax returns).
• Copies of any written operating agreements and amendments, including those no longer in effect.
• A statement of all capital contributions made by all members.
• A statement of the events upon which members will be required to make additional capital contributions.
• The events, if any, upon which the LLC would be dissolved.
• Any other records required by the operating agreement.

[Note: Ind. Code 23-18-4-8(e) provides that the failure to keep the above records is NOT grounds for imposing personal liability on members for the obligations of the LLC. It's more likely to become an issue in the event of a dispute among the members. Thanks to Josh Hollingsworth of Barnes & Thornburg for reminding me. MS:4/7/2014].

5. An Indiana LLC must file a business entity report with the Secretary of State every two years.

The report is due at the end of the month that contains an even-numbered anniversary of the filing of the articles of organization. Failure to file the report within 60 days of the due date is grounds for administrative dissolution of the LLC.

Continue reading "Indiana Limited Liablity Companies and the Required Formalities" »

March 25, 2014

The Difference Between Tax Status and Legal Form of a Business or Nonprofit

iStock_000005953904Small.jpgI just read a report by the Small Business Administation that includes a wealth of statistics and other information about small businesses in the United States. As useful as the report is, it contains a mistake that, although commonly made, one would not expect from the SBA. The last item in the report asks the question, "What legal form are small businesses?" That's a good question, but the SBA didn't answer it. Instead, it answered another question, "What is the tax status of small business?" Even though the two questions are related, they are nonetheless distinct, and answering the second question does not answer the first.

Legal Form of a Business or Nonprofit

As we've discussed before, businesses are commonly organized according to one of a handful of legal forms: sole proprietorships, general partnerships, corporations, and limited liability companies. There are a few others used less frequently, including limited partnerships, limited liability partnerships, and professional corporations. Tax exempt organizations are commonly organized as nonprofit corporations, but they can also be organized as unincorporated associations, charitable trusts, and sometimes limited liability companies.

The legal form of a business or tax exempt organization is primarily related to two fundamental attributes: who controls the organization, and who is liable for the organization's obligations. For example, if a business is structured as a general partnership, the partners collectively control the business and the partners are individually liable for the obligations of the partnership. In contrast, if a business is structured as a corporation, it is probably controlled by a board of directors, elected by the shareholders and acting through the officers. Unless something goes wrong, neither the shareholders, the directors, nor the officers are liable for the corporaton's obligations.

Tax Categories

Although selecting the legal form of an organization determines the attributes of control and liability, it does not determine how much income tax the organization must pay. There are four common possibilities of tax status for businesses and nonprofit organizations, categorized by the applicable subchapter of Chapter 1 of Subtitle A of Title 26 of the United States Code (also known as the Internal Revenue Code): Subchapter C (the default provisions for corporations), Subchapter S (which is an alternative to Subchapter C that can be elected by small business corporations that meet the eligibility criteria), Subchapter K (for partnerships), and Subchapter F (for tax exempt organizations). Finally, some types of legal forms that have a single owner, such as sole proprietorships, are diregarded for income tax purposes, with their income reported on the owner's income tax return. Those businesses or nonprofit organizations are known as, appropriately enough, "disregarded entities."

Each of these tax categories can apply to more than one type of legal form of organization, and with two exceptions (sole proprietorships and general partnerships), each legal form has more than one possibility for the tax category, as shown in the chart below. Even nonprofit corporations have more than one possibility; while most nonprofit corporations are organized with the intent of qualifying for Subchapter F (exempt organizations), if a nonprofit corporation fails to meet the criteria for tax exemption, it will be subject to taxation under Subchapter C.

Thumbnail image for Legal Form Tax Status Table cropped.jpg

Now you won't make the same mistake that the SBA made.


Continue reading "The Difference Between Tax Status and Legal Form of a Business or Nonprofit" »

July 30, 2013

Positive Change in Indiana LLC Laws - Part Two: Even More Flexibility in Management Structure

100_3698.JPGEarlier this year the General Assembly passed HEA 1394 which made several changes to the Indiana Business Flexibility Act, the statute that governs limited liability companies. We have already looked at some changes to the Act that enhance the use of Indiana LLCs for estate planning purposes. This article discusses new alternatives for LLC management structure.

The Indiana Business Flexibility Act already provided for a great deal of flexibility for management structure. One of the key steps in designing the management structure of a limited liability company is to establish who has the apparent authority to bind the company, for example by signing contracts on behalf of the LLC. Prior to the changes there were essentially two choices. In a member-managed LLC, the members have that authority. In a manager-managed LLC, the members appoint managers (who may or may not also be members) who have that authority.

HEA 1394 provides a third choice -- officers, who may or may not be members. At first blush, there may seem to be little difference between officers and managers because, like the managers in a manager-managed LLC, officers have the apparent authority to bind the LLC to third party agreements. But there is at least one important difference: In a manager-managed LLC, only the managers, and not the members, have the apparent authority to bind the company. The new revisions allow the members of an LLC to establish officers who have the apparent authority to bind the company, while also retaining that authority themselves. In fact, a manager-managed LLC can also have officers. In that case, both the managers and the officers, but not the members, have apparent authority to bind the LLC.

HEA 1394 includes other changes to the statute that enhance the alternatives for LLC governance. For example, the Act now permits the operating agreement to make certain significant decisions, including mergers, dissolutions, and amendments to the operating agreement, subject to the approval of a third party who need not be a member.

One context in which such provisions may prove useful is in estate planning. Imagine the founder of a business, held by a limited liability company, with multiple heirs, who wants the business to remain in the family. Although the operating agreement may create significant restrictions on transfers of membership interests and admission of new members, the heirs could later agree to amend the operating agreement to remove those restrictions. The Act now allows the operating agreement to name a trusted outside party who must approve any amendments to the operating agreement, thus increasing the likelihood that the founder's desires will be honored.

Continue reading "Positive Change in Indiana LLC Laws - Part Two: Even More Flexibility in Management Structure" »

July 1, 2013

Positive Changes to Indiana LLC Law - Part One: Estate Planning

100_3698.JPGEarlier this year the Indiana General Assembly passed House Enrolled Act 1394, which takes effect today, July 1, and makes several amendments to the Indiana LLC statute, officially known as the Indiana Business Flexibility Act. This is the first of two articles discussing those changes. This first article addresses some amendments that should enhance the use of LLCs for estate planning purposes, and the second will discuss changes that expressly address the use of officers in the management of limited liability companies.

Permissible Purposes for LLCs
With the new amendments, Section 6 of the Indiana Business Flexibility Act now explicitly states that LLCs may be used not only for business purposes but also for personal and nonprofit purposes. For an example of a personal purpose, a married couple who own a vacation cabin and want it to remain in the family after they are gone might place the cabin in a limited liability company and then, by gift, by will, or by other means, transfer the ownership of the LLC to their children or grandchildren. Because the cabin is not used to generate income, the purpose of the LLC is personal, not business.

Although the circumstances in which the IRS will grant an LLC recognition of tax-exempt status under Section 501(c)(3) are limited, the change to the Indiana Business Flexibility Act confirms that Indiana LLCs may be used for those purposes.

It is debatable whether the amendment actually expands the purposes for which an LLC may be used because the prior language was in fact quite broad; however the new language reduces the uncertainty behind permissible purposes by expressly authorizing personal and nonprofit purposes.

Transferring LLC Interests to Heirs
There are two other changes that should increase the use of LLCs for estate planning, both to Section 10 of the Indiana Business Flexibility Act. One of the changes expressly permits LLC interests to be held in what is known as "joint tenancy with right of survivorship" or simply a "joint tenancy." A joint tenancy involves two or more people who both own property but with one key difference from other forms of common ownership: the right, upon death of one of the tenants, for the remaining tenant(s) to take the entire property as an undivided whole. In a simple scenario, two spouses own a home as joint tenants - when one dies, the other takes title to the entire home -- without going through the sometimes costly probate process.

The other change expressly permits LLC interests to be held as Transfer-upon-death property. This simply means that upon the holder's death the member interest can pass to one or more named beneficiaries, again without having to go through probate. However, unlike joint tenancy, the beneficiary does not own any interest in the property until the death of the original owner.

Estate Planning with the New Amendments
Historically, a corporation was the standard entity of choice for businesses, and limited partnerships have been one of the frequently used tools of estate ploanning. In recent years, however, LLC's have overtaken corporations in popularity for businesses. With changes such as the ones to the Indiana Business Flexibility Act, LLCs may also replace limited partnerships in popularity for estate plans.

Continue reading "Positive Changes to Indiana LLC Law - Part One: Estate Planning" »

May 29, 2013

Seminar: What Estate Planners Need to Know About LLC Formation

On June 26, 2013, from 11:00 am until 12:30 pm EDT, I'll be teaching a National Business Institute teleconference seminar, "What Estate Planners Need to Know About LLC Formation."

Limited liability companies are incorporated more and more frequently into estate plans. A common structure is a limited liability company owned by a living trust, with a business or other assets held by the LLC. The living trust provides the mechanism for the business or other assets to be passed to the grantor's heirs without going through probate, and the LLC provides a liability shield to protect the grantor's other assets from creditors with a claim against the LLC. Another common estate planning tool is a family limited partnership, and a limited liability company can often be used to serve the same purposes while providing additional advantages.

The seminar is designed (surprise!) for estate planners who want to know more about the issues associated with creating and setting up LLCs. Click here to register for the seminar.

Continue reading "Seminar: What Estate Planners Need to Know About LLC Formation" »

February 8, 2013

Proposed Changes to Indiana LLC Statute Part 2: Charging Order Protection

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UPDATE, February 19, 2013.
Yesterday, the House Judiciary Committee amended HB1394 to remove the language discussed in this blog post -- the changes to IC 23-18-6-7 that would have expressly provided that a charging order is the only right that the creditor of an LLC member has with respect to the LLC. It appears that Indiana will remain in the fourth category of states listed in the article -- those in which there is no reverse veil piercing for multi-member LLCs, with the issue remaining unsettled with respect to single member LLCs. The most recent version of the bill is available here.


In my last post, I discussed HB 1394, a bill pending in the Indiana General Assembly that would make several amendments to the statute that governs Indiana limited liability companies. One of the most important changes is to strengthen the so-called "charging order" protection, which I'll describe shortly after a brief review of some attributes of LLCs and corporations.

Recall that corporations and LLCs both have liability shields that protect the owners of the company (for a corporation, the shareholders; for a limited liability company, the members) from being personally liable for the company's obligations. That liability shield (whether it's for a corporation or LLC) is sometimes called a corporate veil, and in some circumstances courts will ignore the shield, or pierce the corporate veil, to allow creditors of the business to reach the personal assets of the owners. I've previously discussed precautions that LLC members can take to keep that from happening.

When a court allows a creditor of the business to reach the personal assets of the owners, it's sometimes called "inside-out veil piercing," which implies there might be something else called "outside-in veil piercing." And there is.

Consider what happens when a shareholder of a corporation owes money to a creditor. The shareholder's stock is just like any other asset, like a bank account, a house, or a car. And just like any other asset (well, most other assets), the stock is subject to foreclosure, which effectively means the creditor takes over ownership. The creditor, now the new shareholder, receives all the rights associated with the stock, including the economic rights (i.e., the right to receive dividends, if there are any) and the non-economic rights (including the right to vote in elections of the board of directors). That's called "outside-in veil piercing" or sometimes "reverse veil piercing." If the creditor takes over enough shares of stock, he or she can gain control of the company. Even if the creditor does not gain control of the company, the other shareholders may suddenly find themselves co-owners with someone they don't even know, maybe even with someone they despise. For large, publicly traded companies with millions of shareholders, that's no big deal. For family businesses or other businesses with only a few shareholders, it can be a very big deal.

The area of reverse veil piercing is one in which LLCs differ tremendously from corporations, at least in some states, and it is one of the reasons that I advise clients to set up LLC's far more often than I advise them to set up corporations. When it comes to the rights of a member's creditors, many states, including Indiana, treat the member's economic rights and non-economic rights separately. For example, IC 23-18-6-7 allows a court to issue an order requiring a limited liability company to pay to a member's creditors anything that the LLC would otherwise be required to pay to the member. That's called a charging order, and it's something like an order for the garnishment of wages, applied to a member's right to receive LLC distributions.

The question is whether a charging order is the only remedy a creditor has against the member's rights. If so, there is no reverse veil piercing, and a member's creditors cannot take over control of the business or gain a seat at the table with the other members. I believe there are currently five categories of states:

  1. Those in which reverse veil piercing is not allowed for LLCs.
  2. Those in which reverse veil piercing is allowed for single-member LLCs but not for multi-member LLCs.
  3. Those in which reverse veil piercing is allowed for both single-member LLCs and multi-member LLCs (essentially treating LLCs the same as corporations).
  4. Those in which there is no reverse veil piercing for multi-member LLCs but for which the law is unresolved for single-member LLCs.
  5. Those in which the law is unresolved for reverse veil piercing both single-member and multi-member LLCs.

Until fairly recently, Indiana was in the fourth group of states. As I've discussed elsewhere, a 2005 decision of the Indiana Court of Appeals, Brant v. Krilich, held that there is no reverse veil-piercing for multi-member LLCs, but apparently leaving the question open for single-member LLCs.

HB 1394 would add a provision to IC 23-18-6-7 expressly stating that a charging order is the exclusive remedy for a judgment creditor of a member and that the creditor has no right to foreclose on the member's interest. Because the bill makes no distinction between single-member and multi-member LLCs, it appears that HB 1394 would place Indiana in the first category of states -- those for which reverse veil piercing is not allowed for either single-member or multi-member LLCs.

Continue reading "Proposed Changes to Indiana LLC Statute Part 2: Charging Order Protection" »

January 29, 2013

Proposed Changes to Indiana LLC Statute

100_3698.JPGStatutes governing limited liability companies, or LLCs, vary considerably from state to state. In our opinion, Indiana's statute is already among the best in the country, and a bill introduced in the 2013 session of the Indiana General Assembly proposes several changes that would make it even better for small business owners, particularly family-owned businesses. Among other things, HB 1394, introduced by Rep. Greg Steuerwald (R Avon) would:

Later posts will discuss these proposed changes in more detail, including a few suggestions for possible revisions to the bill that would make it even better. In the meantime, however, small business owners in Indiana may want to contact their state representatives and senators urging them to support HB 1394.

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January 28, 2013

Letter About Annual Minutes is a Scam -- but Notice About Business Entity Reports is Not!

iStock_000011065644XSmall.jpgThe Indiana Secretary of State has issued a warning about a deceptive letter being received by some Indiana businesses. The letter asks for a fee -- typically $125 or $150 -- to cover the processing of the minutes of a corporation's annual meeting. It is designed to appear as if it is from a state agency, the "Indiana Corporate Compliance Business Division," and it includes a citation to a fictitious law. In fact, it is not from a state agency, and there is no requirement to pay any such fees to the state.

If you receive a letter like the one described above, ignore it. If you have already responded to a letter like this, you may contact the Business Services Division of the Indiana Secretary of State's office at (317) 232-6576.

However, if you receive a letter from the Indiana Secretary of State's office informing you that a business entity report is due by the end of the following month, DO NOT IGNORE IT!

Indiana business corporations and limited liability companies are required to submit a business entity report every two years during the month of the anniversary of the filing of the articles of incorporation or articles of organization. For example, if your articles of incorporation or articles of organization were filed in April of an even-numbered year, a business entity report is due in April of every even-numbered year.

Indiana nonprofit corporations are required to file business entity reports (even though a nonprofit corporation is not usually considered to be a "business") every year in the month of the anniversary of the filing of the articles of incorporation. If the articles of incorporation of your nonprofit were filed in August, a business entity report is due every August.

Business entity reports may be filed on paper or online. The filing fee for business corporations and limited liability companies is $30, and the fee for nonprofits is $10. In both instances, modest discounts are given for filing online.

The Secretary of State's office sends out reminder notices near the end of the month before your business entity report is due, but do not rely on those letters as your only reminder. Because the reports are due even if you do not receive the letter, you should make sure the report is placed on your compliance calendar.

If your organization does not file its business entity reports on time, it is subject to administrative dissolution by the Secretary of State. If that happens, it is possible to have your corporation or LLC reinstated, but the process can be time consuming. It's far better to stay in compliance to begin with.

Continue reading "Letter About Annual Minutes is a Scam -- but Notice About Business Entity Reports is Not!" »

March 7, 2011

Just what IS a limited liability company? Part 7. It's a bundle of tax choices.

[This is the last of a seven-part series of posts discussing the characteristics of limited liability companies and comparing them to the characteristics of corporations, general partnerships, and sole proprietorships. Here's the entire list.

Part 1. Background on sole proprietorships.
Part 2. Background on partnerships.
Part 3. Background on corporations.
Part 4. LLCs are distinct legal entities, separate from their owners.
Part 5. A limited liability company's owners are not liable for the LLC's obligations.
Part 6. Options for an LLC's management structure.
Part 7. Options for an LLC's tax treatment.]

iStock_000007266907XSmall.jpgIn prior posts, I've discussed several characteristics of LLCs. First, like corporations, LLCs are entities separate from their owners. Second, also like corporations, the owners are not liable for the obliigations of the LLC. Third, they offer choices of management structures: They can be managed directly by the owners, like sole proprietorships and many partnerships, or they can be managed by others who are selected by the owners, in much the same way that shareholders of a corporation elect directors to run the business. This last post of the series looks at the tax characteristics of LLCs.

Interestingly, LLCs do not have a specific category in the Internal Revenue Code or the Tax Regulations. Instead, their tax treatment is governed by the so-called "check-the-box regulation." It provides that the LLC may elect to be treated in one of several ways, and the choices depend on whether the LLC has one member or more than one member.

The default status for a single-member LLC is that it is a "disregarded entity" in that all the income and expenses go directly on the member's personal tax return, just like a sole proprietorship. The LLC itself doesn't even have to file a tax return. The default status for a multi-member LLC is to be taxed as if it were a partnership. Alternatively, either a single-member LLC or a multi-member LLC can elect to be taxed as if it were a corporation, either as a Subchapter C corporation or, if the LLC meets certain criteria, as a Subchapter S corporation. To decide which is the best tax strategy for your LLC, you should consult both your lawyer and your accountant.

Continue reading "Just what IS a limited liability company? Part 7. It's a bundle of tax choices." »

February 20, 2011

Just what IS a limited liability company? Part 6. It offers choices of management structure.

[This is the sixth post in a seven-part series discussing the characteristics of limited liability companies and comparing them to the characteristics of corporations, general partnerships, and sole proprietorships. Here's the entire list.

Part 1. Background on sole proprietorships.
Part 2. Background on partnerships.
Part 3. Background on corporations.
Part 4. LLCs are distinct legal entities, separate from their owners.
Part 5. A limited liability company's owners are not liable for the LLC's obligations.
Part 6. Options for an LLC's management structure.
Part 7. Options for an LLC's tax treatment.]

Thumbnail image for Thumbnail image for Thumbnail image for Thumbnail image for Thumbnail image for Thumbnail image for iStock_000008153479XSmall.jpgPrevious posts discussed the management structures of the three classic business entities that we're using as a framework for discussing limited liability companies and, in particular, exactly who is responsible for running the business day-to-day.

Sole Proprietorships. Remember Drucker's General Store, the example I used to illustrate sole proprietorships? Sam Drucker ran his own store on a day-to-day basis. In fact, I'm not sure Sam even had any employees. That's the prototypical management structure for a sole proprietorship -- the proprietor himself or herself runs the business on a day-to-day basis.

Corporations. Once again, corporations are at the opposite end of the spectrum from sole proprietorships. As discussed earlier,the owners of a corporation (i.e., the shareholders), have no role in the day-to-day operation of the business. Instead, their role is limited to electing a board of directors who, in turn, usually delegate responsibility to officers and employees of the company. Of course, in a closely held company, it's very common for the owners, acting as shareholders, to elect themselves as directors and then to appoint themselves as officers.

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General Partnerships. The management structure of general partnerships varies a bit more, but usually the day to day affairs are managed by the partners themselves -- by all of the partners, or by a management committee composed of partners, or by a single managing partner.

Limited Liability Companies. Fundamentally, there are two different ways limited liability companies can be managed -- by the members themselves or by one or more managers, who are appointed by the members. In other words, a limited liability company has the flexibility to be managed like a sole proprietorship and many partnerships are managed -- by the owners of the business themselves. However, it's also possible for the owners to be relatively far removed from the day-to-day operation of the company, with a role largely restricted to appointing one or more managers to operate the LLC. Note, however, that the members of a manager-managed LLC are free to name one or more of their own as manager(s).

Even a single-member LLC has the same choices of management by the members or management by managers. A few days ago, in explaining why a single-member LLC needs an operating agreement, I touched on some of the reasons that the sole owner of a limited liability company might choose to make their LLC manager-managed.

So one of the advantages of a limited liability company is that it offers choices for management structure. Next we'll see that a limited liability company offers choices for tax treatment as well.

Continue reading "Just what IS a limited liability company? Part 6. It offers choices of management structure." »

February 18, 2011

Why should a single-member LLC have an operating agreement?

Thumbnail image for 1065245_79106935.jpgUnder current Indiana law, you can easily start up a limited liability company (LLC) with a credit card and an internet connection. After making a quick trip to the Indiana Secretary of State's website, submitting articles of organization, and paying a fee you could have your very own LLC in about fifteen minutes. But what about creating an operating agreement for your LLC? Nothing about that process requires -- or even mentions -- an operating agreement. Strictly speaking, it's not legally required, and if the LLC has only one member, an operating agreement may even seem pointless. Nonetheless, I advise all my clients with LLCs -- even single-member LLCs -- to have operating agreements.

The reason the Indiana Business Flexibility Act does not require an operating agreement is that it contains default rules that govern the LLC if there is no operating agreement (or if there is an operating agreement but it doesn't address every issue). However, those default rules may or may not be what you want. Having an operating agreement created specifically for the needs and goals of your single-member LLC can help sort out which aspects of the Indiana Business Flexibility Act will apply to your LLC and which will be overridden.

A particular reason that I think single-member LLCs should have an operating agreement flows from the fact that I think most single-member LLCs (at least those owned by individuals rather than by another business entity) should be manager-managed rather than member-managed. Imagine you are the sole member of your own LLC, and it is member-managed. That means that you, and only you, have the authority to take actions on behalf of the LLC. Now imagine that you are in a serious accident and unable to manage your business for an extended period of time. There is no one who can step into your shoes and run the business in your absence.

However, imagine that you set the business up as a manager-managed LLC. You can name yourself as the manager and some other trusted person, such as your spouse, as the assistant manager who has the authority to step in and run the LLC if you are not able to. To do that, you'll need an operating agreement that describes the authority of the other person to run the business when you can't.

It's also likely that third parties, such as banks and the IRS, will want to know various details about how the LLC is organized. An operating agreement includes information like who has the authority to sign contracts for the LLC, the LLC's tax status, and other legally meaningful information. Being able to hand a third party a single document that clearly lays out all of the legally significant details about the LLC can save a lot of time and confusion for the member and the entities the LLC does business with.

Continue reading "Why should a single-member LLC have an operating agreement?" »