Spring 2004-03 Limited liability companies a new form of business organization

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Number 55
Spring 2004

Limited liability companies: a new form of business organization

For those entrepreneurs who are confronted with the issue of choosing the appropriate entity to conduct their business in Puerto Rico, there is a new alternative on the way: the limited liability company ("LLC").

The Puerto Rico legislature is considering the adoption of an act that recognizes the existence of LLCs in our jurisdiction. Currently LLCs have attained virtually universal legislative acceptance, having been adopted in all fifty states of the United States, the District of Columbia, the U.S. Virgin Islands and several countries in Europe and Latin America.

What is it?

LLCs constitute a hybrid between a partnership and a corporation. Nonetheless, LLCs offer one main advantage over corporations, that is, they lack the rigidity and formality of corporate organization. To understand better the nature and use of a LLC, several definitions under the act are helpful.

Members

A limited liability company is an organization owned by members who are not individually liable for the obligations and liabilities of the entity. An LLC may be composed of one or several members. A member may be a natural person, a partnership (whether general or limited), trust, estate, association, corporation, custodian, nominee, or any other individual or entity in its own right, or any representative capacity, in each case, whether domestic or foreign. Even another LLC or foreign LLC may be a member. A person becomes a member by acquiring an interest in the LLC and forming part of an operating agreement.

Operating agreement

The operating agreement is an oral or written agreement that governs the administration and states the relationship between members.

Activities

The LLC is a separate legal entity from its members and may carry on any lawful business, purpose or activity, whether or not for profit, except for insurance or banking activities.

Flexibility

As stated above, one of the principal characteristics of the LLC is the flexibility and informality in its organization and management, as opposed to corporations. Regular corporations must adhere to more rigid management rules which are not present in LLCs. Management in an LLC is stripped from practically all formality. Members can decide that management be vested on the members themselves or on other managers. If vested upon managers, these in turn may delegate management functions to other persons.

Managers can also act as members and, therefore, be allowed to make contributions to the LLC and share in its profits and losses. The operating agreement can provide for different types or groups of managers, each with its own rights and powers, and subject to the restrictions and liabilities set forth in the agreement.

Also, in a LLC there are no rules imposing an obligation to conduct annual or periodic meetings of members or managers.

In sum, members are free to structure the type of management that works best for their business. Since the act does not impose a management structure upon the members, they can address many of the matters that govern management and organization in the operating agreement, for example, formation, purpose, capitalization, allocation of profits, losses, and distributions, voting rights, liability of managers and members and rights and limitations of members.

Fiduciary duties

In terms of fiduciary duties, the LLC law itself does not define the nature or extent of fiduciary duties required of members, managers and other persons. It does, however, allow for these duties to be established, modified or limited in the operating agreement. Therefore, members are free to define contractually the scope of these duties.

A member, manager or other person in a LLC will not be held liable for breach of a fiduciary duty for good faith reliance on the operating agreement, company records and information obtained from other managers, members and other related parties.

Duration

Regarding the duration of its business, LLCs have perpetual existence, unless provided otherwise in the agreement. They may dissolve:

(i) at the time, or on the happening of events, as provided in the agreement,

(ii) by an affirmative vote of its members or

(iii) at any time there are no members left, unless its operations are continued by a new member in a manner permitted by the operating agreement and the LLC act, or a representative of the last remaining member agrees in writing to continue the LLC.

Taxes

For tax purposes, a Puerto Rico LLC will be treated like a corporation and, therefore, subject to double income taxation (first to the LLC and then to its members for the dividends received) unless it qualifies for exemption under some other statute.


© 2004 Goldman Antonetti