LIMITED LIABILITY COMPANIES

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LIMITED LIABILITY COMPANIES

RANDI S. NATHANSON[1]

I. INTRODUCTION

In 1977, an organization doing business in Wyoming sought relief from the tax burdens imposed on corporations while seeking the legal protection afforded to the shareholders of a corporation. In response the Wyoming legislature enacted the first limited liability company (“LLC”) statute and in so doing created a legal entity where all of the members have the limited liability of shareholders and the tax treatment of partners. In 1982, the State of Florida sought to lure foreign investors by providing a form of business organization similar to the “limited” used in Central and South America and thus the Florida Limited Liability Company Act was passed. Florida also believed that this new entity would be attractive to

domestic businesses. However, neither Wyoming nor Florida, nor the United States as a whole, saw LLCs flourish for many years. The rationale for their lack of popularity was the lack of certainty as to their tax status. While they by statute afforded the protections of a limited partnership to all of the members, whether they would be treated as a partnership for tax purposes remained uncertain. That uncertainty was resolved in 1988 when the IRS issued Revenue Ruling 88-76 which classified a Wyoming LLC as a partnership for tax purposes. Since that time 27 states have enacted LLC statutes and 10 more have legislation pending with respect thereto. See Appendix A. Summaries of the key provisions of those statutes are attached hereto in Appendix B. The rationale which led the IRS to the conclusion which opened this floodgate and the tax implications of an LLC will be discussed in Part II of this paper. This portion of the paper will address what is an LLC and how is it organized.

II. KEY TERMS

The LLC has its own unique vocabulary which includes the following terms:

Articles of Organization--The document filed with the Secretary of State for the purpose of forming an LLC.

Capital Contribution--Cash, property, or services rendered or a promissory note or other binding obligation to contribute cash or property or to perform services which is delivered to an LLC by each Member.

Manager or Managers--A person or persons designated by the Members of the LLC to manage the LLC as provided in the Articles of Organization or Operating

Agreement.

Member--A person that owns an interest in an LLC.

Membership Interest--A Member's share in the profits and losses of an LLC and right to receive distributions from the LLC.

Operating Agreement--An agreement among the Members of an LLC which governs the manner in which the business of the LLC is conducted.[2]

III. FORMATION OF AN LLC

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Depending on the state law under which an LLC is organized, an LLC will be formed upon either the execution of its Articles of Organization by the Members, the filing of its Articles of Organization with the Secretary of State or the issuance of a Certificate of Organization by the Secretary of State.

The Articles of Organization must specify contain certain basic information in much the same way that Articles of Incorporation are required to set forth certain basic information concerning a corporation. For example, the purpose for which the LLC is formed must be included in the Articles. In most states an LLC may be formed for any lawful purpose, although in a few states LLCs are prohibited from participating in the banking and insurance industries or rendering professional services.

In addition, the Articles must specify the name of the LLC. As in the case of a corporation's or limited partnership's name, the LLC's name must clearly indicate that it is an LLC through the use of “limited liability company, “limited company” or “L.C.” in its name. The goal of this requirements is to ensure that third parties dealing with the LLC are put on notice as to the limited nature of its liability so as not to be misled as to the resources available to satisfy their claims. In certain states if the proper name is not used the limited liability afforded to an LLC will be lost. The Articles must also indicate the period of duration of the LLC. Because the lack of continuity of an LLC is a critical element of its tax treatment, an LLC, unlike a corporation, cannot have perpetual duration and in some states, cannot have more than a 30 year duration.

II. THE POWER OF AN LLC

By statute, an LLC is granted a broad range of basic powers. For example, most LLC's are authorized by statute to sue and be sued, deal in property, lend money for proper purposes, deal in shares, interests or obligations of other LLCs,

corporations, partnerships, the United States government or any nation, make contracts and guarantees and incur liabilities, conduct its business in any state of the United States, elect or appoint managers and agents, make and alter operating agreements, cease activities, dispose of its property or assets and exercise all powers necessary or convenient to effect any of the purposes for which it is organized.

Certain states define a list of secondary powers which are specifically authorized by statute including the power to indemnify, pay compensation, insure, lend money to assist members, donate to charities, pay pensions and become a promoter. Even in those states where such powers are not enumerated they are for the most part so essential to the operation of the business that it is safe to assume they are subsumed within the basic catchall of “necessary and convenient powers” noted above.

III. THE MEMBERS OF AN LLC

As noted above, the members of an LLC have the distinct advantage of having no liability under any judgment, decree or order of a court or in any other manner for a debt, obligation or liability of the LLC. Thus, they have the same protection as a shareholder in a corporation or a limited partner in a limited partnership.

In addition, as a general rule members of an LLC are free to transfer their interests in an LLC and the creditors of a member can attach their LLC interest to the extent of any debt which is owing to the creditor. However, under most state laws, in the case of a voluntary transfer of an LLC interest, if the remaining members of the

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LLC do not unanimously consent to the transfer, the transferee has no right to participate in the business of the LLC, but only the right to receive the profits or other compensation to which the transferor was entitled. In this respect the LLC is like many limited partnerships which distinguish between Limited Partners, which by definition includes only approved transferors of a limited partner's interest, and Interest Holders, which by definition includes Limited Partners and non-approved transferors of a limited partner's interest.

Most state LLC statutes also contain provisions dealing with the addition of new members and, as a general rule, require the consent of all of the existing members for the admission of a new member.

IV. CAPITALIZATION OF THE LLC

Each LLC statute provides a framework for the capitalization of an LLC and the distribution of the profits and houses of an LLC. Members of an LLC are generally allowed to contribute capital in the form of cash, property, services rendered or a promissory note or other binding obligation to contribute cash, property or services in the future. In some states, however, a member may not contribute services in lieu of cash or property, but may only do so in addition thereto, thus precluding

membership by persons who have valuable services, but little cash or property, to contribute to the entity.

In addition, under most LLC statutes a member is not entitled to the return of a capital contribution either if the LLC is or will be rendered insolvent as a result thereof or until (i) all liabilities other than members' contributions are paid or covered by the fair value of the LLC's remaining assets, (ii) all of the members consent to such a return of capital or the member is otherwise lawfully entitled to a return of the contribution due to dissolution, the arrival of a date specified in the Articles or Organization or the expiration of a 6 month notice of withdrawal period and (iii) the Articles of Organization are amended to reflect the reduction in capital. Once such capital is returned, as a general rule the member has no right to demand that capital in any form but cash. This provision is designed to ensure that the LLC will be in a position to continue to carry on its business even after the withdrawal of a member, assuming the remaining members elect to continue that business. With respect to the profits and losses of the LLC, most state statutes permit the members to establish an allocation in the Operating Agreement. If, however, the members fail to do so, the statute itself will provide for an allocation either based on the value of each member's interest in the LLC or equally among the members. No such distributions will be allowed, however, if the LLC is or will be rendered insolvent as a result thereof.

Finally, some of the more recent LLC statutes provide that once a member becomes entitled to receive a distribution, the member has the status of a creditor of the LLC and has all of the rights and remedies available to a creditor.

V. MANAGEMENT OF THE LLC

The majority of the LLC statutes which have been adopted to date generally contain the following three basic management rules:

i. Unless, otherwise provided in the Articles of Organization, management powers are vested in the members of the LLC either equally or in proportion to their capital contributions;

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ii. If the members do not choose to retain the power to manage, they still retain the right to select those who will perform management duties for the LLC; and iii. The managers of the LLC are entitled to hold the offices and have the

responsibilities accorded to them by the members and set out in the Operating Agreement.

The first of these rule is designed to reflect that the members have the right to opt out of management responsibility, but if they elect not to do so when forming their LLC, then that responsibility will be borne in proportion to each member's

investment in the business and thus those members with a larger investment will have a larger role in the management of the business. The second rule reflects more of a partnership than a corporate approach to management, i.e., a corporation's shareholders generally look to its Board of Directors and officers to manage the day to day affairs of the business, rather than delegating that responsibility to a third party, whereas it is more common for a partnership to delegate such management responsibility to a third party. The third rule is designed to give the members free rein in allocating responsibilities to the managers of the business. In a few instances the statute provides for a presumption that the business of the LLC will be controlled by designated managers unless the members of the LLC to elect to do so in the Articles of Organization.

VI. DISSOLUTION OF AN LLC

The LLC statutes provide for both voluntary and involuntary dissolution of an LLC. Those which provide for voluntary dissolution are triggered by the occurrence of a dissolution event which may include the expiration of the fixed duration of the LLC, the unanimous written agreement of the members of the LLC, the death, retirement, resignation, expulsion, bankruptcy or dissolution of a

member of any other event which terminates the continued membership of a member. However, the remaining members have the ability to override a

dissolution event and to continue the existence of the LLC, either on a unanimous or majority vote of the members or the remaining members, as applicable,

depending on the laws of the state under which the LLC is organized.

Involuntary dissolution is authorized under some, but not all of the LLC statutes where the LLC is shown to have procured its Articles of Organization through fraud, continued to exceed or abuse its legal authority, committed a violation or law that requires forfeiture of its charter, abused its powers contrary to state public policy or failed to maintain a registered agent or to notify the Secretary of State of a change in its registered agent.

VII. THE LLC VERSUS OTHER LEGAL ENTITIES

An LLC would appear to be most like a Subchapter S corporation--its members, like the shareholders of a Subchapter S corporation, have limited liability and it, like a Subchapter S corporation, is taxed as a partnership. However, an LLC is free of the constraints imposed on Subchapter S corporations with respect to the number (35) and type (only US citizens or resident aliens) of permissible shareholders. In addition, a Subchapter S corporation must elect that status and thus can lose or revoke its limited liability. On the other hand, the limited liability of an LLC is created by statute and thus is less likely to be lost. Finally, the Subchapter S corporation can only have one class of stock, whereas the LCC's Operating Agreement can provide for special allocations among the members.

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An LLC is a bit like a limited partnership as well. However, unlike the limited partnership where the general partner has unlimited liability, in the LLC all of the members enjoy the benefits of limited liability. In addition, a limited partner can lose the limitations on his/her liability if he/she participates too actively in the partnership's business whereas no such risk is faced by the members of an LLC who are authorized by statute to participate as fully as they desire in the business of the LLC.

IX. THE OPEN LCC ISSUES

Given the relatively new nature of the LLC, there are bound to be issues which are as yet unresolved. Included within them are the ability of an LLC to do business as a foreign entity in a state which does not authorize the creation of LLCs. A few states have by statute authorized such foreign qualification. In the remaining states, though, the ability to do business is a bit unclear. Thus, for a business operating in many states, the LLC may not be the best vehicle at this time.

In addition, the question exists as to whether the interests in an LLC are securities for state or federal securities law purposes. All of those who have looked at this issue agree that the answer rests on the rule articulated in SEC v. Howey , 328 U.S. 293 (1946). The Howey case established the following three prong test for

determining what is a security: (i) is there a contract, transaction or scheme whereby a person invests his money in a common enterprise, (ii) is that person led to expect profit and (ii) if so, are the profits coming solely from the efforts of the promoter or a third party? It is the third prong which requires analysis in the case of an LLC, i.e., who is responsible for the management of the business of the LLC, all of the members or only certain members or designated managers? It would appear that the determination of whether the interests of an LLC constitute securities will be decided on a case by case basis with reference to the applicable state law and Operating Agreement provisions.

X. CONCLUSION

LLCs are an alternative form of business entity which have been around for some time, but are only now becoming readily accessible to business as throughout the United States. It is yet to be seen if these will be the Edsell of the 1990s or a legal entity that will be used for years to come. For the present they are an interesting alternative which should be explored when entering into any new business venture in a state which authorizes them.

APPENDIX A

STATE LIMITED LIABILITY COMPANY LEGISLATION

States with Limited Liability Company Legislation Alabama Arizona Arkansas Colorado Delaware Florida

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Georgia Idaho Illinois Indiana Iowa Kansas Louisiana Maryland Minnesota New Mexico Nevada North Carolina North Dakota Oklahoma Rhode Island South Dakota Texas Utah Virginia West Virginia Wyoming

States Considering Limited Liability Company Legislation California District of Columbia Mississippi Missouri Montana New York Pennsylvania Tennessee Wisconsin

APPENDIX B

ALABAMA HIGHLIGHTS

Alabama Limited Liability Company Act, Code of AL. §§ 10-12-1 to -61 (Michie Supp. 1993).

Significant Features:

• LLCs may render professional services, if each member is licensed or registered to render the services under Alabama law. § 10-12-4(s).

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which the initial registered office of the LLC is located. § 10-12-9.

• Unless otherwise stated in the articles of organization, the management of an LLC is vested in the members. § 10-12-22.

• Profits and losses are allocated by the operating agreement; if it does not so provide they are allocated on the basis of the pro rata value of the contributions made by each member.

• Members' derivative actions in the right of a LLC permitted where Members or Managers with authority to bring action have refused to do so. § 10-12-25(a). • Articles of dissolution must be delivered to the Probate Judge who must issue a certificate of dissolution and return the certificate and a certified copy of the articles of dissolution to a representative of the dissolved LLC. The Probate Judge must transmit to the Secretary of State a certified copy of the articles of dissolution. § 10-12-42(b).

• A special article governs LLCs performing professional services. LLCs performing professional services may render only one specific type of professional service. § 10-12-45.

• A special article governs foreign LLCs: § 10-12-46.

ARIZONA HIGHLIGHTS

Arizona Limited Liability Company, Ariz. Rev. Statutes §§ 29-601 to -857 (West 1993 Supp.).

• Banking and insurance are excepted from the business and activities a LLC may conduct. § 29-609.

• One or more natural persons may form a LLC but are not required to be members of the LLC at formation. § 29-631. (Formation by two members is the more general rule.) The articles must include a statement that there will be two or more members at the time the LLC is formed. § 29-632.

• Management of the LLC is vested in the members, unless the articles provide that management is vested in one or more managers. § 29-681.

• Members have the status of creditors of the LLC at the time they become entitled to receive distributions. § 29-705.

• Profits and losses are allocated among members by operating agreement; if not provided therein, profits are allocated according to the manner in which members share in distributions that exceed the repayment of their capital contributions. Losses are allocated among members according to members' capital contributions. § 29-709.

• If a Member receives a distribution in violation of the statute or operating agreement, he is liable to the LLC for six years thereafter for the amount of the wrongful distribution. § 29-706.

• Members have the right to bring derivative actions. § 29-831. • Provisions regarding foreign LLCs are set out in §§ 29-801 to -812. • A special article governs professional LLCs. §29-841 to -847.

• Tax provisions governing limited partnerships apply to domestic and foreign LLCs. §29-857.

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ARKANSAS HIGHLIGHTS

Arkansas Small Business Entity Tax Pass Through Act , Ark. Code Ann. §§ 4-32-101 -1316 (Michie Supp. 1993).

• LLCs may be organized to perform professional services and related activities. § 4-32-106. The name of the LLC performing professional services must contain the word “Professional” or an abbreviation thereof. § 4-32-103.

• LLCs may be formed by one or more persons. § 4-32-202.

• Management of LLC is vested in the members unless the articles or an operating agreement provides otherwise. § 4-32-401.

• Each member will share equally in the profits and assets remaining after all liabilities are satisfied. §4-32-503.

• Members have the status of creditors of the LLC at the time they become entitled to receive distributions. § 4-32-701.

• Foreign LLCs are governed by §§ 4-32-1001-1008.

• All LLCs must make tax returns for each year as required for every partnership pursuant to §26-51-802.

COLORADO HIGHLIGHTS

Colorado Limited Liability Company Act, Colo. Rev. Stat. §§ 7-80-101 to -913 (West Supp. 1993).

• An LLC may conduct any business that a partnership with limited partners may lawfully conduct. § 7-80-103.

• One or more natural persons 18 years of age or older may organize a LLC; such persons need not be members after formation. LLC must have two or more members at time of formation. § 7-80-203.

• Period of duration for LLC limited to 30 years. § 7-80-204.

• LLCs must file a “LLC Report” within 60 days from the last day of the month in which report form is mailed to LLC by Sec. of State. § 7-80-303.

• Management powers presumed to be vested in managers; managers are not required to be residents of state or members of LLC unless articles or operating agreement mandates. § 7-80-401. Where there are more than six managers, managers may be classified and be elected for staggered terms. § 7-80-403. • Managers are held to a “good faith” standard and must act with care that an ordinary prudent person in a like position would use. § 7-80-406.

• Profits and losses of an LLC are allocated on the basis of the value of a member's capital contributions. § 7-80-503.

• A member may be liable upon return of his contribution (i) for six years; (ii) for six additional years if the member has received return of contribution in violation of the operating agreement or the LLC statute. § 7-80-607. • Provisionns governing foreign LLCs are set out in §§ 7-80-901 to -913.

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Delaware Limited Liability Company Act, Del Code Ann. tit. 6, §§ 18101 to -1106 (Michie 1992 Supp.)

Significant Features:

• Insurance and banking are excepted from the lawful business or activity an LLC may conduct. § 18-106.

• One or more persons may execute a certificate of formation. § 18-201. The certificate must be canceled upon dissolution and completion of winding up or at any other time there are less than 2 members. § 18-203.

• Unless otherwise provided, management of an LLC is vested in its members in proportion to the then current percentage of members in the profits of the LLC owned by all members, the decision of members owning more than 50% of the said percentage in the profits controlling.

• Domestic and foreign LLCs are taxed as partnerships for purposes of taxation in Delaware. Domestic and foreign LLCs must pay annual tax in the amount of §100 to the state of Delaware. § 18-1106.

• Members have right to bring derivative actions. § 18-1001.

• Provisions regarding foreign LLCs are set out at §§ 18-901 to -911.

FLORIDA HIGHLIGHTS

Florida Limited Liability Company Act, Fla. Stat. Ann. §§ 608.401 to -471.

• LLCs may be organized for any purpose except if special statutes exist regulating specific types of business, those laws control. § 608.403. • LLCs' period of duration may not exceed 30 years. § 608.407.

• An LLC is considered organized when the Secretary of State issues a certificate of organization.

• Unless otherwise provided, management of LLC is vested in members in proportion to capital contributions. § 608.422.

• Capital contributions may consist of cash or other property, but not services. § 7-80-501.

• Prior to dissolution the LLC must execute a statement of intent to dissolve and file articles of dissolution with the Department of State. LLC ceases to exist upon issuance of a certificate of dissolution by Department of State. §§ 608.442; 608.446.

• No provisions regarding foreign LLCs.

• Income of LLCs is subject to the Florida Income Tax Code. § 608.471.

GEORGIA HIGHLIGHTS

Georgia Limited Liability Company Act, Official Code of Georgia §§ 14-11-100 to -1109 (Harrison Supp. 1993; effective on March 1, 1994).

• One or more persons may act as the organizer of a LLC, but need not be a member of the LLC. § 14-11-203.

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organization or a written operating agreement provides otherwise. § 14-11-304. • A member or manager must exercise fiduciary duties while managing the business or affairs of the LLC. § 14-11-305.

• Specific provisions govern meetings; meeting may be called by any manager or at least 25% of members. Two days notice must be given in advance of any

meeting. § 14-11-310.

• Profits and losses shall be allocated as provided in the articles of organization or in a written operating agreement. If not so provided, profits and losses shall be allocated equally among members. § 14-11-403.

• Foreign LLCs are subject to provisions in §§ 14-11-701 to -712.

• Right provided for member of commence derivative action in right of LLC to recover judgment in its favor. § 14-11-801.

• Provides for Dissenters' Rights. § 14-11-1002.

IDAHO HIGHLIGHTS

Idaho Limited Liability Company Act, Idaho Code §§ 53-601 to -672 (Michie Supp. 1993).

• One or more persons may form a LLC. § 53-607.

• LLCs may render professional services if each member is licensed or registered to render those services under Idaho law. § 53-605. Special provisions govern professional service LLCs which may organize for the sole purpose of providing the same specific professional service. § 53-615, § 53-650.

• LLCs must file annual report with the Secretary of State on forms furnished by the Secretary. § 53-613.

• Management is vested in LLC members unless the operating agreement provides otherwise. § 53-621.

• Profits are to be shared equally among members in the profits and assets. § 53-628.

• A LLC may recover damages from a withdrawing member whose withdrawal is a breach of the Operating Agreement. § 53-641.

• Provisions governing foreign LLCs are at §§ 53-650 to –657.

ILLINOIS HIGHLIGHTS

Illinois Limited Liability Company Act, IL. Code 180/1-5 to /60-1 (Supp. 1993). Effective date January 1, 1994.

• A limited liability company may carry on any lawful business except banking or insurance. § 1-25.

• One or more persons may organize an LLC; organizers need not be members of LLC. § 5-1.

• Management shall be vested in members unless otherwise provided in the articles of organization. § 15-1.

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none provided therein, distributions must be made to each member on the basis of the book value of the member's membership interest. § 20-10.

• Members have derivative actions to enforce rights. § 40-1

• Provisions controlling foreign LLCs are set out at § 45-1 to § 45-60.

• All domestic and foreign LLCs must file an annual report with the Secretary of State. § 50-1.

INDIANA HIGHLIGHTS

Indiana Business Flexibility Act, Ind. Code Ann. §§ 23-18-1-1 to -13-1 (Michie Supp. 1993).

• Specific provisions authorizing professional service limited liability companies. § 23-18-2-2.

• One person may form a LLC; need not be a member at time of formation. § 23-18-2-4.

• Management is vested in members unless otherwise provided in the articles of organizations.

• Specific provisions on Operating Agreement - the initial Operating Agreement must be agreed to by all persons who are members at the time the initial agreement is accepted. § 23-18-4-6.

• The written operating agreement may provide that managers do not have the right to resign as managers; LLC may recover damages from manager resigning in contravention of breach of operating agreement. § 23-18-4-11.

• Profits and losses are allocated on the basis of members contributions unless otherwise provided in the operating agreement. § 23-18-5-3.

• Unless otherwise provided in the Operating Agreement, profits and losses are allocated on the basis of the agreed value of contributions made by each member. § 23-18-5-3.

• Domestic and foreign LLCs must file an annual report with the Secretary of State. § 23-18-12-11.

• A foreign LLC which transacts business without a certificate is liable for a civil penalty of not more than 10,000. § 23-18-11-3. Other provisions regarding foreign LLCs under §§ 23-18-11-1 to -18-18.

IOWA HIGHLIGHTS

Iowa Limited Liability Companies Act, Iowa Code Ann. §§ 4901A.100 to 490A.1601.

• One or more persons may form an LLC and need not be members after formation. § 490A.301.

• Unless the articles of organization provide otherwise, management of an LLC is vested in its members. § 490A.702.

• Managers must discharge duties in good faith and with the care that an ordinary prudent person would exercise in a like situation. § 490A.706.

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• Profits and losses shall be allocated among members in manner provided in articles of incorporation or in operating agreement; if none provided therein they must be allocated on basis of members' respective capital contributions.

• A member who has received a wrongful distribution in violation of the articles, the operating agreement, or the statute is liable to the LLC for a period of five years for the amount of the distribution. § 490A.808.

• A member has the right to bring a derivative action. The plaintiff must fairly and adequately represent the interests of the members enforcing the right of the LLC. § 490A.1001.

• Foreign LLCs are treated under the provisions of §§ 490A.1401 to -.1410. • Professional LLCs are treated under the provisions of §§ 490A.1501 to -.1519.

MARYLAND HIGHLIGHTS

Maryland Limited Liability Company Act, Md. Code Ann. §§4A-101 to - 1103 (including sections from 1993 Supp.)

• An LLC may not act as an insurer (professional services were excluded before 1993 amendments). § 4A-201.

• The 12 professional services permitted by an LLC are specified in definitions. § 4A-101.

• Management provisions are not specific; the operating agreement may include provisions establishing the management of the LLC. § 4A-402.

• Except as otherwise provided in the operating agreement, the profits and losses of an LLC are allocated among members in proportion to their respective capital interests. § 4A-505.

• Members may bring derivative actions to enforce a right of an LLC to the same extent that a stockholder may bring an action for a derivative suit under the

corporation of Maryland. § 4A-801.

• If an LLC is continued after articles of dissolution have been filed but before LLC has been terminated, members must file articles of continuation. § 4A-909. • Provisions governing foreign LLCs are at §§ 4A-1001 to - 1012.

LOUISIANA HIGHLIGHTS

Louisiana Limited Liability Company Law, La. Rev. Stat. Ann. §§ 12:1301 to -1369 (West Supp. 1993).

• LLCs may not be formed for the purposes of banking or insurance underwriting or for the purpose of operating homesteads or building and loan associations. § 1302.

• Management of LLC is vested in members unless articles of organization provide otherwise. § 1311.

• Managers and members who are managers have fiduciary duties to the LLC. § 1314.

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• Profits and losses shall be allocated in the manner provided in a written operating agreement or if not provided therein, equally among members. § 1323. • Specific provision that for state income tax purposes LLCs are taxed in the same manner as they are treated and taxed for federal income tax purposes. § 1368. • LLCs are treated as unincorporated associations under the LA Code of Civil Procedure for the purpose of bringing derivative actions. § 1365.

KANSAS HIGHLIGHTS

Kansas Limited Liability Company Act, Kan. Stat. Ann. §§ 17-7601 to 17-7651 (1992 Supp.).

• An LLC may conduct any business which a partnership or individual may conduct. § 17-7603.

• Specific power to employ professionals to practice a profession, which must be limited to one profession. § 17-7604.

• “Any person” may form an LLC. § 17-7605.

• Management is vested in members with each member having one vote unless the articles of organization provide otherwise. § 17-7612

• Operating Agreement is required by statute. § 17-7613. • No specific provisions governing sharing of profits and losses.

• Upon any event effecting dissolution the LLC must execute a statement of intent to dissolve and file it with the Secretary of State. § 17-7622.

• All LLCs required to make an annual report to the Secretary of State. § 17-7647.

• No approval rights required for merger or consolidation of LLC.

MINNESOTA HIGHLIGHTS

Minnesota Limited Liability Company Act, Minn. Stat. §§ 322B.01 to -955 (Supp. 1993).

Features:

• One or more natural persons of full age may act as organizers of an LLC. § 322B. 105.

• An LLC's period of existence may not exceed 30 years. § 322B.115. • Management of LLC to be under the direction of a board of governors. The first board of governors may be named in the articles of organization or elected by the organizers or by the members. § 322B.606.

• Governors shall discharge their duties in good faith and with the care an ordinary prudent person in a like position would exercise in like circumstances. § 322B.663.

• Foreign LLCs are governed under the provisions of §§ 322B.90 to -955.

NEVADA HIGHLIGHTS

Nevada Limited-Liability Companies Act, New Rev. Stat. §§ 86.010 to -571 (Michie 1991 Supp).

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• Banking and insurance are excepted from the purposes for which an LLC may be organized. § 86.141.

• Period of duration of LLC is limited to 30 years. § 86.161.

• Secretary of State must take action to endorse articles before LLC is considered organized. § 86.201.

• Management is vested in members in proportion to their capital contributions, unless other provisions are made in the articles of organization. § 86.291.

• An LLC may distribute profits upon basis set out in operating agreement. § 86.341.

• Foreign LLC's register by complying with NRS § 88.570 to -605, which provide for the registration of foreign limited partnerships. § 86.551.

NEW MEXICO HIGHLIGHTS

New Mexico Limited Liability Company Act, N.M. Stat. Ann. §§ 19-1 to 53-19-74.

• One or more persons may form a LLC; person forming LLC need not be members. § 53-19-7.

• Management is vested in members unless otherwise provided in the articles of organization. § 53-19-15.

• Members who have contributed to the capital of the LLC shall vote in proportion to the value of their capital contributions. § 53-19-17.

• Profits and losses of an LLC are allocated equally among the members in the manner provided in the articles or operating agreement or if none is provided, in proportion to the value of members' capital contributions.

• The withdrawal of a member for a definite term who attempts to withdraw voluntarily without a right to do so is ineffective; such member shall be deemed to have relinquished his rights to vote and participate. § 53-19-37.

• Once the Articles of Dissolution are filed, only a person named in the Articles shall have the authority to bind the LLC and transact business on its behalf. § 53-19-41.

• Foreign LLC are governed by § 53-19-47 to 19-57.

NORTH DAKOTA HIGHLIGHTS

North Dakota Limited Liability Company Act, N.D. Cent. Code §§ 103201 to -155 (Michie 1993 Supp.).

• One or more individuals of the age of 18 years or more may act as organizers of an LLC; LLC must have 2 members at time of formation. §§ 15; 10-32-06.

• Secretary of State must issue a certificate or organization before an LLC begins its existence. § 10-32-08.

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State on forms prescribed by it. § 10-32-149.

• Management vested in a board of governors; the first board of governors may be named in the articles of organization or elected by the organizers or the members. §10-32-69.

• Profits and losses of an LLC are allocated among members in proportion to the value of their capital contributions. § 10-32-36.

• Provisions governing foreign LLc's §§ 10-32-135 to -149.

NORTH CAROLINA HIGHLIGHTS

North Carolina Limited Liability Company Act, N.C. Gen. Stat. §§ 57C101 to -10-07 (Michie Supp. 1993).

• An LLC may render professional services only to the extent that a professional corporation may render such services under Chapter 55B of the General Statutes (Professional Corporation Act). § 57C-2-01.

• Domestic and foreign LLC's must file an annual report with the Secretary of State including informational requirements and a description of the nature of its business. § 57C-2-23.

• All members are presumed to be managers unless articles provide otherwise. § 57C-2-20. Managers must exercises management responsibilities in good faith and with care an ordinary person would use in a similar position. § 57C-3-22.

• Profits and losses are allocated in the manner agreed to in the operating agreement, or if no provision is made therein, according to the value of the member's contribution. § 57C-4-03.

• Specific article governs foreign LLC's § 57C-7-01. • Provides for member derivatives actions. § 57C-8-01.

• Domestic and foreign LLC's are subject to state taxation in accordance with their classification for federal income tax purposes. 57C-10-06.

OKLAHOMA HIGHLIGHTS

Oklahoma Limited Liability Company Act, Okla. Stat. Ann. tit. 18 §§ 2000 to 2060. (Supp. 1993)

• An LLC shall be managed by one or more managers, unless otherwise provided in the articles of organization or operating agreement. The managers need not be members of the LLC. § 2013.

• The managers must discharge their duties in good faith, with the care an ordinary person in a like position could exercise under similar circumstances. § 2016.

• The profits and losses of an LLC are allocated among members in proportion to their respective capital interests. § 2025.

• A member may be liable for a wrongful distribution if he received it in violation of the operating agreement or the statute. § 2051.

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• Provisions governing foreign LLC's: §§ 2041-2050.

RHODE ISLAND HIGHLIGHTS

Rhode Island Limited Liability Company Act, R.I. Gen. Laws § 7-16-1 to -75 (including provisions in Michie 1993 Supp.).

• An LLC may carry on any business which a limited partnership may carry on, except the provision of professional services. § 7-16-3.

• Management is vested in members unless the articles of organization or a written operating agreement otherwise provides. § 7-16-14.

• Profits and losses of an LLC are allocated to each member on the basis of the member's capital value. § 7-16-26.

• Domestic and foreign LLCs are required to file an annual report with the Secretary of State. § 7--16-66.

• Members have the right to bring derivative actions. § 7-16-56. • Foreign LLCs are governed by provisions set out at § 7-16-48 to -55.

SOUTH DAKOTA HIGHLIGHTS

South Dakota Limited Liability Companies, S.D. Codified Laws Ann. §§ 47-34-1 to 47-34-59. (Michie Supp. 1993).

• Banking and insurance are excepted from the purposes for which an LLC may be organized. § 47-34-5.

• An LLC's period of duration may not exceed 30 years. § 47-34-12.

• An LLC may not be considered organized until the Secretary of State issues a certificate of organization. § 47-34-14.

• Management of an LLC is vested in its members in proportion to their capital contributions unless other management provisions set out in the articles of organization provide for management by a member or managers. § 47-34-19. • Profits may be divided and distributed to members on the basis stipulated in the operating agreement. § 47-34-22.

• Members have right to bring derivative action. § 47-34-22. • Provisions governing foreign LLC's: § 46-34-45 to -59.

TEXAS HIGHLIGHTS

Texas Limited Liability Company Act , Tex Rev. Civil Stat. Ann. Art. 1528n. Articles 1.01 to 9.02.

• Any person over the age of 18 may act as an organizer of an LLC. Art. 3.01. • An LLC may not have a period of existence of more than 30 years. Art. 3.01. • An LLC commences its existence upon the issuance of a certificate of organization by the Secretary of State. Art. 3.04.

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• Management of an LLC is vested in the its managers, unless the regulations reserve the same to the members. The number of managers is fixed by the regulations. Art. 2.12, 2.13.

• Distributions of assets are made to members in the manner provided in the regulations or if the regulations do not otherwise provide, on the basis of the value of members' contributions. Art. 5.03.

• Foreign LLCs are governed by provisions in Articles 7.01 to 7.13.

UTAH HIGHLIGHTS

Utah Limited Liability Company Act , Utah Code Ann. §§ 48-2b-101 to -156.

• An LLC may conduct any lawful business which a partnership, general corporation, or professional corporation may conduct or promote. § 48-2b-104. • Management is vested in the members unless otherwise provided in the articles of organization. Management vest in proportion to their interests in the profits of the LLC. § 48-2b-125.

• Domestic and foreign LLCs must file an annual report with the Secretary of State. § 48-2b-120.

• Profits and losses are allocated as provided in the operating agreement. If the operating agreement does not so provide, profits and losses are allocated on the basis of value of the member' contributions. § 48-2b-130.

• Foreign LLCs are governed under the provisions of §§ 48-2b-143 to -148.

VIRGINIA HIGHLIGHTS

Virginia Limited Liability Company Act , Va. Code Ann. 13.1-1000 to -1073.

• One or more persons may form an LLC; such persons need not be members of the LLC after formation has occurred. § 13.1-1010.

• Management of an LLC is vested in its members unless the articles of operating agreement provides otherwise. § 13.1-1022.

• Managers must discharge their duties in accordance with the manager's good faith business judgment of the best interests of the LLC. § 13.1-1024.1.

• If manner of allocating profits and losses is not provided in the articles of organization, they are to be allocated on the basis of the value of members' contributions. § 13.1-1029.

• A member who has received a distribution in violation of the articles or the statute is liable to the LLC for a period of 6 years thereafter. § 13.1-1306. • Members have the right to bring derivative actions. § 13.1-1042. • Foreign LLCs are regulated pursuant to §§ 13.1-1051 to -1060.

WEST VIRGINIA HIGHLIGHTS

West Virginia Limited Liability Company Act , W. Va. Code §§ 31-1A-1 to -69 (1993 Supp.).

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• LLC exists upon issuance of a certificate of organization by the Secretary of State. § 31-1A-10.

• Management of an LLC is vested in members of unless otherwise provided in the articles or organization or an operating agreement. § 31-1A-18.

• Profits and losses of an LLC are allocated among the members by provisions in the articles or operating agreement; if not provided therein, the are allocated on the basis of the value of the members' contributions. § 31-1A-24.

• A member who receives a distribution in violation of the statute is liable to the LLC for a period of four years thereafter for the amount of the distribution. § 31-1A-30.

• Foreign LLCs are regulated by provisions in §§ 31-1A-48 to 31-1A-63.

WYOMING HIGHLIGHTS

Wyoming Limited Liability Company Act , Wyo. Stat. §§ 17-15-101 to -136.

• LLCs may not be organized for the purpose of banking or insurance. § 17-15-103.

• The period of duration of an LLC may not exceed 30 years. § 17-15-107. • An LLC is considered organized when the Secretary of State has issued an certificate of organization. § 17-15-109.

• Capital contributions may consist of cash or other property but not services. § 17-15-115.

• Management of an LLC is vested in its members in proportion to their contributions to capital, unless other provisions are established in the articles of organization. § 17-15-116.

• No provisions governing foreign LLCs.

Footnotes

[1] The author wishes to thank Margaret Lane for her assistance in preparing this

article.

[2] A model Operating Agreement can be found in the ALI-ABA Course Materials

Journal, Volume 18, No.1.

Bernard J. Truffer,

Medicaird Bureau, HCFA

Long Term Care and the Law January 19–21, 1994

Provider Tax Update

PROVIDER TAX UPDATE

SUBJECT:

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On August 13, 1993, the Health Care Financing Administration (HCFA) published Final regulations concerning, among other things, the requirements for provider taxes and donations to be considered permissible sources of funding of the State's share of the cost of the Medicaid program.

BACKGROUND:

The Medicaid program is a health care financing program serving millions of low-income Americans. The program is jointly-administered and funded by the States and the Federal Government. The Federal share of the costs of Medicaid is determined by a statutory formula and varies from 50 percent, in the wealthiest States, to nearly 80 percent in those States with the lowest per-capita incomes. During the 1980s, States, faced with the double-edged sword of growing costs, fueled by expanding eligibility rolls and benefit mandates, and flat tax revenues, resulting from economic problems, were hard pressed to continue to maintain their share of Medicaid program expenditures. Beginning in the mid-1980s, States found a vehicle to permit the Federal share of Medicaid costs to increase, while not putting any additional State funds into the equation. This device used, as part of the State share of Medicaid expenditures, revenues received from providers in the form of contributions or from special purpose taxes. This device was successful because States were able to use the provider funds as the State share of inflated provider payments, which would repay the providers for their donations or tax payments and distribute the Federal funds, which were the only “real money” in the system. For the most part, use of taxes and donations was a phenomenon associated with hospital payments, particularly disproportionate share hospital adjustments. These payments were a particularly well-suited vehicle for the tax and donation schemes since the Medicaid law gave States tremendous flexibility in defining which hospitals could qualify for the DSH adjustments, as well as in designing the formulas for the adjustments themselves. This flexibility permitted States to tailor tax and repayment programs to specific facilities. However, a few States also developed funding schemes involving nursing facilities or intermediate care facilities for the mentally retarded. Most commonly, these latter programs used inter-governmental transfers from public facilities as a vehicle to generate the State share of the enhanced Medicaid payments.

As an example of the degree to which Medicaid spending was fueled by the infusion of provider donations and taxes, Medicaid spending for disproportionate share hospital adjustments, which was largely non-existent in Fiscal Year 1987, grew to an amount in excess of $18 billion in Fiscal Year 1992. This increase in DSH spending was largely responsible for growth rates in overall Medicaid expenditures in excess of 30 percent in each of Fiscal years 1991 and 1992. These rates of growth were nearly triple the usual rate of increase in Medicaid spending.

FEDERAL RESPONSE TO STATES' USE OF PROVIDER TAXES AND

DONATIONS

In an effort to keep Federal financial participation (FFP) from being affected by taxes and donations, HCFA published a manual transmittal on this issue. This provision, section 2493 of the State Medicaid Manual, provided that any revenues form donations or provider-specific taxes would not be recognized for FFP purposes. In subsequent litigation involving this issue, HCFA was informed that it needed to promulgate this policy in regulations. HCFA's promulgation of the manual provision resulted in the first of a series of Congressional moratoria on

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promulgation of policies affecting States' use of tax and donations revenue. In §8431 of the Technical and Miscellaneous Revenue Act of 1988, Congress

prohibited the enactment of final rules changing the treatment of provider taxes and donations, until May 1, 1989. This publication was extended until December 31, 1990, by §6411(b) of the Omnibus Budget and Reconciliation Act of 1989, and until December 31, 1991, by §4701(a) of the Omnibus Budget Reconciliation Act of 1990. Section 4701(b) of the same Act, while generally prohibiting HCFA from limiting payments attributable to taxes on hospitals or nursing facilities, the statute did exempt payments to “reimburse the hospital or facility for the costs attributable to taxes imposed by the State solely with respect to hospitals or facilities.”

In February 1990, anticipating the end of the Congressional Moratorium, HCFA published proposed rules which would have, if enacted in final form, reduced FFP when States received revenues from provider taxes and donations. In September 1991, anticipating the end of the third moratorium, HCFA published rules, to be effective January 1, 1992, to accomplish the same goal. This regulation produced a firestorm of protest from the States dependent on the tax and donation programs for revenue to operate their programs, and from their Congressional supporters, who accused the Administration of deliberately subverting the intent of Congress in enacting the OBRA 90 provisions. Several acrimonious Congressional hearings were held in October, 1991.

To deflect some of the criticism, HCFA published a second regulation in October 1991, to provide some transition for States using tax and donation programs. However, these regulations led to a great deal of uncertainty as to which States would be able to continue their use of taxes and donations.

In an effort to achieve long-term resolution of this issue, HCFA, OMB and the National Governors Association began a series of negotiations. These negotiations were held to determine if the Administration and the States could agree on a set of principles governing States' ;use of taxes and donations to use as the basis for legislation. These negotiations were concluded in November 1991, and became the basis for Public law 102-234, the Medicaid Voluntary Contributions and Provider Specific Tax Amendments of 1991.

PROVISIONS OF THE TAXES AND DONATIONS LAW

In general, P.L. 102-234 provided for:

1. A transition period for States using impermissible taxes and donation programs to continue to use them.

2. A general prohibition on the use of most provider donations.

3. A set of provisions governing the circumstances under which new taxes would be permitted.

4. Establishment of new Statewide limits on Medicaid payments to Disproportionate Share Hospitals.

STATUTORY PROVISIONS REGARDING TAXES

Under Public Law 102-234, taxes are permissible if:

1. They are broad-based. That is the tax must be on a class of items and services designated either under the statute or by regulations promulgated by the Secretary. 2. They must be uniform. That is, the tax must affect all the providers the same way. 3. The State must not hold providers harmless for their tax costs.

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FEDERAL REGULATIONS

HCFA published interim regulations on November 24, 1992 ( 57FR 55118) and final rules on August 13, 1993 ( 58 FR 43156)to promulgate the statutory provisions.

Broad-based ( 42 CFR 433.68(c))

A tax must meet two requirements to be considered broad-based. It must cover a permissible class of items and services, and it must tax all providers of items and services within the class.

The permissible classes include eight classes of items and services designated in the statute (items 1 - 8 below) the one additional class designated by the Secretary in the November 1992 interim final rules (item 19 below) and ten additional classes (items 9 - 18) designated by the Secretary in the August 1993 final regulations. These are as follows:

1. Inpatient Hospital Services 2. Outpatient Hospital Services 3. Nursing Facility Services

4. Intermediate Care Facility for the Mentally Retarded Services. 5. Physicians' Services

6. Home Health Care Services 7. Outpatient Prescription Drugs

8. Services of Health Maintenance Organizations 9. Ambulatory Surgery Center Services

10. Dental Services 11. Podiatric Services 12. Chiropractic Services

13. Optometric/Optician Services 14. Psychological Services

15. Therapist Services, including physical, speech, occupational, and respiratory therapy.

16. Nursing services, including the services of nurse-midwives, nurse practitioners, and private duty nurses.

17. Laboratory and X-Ray Services, provided in a licensed, free-standing laboratory or X-Ray facility.

18. Emergency Ambulance Services

19. Other health care items or services not listed above on which the State has enacted a licensing or certification fee.

Uniform Taxes

( 42 CFR 433.68(d))

Taxes are uniform if:

1. The tax is the same amount for each provider, as in a licensing fee; 2. The tax is the same amount per bed in each provider;

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4. If the tax is imposed on some other basis, such as an admissions tax, the State demonstrates to the satisfaction of the Secretary that the tax is uniform.

States need not tax Medicare or Medicaid revenues. Further, they are permitted to exclude Federal or public facilities from the tax.

Waivers of the Broad-Based and Uniform Requirements

( 42 CFR 433.68(e))

The law permits taxes, which are not broad-based or uniform, to be permissible, if they are “generally redistributive.” HCFA has interpreted this requirement to mean that taxes which are not broad-based or uniform will only be approved if the tax, by providing credits, exceptions or exclusions, or by its lack of uniformity, has a tendency to shift the burden of the tax to the Medicaid program, or to providers with higher than average Medicaid utilization.

The waiver test is implemented by requiring the State to perform one of two numerical tests (depending on the kind of waiver the State is seeking) spelled out in the regulations. Both tests do essentially the same thing. That is, they each measure the tendency of the tax, by its exclusions or credits, to shift the burden of the tax to Medicaid.

In general, waivers are permitted if the tax, as proposed by the State, is as least as redistributive as a hypothetical broad based or uniform tax. The regulations, however, permit a slightly less rigorous test, if the tax provides credits or excludes only the following providers:

1. Providers that furnish no services within the class in the State. 2. Rural and Sole-Community Hospitals

3. Providers That Do Not Charge for Services 4. Physicians in Medically Underserved Areas 5. Financially Distressed Hospitals

6. Psychiatric Hospitals

7. Providers or Payers Within Regional Pooling Arrangements.

Hold Harmless

A hold harmless is deemed to be in effect, if any of the following conditions is present.

1. The State provides, directly or indirectly, for a non-Medicaid payment to those providers or taxpayers and the amount of the payment is positively correlated to either the amount of the tax or the difference between the Medicaid payment and total tax costs.

2. All or any portion of the Medicaid payment to the taxpayer varies based only on the amount of the total tax paid.

3. The State provides any direct or indirect payment that guarantees to hold taxpayers harmless for all or part of their tax costs.

The States are not barred from repaying providers for the Medicaid program share of tax costs, except that, if the tax rate exceeds 6 percent of providers revenue, or its equivalent, and if more than 75 percent of providers are repaid for more than 75 percent of their tax costs, a hold harmless will be deemed to exist.

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Classes Who's in the Who's Out?

Waivers How does a State apply? When is a waiver required? When does a State get a waiver?

Hold Harmless

Can States give tax credits to private pay patients of nursing homes subject to a provider tax?