Unincorporated Business Entities Section - Limited Liability Partnership
Post on 20-Aug-2015
2225 Views
Preview:
Transcript
Unincorporated Business Entities
Section III.3:
Limited Liability Partnership
Prof. Amitai AviramAviram@law.uiuc.edu
College of LawUniversity of Illinois
Copyright © Amitai Aviram. All Rights ReservedS07
Copyright © Amitai Aviram. All Rights Reserved 2
Statutory Foundation of LLPs LLP is a variation of general partnership (not limited partnership)
LLP option added in a 1996 amendment to RUPA (1994) RUPA §306(c): “An obligation of a partnership incurred while the
partnership is a limited liability partnership, whether arising in contract, tort, or otherwise, is solely the obligation of the partnership. A partner is not personally liable, directly or indirectly, including by way of contribution or otherwise, for such a partnership obligation solely by reason of being or so acting as a partner.” Limited liability applies only to obligations that were incurred after entity
became an LLP RUPA commentary to §401: “…Section 401(c) makes clear that a
partner's right to indemnification by the entity is not affected by a partnership becoming a limited liability partnership. Accordingly, partners continue to share partnership losses to the extent of partnership assets.”
Copyright © Amitai Aviram. All Rights Reserved 3
Limited Liability PartnershipsFormation of an LLP
LLPs are not born; they’re converted (from a GP). RUPA §1001: A partnership becomes an LLP after:
1. “The terms and conditions on which a partnership becomes a limited liability partnership [are] approved by the vote necessary to amend the partnership agreement except, in the case of a partnership agreement that expressly considers contribution obligations, the vote necessary to amend those provisions.” [1001(b)]
2. A statement of qualification is filed, containing: Name of partnership Street address of chief executive office Street address of an office in the state of filing or of agent for service of
process A statement that the partnership is applying for status as an LLP A deferred effective date, if any.
Copyright © Amitai Aviram. All Rights Reserved 4
Limited Liability PartnershipsForeign LLPs
RUPA §1102: An LLP must file a “statement of foreign qualification” in any state in which it transacts business (if that state adopted the RUPA amendments). Information in this statement is similar to that of the statement of
qualification. Why file a statement in each state? Why file only one “statement of qualification”, and have the rest
be “statements of foreign qualification”? I.e., why the requirement to choose one state and be a foreign LLP in all
others? Failure to file a statement of foreign qualification does not
eliminate limited liability, but prevents LLP from maintaining a legal action in the state. The state’s secretary of state becomes the agent for service of process to the LLP.
Copyright © Amitai Aviram. All Rights Reserved 5
Limited Liability PartnershipsForeign LLPs
Hypo 1: Acme is a GP. Partners vote unanimously to turn it into an LLP and ask Jack (a partner) to file a statement of qualification in Florida. Jack forgets to do so. Acme later becomes insolvent and Jill, another partner, is sued. Is Jill liable?
Hypo 2: Acme is a GP. Partners vote unanimously to turn it into an LLP and ask Jack (a partner) to file a statement of qualification in Florida. Jack does so. Acme then extends its business to Georgia. Jack is told to file a statement of foreign qualification in Georgia, but forgets to do so. Acme later becomes insolvent and Jill, another partner, is sued by a Georgia creditor. Is Jill liable? From a policy perspective, is there a reason for the difference
between Hypos 1 and 2?
Copyright © Amitai Aviram. All Rights Reserved 6
Limited Liability PartnershipsMisc. differences between GPs/LLPs
Name “The name of a limited liability partnership must end with ‘Registered
Limited Liability Partnership’, ‘Limited Liability Partnership’, ‘R.L.L.P.’, ‘L.L.P.’, ‘RLLP,’ or ‘LLP’.” [§1002]
Governing law In general partnerships, the law governing internal relations (between
partners and between a partner & the partnership) is that of the jurisdiction in which a partnership has its chief executive office. [§106(a)]
For LLPs, the law of the state in which a statement of qualification was filed governs internal relations and the liability of partners for an obligation of a limited liability partnership. [§106(b)]
Annual Report LLP must file an annual report in each jurisdiction in which it transacts business:
States addresses of the LLP’s office & agent for service & state under which LLP formed
Copyright © Amitai Aviram. All Rights Reserved 7
History of the LLP Born in Texas, on August 26, 1991, as a response to a
surge in malpractice suits against lawyers and accountants resulting from the Savings & Loans crisis of the 1980s Lawyers and accountants were organized as GPs, and
partners feared losing their personal assets for suits unrelated to matters they were handling
Also among the potentially liable: Retired partners & partners that left the defendant law firm to join other firms
Initially greeted with suspicion Becomes known as the “help-a-lawyer bill” Due to criticism, Texas opts for a narrow non-liability statute
Copyright © Amitai Aviram. All Rights Reserved 8
History of the LLP LLPs become popular with professional firms
Within a year of the Texas bill’s passage, 1,200 Texas law firms including all of the largest firms became LLPs.
Why didn’t it become popular with other businesses? Why didn’t professional firms opt for corporations/LLCs?
In 1994, Minnesota enacts the first broad non-liability statute. Many states quickly follow. Result: LLP Partners face similar liability to LLC members or
a corporation’s SHs. In 1996, RUPA is amended to allow for the creation of
LLPs, adopting the broad non-liability model.
Copyright © Amitai Aviram. All Rights Reserved 9
LLPs as Law Firms’ Entity of ChoiceGlater, New York Times (Jan. 10, 2003)
The article describes a trend of law firms converting from GPs to LLPs
A senior partner is cited saying: “Clients don’t seem to care.” Does the shift to being an LLP: Reduce the effort an attorney would devote to her work? Reduce the effort an attorney would devote to policing that
other partners aren’t negligent? Is there anything other than legal liability that gives lawyers an
incentive to police other partners?
Are clients rational in not caring about LLP status?
Copyright © Amitai Aviram. All Rights Reserved 10
Chinks in the LLP Armor?
Despite the optimism of law firms reported in the NY Times article, there are situations in which LLP partners do not enjoy limited liability, including: Narrow Non-Liability Statutes Unshielded obligations Direct Liability Contribution Requirements
Copyright © Amitai Aviram. All Rights Reserved 11
Losing theLimited Liability Shield
Narrow Non-Liability Statutes Unshielded obligations Direct Liability Contribution Requirements
Copyright © Amitai Aviram. All Rights Reserved 12
Losing the Limited Liability ShieldNarrow Non-Liability Statutes
Texas Business Organizations Code, § 152.801(b):
“[LLC partner] is not personally liable for a debt or obligation of the partnership arising from an error, omission, negligence, incompetence, or malfeasance committed by another partner or representative of the partnership while the partnership is a limited liability partnership and in the course of the partnership business unless the first partner:” Was supervising or directing the other partner when liability was created Was directly involved in the specific activity that created the liability; or Had notice of the cause of liability and failed to take reasonable action to
prevent or cure it.
Copyright © Amitai Aviram. All Rights Reserved 13
Losing the Limited Liability ShieldNarrow Non-Liability Statutes
Alex and Bridget are partners in an LLP. Partnership agreement is silent about each partner’s authority.
Alex signs an agreement with Chris under which Chris lends the LLP $1,000. Bridget does not know of this loan.
When Chris tries to collect the loan, he finds that neither the LLP nor Alex have any assets. He sues Bridget.
Bridget argues that her liability is limited since the entity is an LLP. Is she correct if: The governing law is RUPA (including the 1996 amendments)? The governing law is a narrow non-liability statute?
Copyright © Amitai Aviram. All Rights Reserved 14
Losing theLimited Liability Shield
Narrow Non-Liability Statutes Unshielded obligations Direct Liability Contribution Requirements
Copyright © Amitai Aviram. All Rights Reserved 15
Losing the Limited Liability ShieldUnshielded Obligations
An LLP may have unshielded liabilities. E.g., Pre-conversion liabilities Liabilities to which personal guarantees were given
If the LLP uses its assets to pay shielded liabilities before unshielded ones it may not have enough assets to pay the unshielded liabilities.
Copyright © Amitai Aviram. All Rights Reserved 16
Losing the Limited Liability ShieldUnshielded Obligations
Hypo: Acme is a GP with $50K in assets; Al and Bev are the partners. Acme borrows $100K from Charlie.
Acme then files a statement of qualification & converts into an LLP.
A month later, it borrows another$100K from Dangerous Dave. Is the liability to Dave shielded?
And the liability to Charlie?
Copyright © Amitai Aviram. All Rights Reserved 17
Losing the Limited Liability ShieldUnshielded Obligations
The next day Acme loses $120K on a bad investment Dangerous Dave learns that the LLP now has only
$130K in assets and $200K in debt He has a talk with Al and Bev, after which Acme
repays Dangerous Dave’s debt. When Charlie tries to collect his $100 loan, he finds
Acme only has $30 in assets. Are Al and Bev personally liable to Charlie?
Copyright © Amitai Aviram. All Rights Reserved 18
Losing the Limited Liability ShieldUnshielded Obligations
From Dave’s perspective An LLP creditor (like Dave)
may want to restrict diversion of LLP assets towards quenching unshielded obligations
Copyright © Amitai Aviram. All Rights Reserved 19
Losing theLimited Liability Shield
Narrow Non-Liability Statutes Unshielded obligations Direct Liability Contribution Requirements
Copyright © Amitai Aviram. All Rights Reserved 20
Liability of an LLP PartnerDow v. Donovan [D. Mass. 2001]
Andrea Dow was an associate at Lyne, Woodworth & Evarts, LLP (“LWE”).
‘Making partner’ in a law firm is no different from admitting a new partner to any other existing partnership. The default rule: admitting an new partner requires the consent of
all existing partners. LWE followed the default rule. After Dow spent eight years as an associate, the LWE partners
met to discuss her candidacy for partnership. “Not a single partner spoke in favor of making Dow a partner, and
several spoke against that action.”
Copyright © Amitai Aviram. All Rights Reserved 21
Liability of an LLP PartnerDow v. Donovan
Dow was informed that she was declined partnership, and her associate position will be terminated. She was given three months to seek other employment.
Dow sued LLP and each of the partners, alleging gender-based employment discrimination. Suppose that the law firm is found to have violated
employment anti-discrimination laws. Are the individual partners vicariously liable? Could they be liable on other grounds?
Copyright © Amitai Aviram. All Rights Reserved 22
Megadyne Information Systems v. Rosner, Owens and Nunziato [Cal. CA 2002]
Megadyne wins a bid and enters a contract with the Orange County Transportation Authority (OCTA).
By Nov. 1995 it learns that its bid was based on misinformation furnished by OCTA in March 1995.
11/95 11/98
12/95
11/96
5/97
11/97
1/98
8/98
Copyright © Amitai Aviram. All Rights Reserved 23
Liability of an LLP PartnerMegadyne Information Systems
Dec. 1995: Megadyne referrs this matter to Irell & Manella (“I&M”). I&M handled various matters for Megadyne in the
past 20 years.
11/95 11/98
12/95
11/96
5/97
11/97
1/98
8/98
Copyright © Amitai Aviram. All Rights Reserved 24
Liability of an LLP PartnerMegadyne Information Systems
I&M never files a formal claim against OCTA. Nov. 1996: The one-year statute of
limitations for this claim expires.
11/95 11/98
12/95
11/96
5/97
11/97
1/98
8/98
Copyright © Amitai Aviram. All Rights Reserved 25
Liability of an LLP PartnerMegadyne Information Systems
May 1997: I&M suggested to Megadyne to refer the case to another law firm – Rosner, Owens & Nunziato (“RON”).
I&M referred ~15 cased to RON in a five-year period.
11/95 11/98
12/95
11/96
5/97
11/97
1/98
8/98
Copyright © Amitai Aviram. All Rights Reserved 26
Liability of an LLP PartnerMegadyne Information Systems
Nov. 1997: RON serves OCTA a statutory claim Owens handles the matter. Nunziato’s name also appears in the caption
page of the claim.
11/95 11/98
12/95
11/96
5/97
11/97
1/98
8/98
Copyright © Amitai Aviram. All Rights Reserved 27
Liability of an LLP PartnerMegadyne Information Systems
Jan. 1998: OCTA returns the claim because the statutory time limit had lapsed. After the rejection, RON does nothing, but reassures
Megadyne that they are “zealously protecting [Megadyne’s] interests.”
Owens testifies that during this time “there might have been discussions” between him and the other two partners that Megadyne had a viable legal malpractice claim against I&A.
Why didn’t RON advise Megadyne to sue I&A?
11/95 11/98
12/95
11/96
5/97
11/97
1/98
8/98
Copyright © Amitai Aviram. All Rights Reserved 28
Liability of an LLP PartnerMegadyne Information Systems
Aug. 1998: Megadyne fires RON. Sept. 1998: Megadyne hires another firm, but
the claim is again rejected for failing to abide by the 1 year limit.
11/95 11/98
12/95
11/96
5/97
11/97
1/98
8/98
Copyright © Amitai Aviram. All Rights Reserved 29
Liability of an LLP PartnerMegadyne Information Systems
~ Nov. 1998: Megadyne sues RON. Why didn’t they also sue I&A?
Suppose that RON and Owen are liable. Are Rosner and Nunziato also liable?
11/95 11/98
12/95
11/96
5/97
11/97
1/98
8/98
Copyright © Amitai Aviram. All Rights Reserved 30
Losing theLimited Liability Shield
Narrow Non-Liability Statutes Unshielded obligations Direct Liability Contribution Requirements
Copyright © Amitai Aviram. All Rights Reserved 31
Losing the Limited Liability ShieldContribution Requirements
Converting a GP into an LLP can conflict with contribution requirements in the partnership agreement.
Hypo: Alan, Becky and Cheryl form a general partnership. To ensure that the partnership has sufficient funds, the partnership agreement allows the partnership (through a majority vote of partners) to impose a mandatory contribution from the partners. This contribution is capped at $10,000 per year. What are the advantages of this method of raising capital?
Why is the contribution capped?
Copyright © Amitai Aviram. All Rights Reserved 32
Losing the Limited Liability ShieldContribution Requirements
The partners vote unanimously to convert the GP into an LLP. Later that year Alan and Becky want to expand business,
financing the expansion with a $300,000 loan for 20 years @10% interest (i.e., interest payment of $30,000/year).
Cheryl does not want to pay $10,000 a year for the next 20 years and objects, but is outvoted 2-1.
Nonetheless, she refuses to pay her contribution, claiming that the mandatory contribution is a form of unlimited liability, from which she is shielded as a partner in an LLP. Is she correct? Note the last sentence in RUPA §306(c). Is there any reason that the LLP might want both a limited liability
shield and a mandatory contribution requirement?
Copyright © Amitai Aviram. All Rights Reserved 33
Losing the Limited Liability ShieldContribution Requirements
The partners reach a compromise – they will take the loan and require the mandatory contribution, but they will not force Cheryl to pay her share. Alan and Becky calculate that partnership profits would suffice to replace
the $10,000 Cheryl would have contributed. Cheryl trusts her partners not to renege on their promise, and knows that
she can veto the admission of other partners who might insist that she contribute, so she goes along with the compromise.
The LLP applies to a bank for the $300,000 loan. The bank insists that the partners vote to ratify the contribution section.
The bank then lends the money. Ultimately the LLP defaults on the loan. The bank tries to force Cheryl to make the mandatory contributions. Cheryl claims immunity to liability, pointing out to RUPA §306(c). Will she defeat the bank’s claim?
Copyright © Amitai Aviram. All Rights Reserved 34
Losing the Limited Liability ShieldContribution Requirements
Same fact pattern as before, except that Cheryl first checks the LLPs financial condition and finds that it will be able to repay the loan. Indeed, the LLP does not default on the loan.
However, Alan defaults on a personal credit card debt. The credit card company seizes Alan’s transferable interest in the LLP. It then learns that Cheryl had not contributed the mandatory payments, and sues to enforce her contribution duties. Cheryl responds that her liability is limited and that the credit card
company is not a partner and therefore lacks standing to enforce the partnership agreement. Is she right? Note RUPA §807(f).
Copyright © Amitai Aviram. All Rights Reserved 35
Raising Additional Capital
Copyright © Amitai Aviram. All Rights Reserved 36
Raising Additional CapitalHypo
The Project Dave, a real estate
developer, plans to construct an apartment building at a cost of $10 million.
Copyright © Amitai Aviram. All Rights Reserved 37
Raising Additional CapitalHypo
Debt Capital Dave decides to borrow as
much of the $10M as he can. A bank is willing to lend Dave
$9 million, if he has equity capital of at least $1 million.
Copyright © Amitai Aviram. All Rights Reserved 38
Raising Additional CapitalHypo
Equity Capital To raise the $1 million in equity,
Dave forms Acme Corp. 40 investors invest $25,000
each in Acme 40 x $25,000 = $1 million
Each investor receives one share for each $1,000 he/she invests (so, each investor receives 25 shares).
Copyright © Amitai Aviram. All Rights Reserved 39
Raising Additional CapitalHypo
Difficulties Unfortunately, after the $10 million are
spent, the building is not yet complete. The incomplete building can’t generate
rents, but can be sold for $9 million. If the unfinished building is sold, Acme
will have $9 million in cash. After paying out the $9 million debt to the bank, Acme will have no assets left. Investors lose all of their investment
Copyright © Amitai Aviram. All Rights Reserved 40
Raising Additional CapitalHypo
Salvaging the Project Dave estimates that if Acme spent another $500,000, the
building can be completed. Such a building will be worth $10 million.
If the building is completed and sold, and the debt is repaid, Acme will have a $1 million surplus. In other words, if the investors can raise another $500,000,
they will likely create a surplus of $1 million – a good deal. But how to get the $500,000?
Copyright © Amitai Aviram. All Rights Reserved 41
Raising Additional Capital1. Shareholders’ Voluntary Loan
Each of the 40 investors to lend $12,500, charging zero interest If all investors lend the money, the corporation will have a $10
million building, and $9.5 million in debt. This leaves a surplus of $500,000, or $12,500 per investor. Is there a cost to the investors in lending the money?
If one investor doesn’t lend the money, while all other investors do, the corporation may lend the remaining money, but it will have to pay interest, which will reduce the surplus. Suppose the interest amounts to $400. How much of that cost will be borne by the shirking investor?
Result: Investors are likely to decline to lend the money.
Copyright © Amitai Aviram. All Rights Reserved 42
Raising Additional Capital2. Issuing Shares at Original Price
Instead of raising debt capital from the investors, Acme can offer each investor to buy 12.5 additional shares, at the same price as the original shares cost ($1,000/share). This will raise: 40 (investors) x 12.5 (shares) x $1,000 (price) = $500,000
The problem is that the value of Acme dropped. Even if it gets the additional capital, it will cost $10.5 million to build a $10
million building. Therefore, the value of an Acme share dropped below the original value
of $1,000. A share is now worth $500 (I won’t bother you with the math of
calculating this). A rational investor would not pay $1,000 to buy a share worth
$500, so this attempt to raise capital will fail.
Copyright © Amitai Aviram. All Rights Reserved 43
Raising Additional Capital3. Issuing Shares at Reduced Price
If Acme offered shares at their actual value ($500), it would need to issue 1,000 shares to raise $500,000. With this money it will complete the building, sell it for $10 million, pay off
the $9 million debt, and divide the surplus between the 2,000 shares (1,000 original shares and 1,000 new shares), distributing $500 ($1,000,000/2,000) per share.
This may be too close a margin for some investors – if there are any additional costs, the value of a share will drop below $500, so why buy additional shares?
To attract investors to buy the shares, a corporation may offer the new shares at a discount from their expected value. E.g., offer 2,000 new shares for $250 each. Since the expected value
of a share is $500, this is a good deal for each investor.
Copyright © Amitai Aviram. All Rights Reserved 44
Raising Additional Capital3. Issuing Shares at Reduced Price
This is sometimes called a “penalty dilution”, because an investor who does not buy the reduced price shares will lose some of the value of her existing investment. An equity interest is like a slice of the corporation pie (the pie
is the total assets of the corporation) Issuing a new share reduces the size of each slice But the money for which the share was purchased increases
the corporation’s assets, so it makes the pie larger
Copyright © Amitai Aviram. All Rights Reserved 45
Raising Additional Capital“Penalty Dilution” – Intuitive Explanation
Suppose a corporation issued 4 shares when it was formed. Each share represents an equal slice of the corporation’s assets.
Size of each slice (i.e., value of a share) = size of pie/number of slices (i.e., corporation’s total assets/number of shares).
Now the corporation has issued another share. Another slice was added to the pie, making the relative size of each slice smaller. But the money received for selling the fifth share was added to the corporation’s assets, making the pie larger.
Is each slice in the lower pie larger or smaller than a slice in the higher pie?
What does that depend on?
1
2
3
4
1
2
3
4
5
Copyright © Amitai Aviram. All Rights Reserved 46
Raising Additional Capital“Penalty Dilution” – Intuitive Explanation
When a point is bought for exactly its value, the size of each slice doesn’t change – the increase to the size of the pie (money paid for the share) is equal to the size of the new “slice”.
If a point is sold below its value, the increase to the size of the pie was less than the size of the new slice. Therefore, the other slices become smaller.
Purchasing a share below its value results in a transfer of wealth from the owners of the existing shares to the owner of the new share. This is called “dilution” of the existing shareholders.
Copyright © Amitai Aviram. All Rights Reserved 47
Raising Additional Capital “Penalty Dilution” – Numerical Example
Alice owns 1 of 3 shares in Acme. Brian owns the other 2 shares. Acme is worth $90K ($30K/share)
Acme offers its SHs 3 new shares, pro rata, for $10K/share Alice does not have $10,000 in cash & has to decline Brian purchases the 2 shares offered to him, paying $20,000
Acme is now worth $110K, and has 5 shares Each share is worth $22K (110,000/5)
Alice lost $8,000 (30K-22K) Brian gained $8,000
Before: 2x$30K= $60K After: 4x$22K= $88K Gain: $88K-60K-20K = $8K
Copyright © Amitai Aviram. All Rights Reserved 48
Raising Additional CapitalNo Dilution if Everyone Participates
If the existing shareholders buy the all of the newly issued shares pro rata (i.e., at the same proportions as their current ownership), then the wealth will be transferred from them (as the owners of the existing shares) to… them (as the owners of the newly issued shares).
In other words, they will not be diluted – they will neither gain nor lose from buying the new shares. Meanwhile, the corporation will raise more capital.
Copyright © Amitai Aviram. All Rights Reserved 49
Raising Additional CapitalProblems with “Penalty Dilution”
1. SHs who don’t have money to invest will lose value Potential for opportunistic behavior when minority SHs are
low on cash
2. SH who doesn’t want to invest more in the corporation will lose some of the investment value
Harms SHs who have a greater need to diversify
Copyright © Amitai Aviram. All Rights Reserved 50
Raising Additional Capital4. Shareholder Loans at Above-Market Interest Rate
Another option is to raise the money as a loan (as in Option 1), but pay an above-market interest rate. If all SHs lend, interest rate does not matter – interest comes out
of one pocket (SHs as owners of the firm’s assets) into their other pocket (SHs as creditors of the firm).
But if some SHs refuse to lend, they pay high interest payments (i.e., the value of their shares shrinks), but don’t receive interest payments (since they did not lend).
This is another type of penalty dilution; same pros & cons
Copyright © Amitai Aviram. All Rights Reserved 51
Raising Additional Capital5. Mandatory Capital Contributions
Options 1 & 2 for raising capital from the existing shareholders were completely voluntary
Options 3 & 4 were voluntary, but refusal resulted in a dilution of the refusing party
Alternative: Mandatory contribution BoD given the right to require each SH
to contribute more capital to the firm
Pros & cons of this option? Contribution caps mitigate the
disadvantages
Copyright © Amitai Aviram. All Rights Reserved 52
Raising Additional Capital6. Turning to Outsiders
Options 1-5 raised capital from existing SHs. Another source: Third parties Authorize (in the AoI or the bylaws) BoD to:
Issue shares to third parties; or Lend money/sell bonds to third parties
What are the pros & cons of this option?
top related