Note: All articles on Utah’s New LLC Act are in the process of being updated to conform to the changes made before it was enacted in 2014. Please check back to see the revised articles.
The traditional approach to advising clients as to ‘choice of entity’ when forming a new business organization has been to consider possible entity candidates only in terms of C corporation vs. S Corporation vs. LLC (either member-managed or manager-managed) vs. limited partnership–usually all formed under the laws of the same state or jurisdiction, such as Utah. That approach has usually focused on two groups of issues–the tax issues and the non-tax issues. Choice of entity is more complex now than before. Why? There are two basic reasons: improved Internet access and new entity choices.
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1. Internet Access to Laws of All 50 States.
The Internet, cheaper data storage and improved electronic communications have enabled easy access to the statutory laws of all 50 states as well as the ability to file entity documents electronically from anywhere. And filing fees can be paid with credit cards, also via the Internet. With these technology break-throughs, more entity choices are available now than ever before. In fact, the breadth of choices is mind-boggling.
Rather than use the traditional approach to choose an entity, the astute advisor is now able:
–via the Internet, to forum shop for the entity law, structure and allowable attributes most friendly to the client’s needs in the particular situation;
–via the Internet, to consider and compare the tax and non-tax attributes of not only the four traditional choices of entity, but to also consider those attributes for other types of entities or variants of those entities [see 2. below] and to consider the unique features of each entity candidate under the laws in each of the 50 states (where applicable);
–to recommend to the client the entity jurisdiction, structure and attributes most conducive to the client’s needs; and
–via the Internet, to prepare and file entity formation documents in any of the 50 states.
With this enhanced breadth of choices, an astute advisor can provide internal agreements or bylaws and advice tailored to the chosen entity and the client’s needs.
2. Additional Entity Choices.
Currently, there are other entities or variants of entities that were not around a decade or two ago. Some of those variants may be useful only in a restricted application and others could be used in a variety of situations. Some examples include:
At-Will General Partnership–a variant of a general partnership and available under UUPA and RUPA
Term General Partnership–a variant of a general partnership and available under UUPA and RUPA
LLP–a variant of a general partnership but with limited liability for the partners and available under UUPA and RUPA
LLLC–a variant of a limited partnership but with limited liability for the general partners and available under UULPA and ULPA
Series LLC–a variant of an LLC and available under the Existing LLC Act or under the New LLC Act
PLLC–a variant of an LLC for use with a professional practice and available under the Existing LLC Act or under the New LLC Act
Low-profit LLC–a variant of an LLC for use in certain private/tax-exempt projects and available under the Existing LLC Act or under the New LLC Act
Thus, there has been a paradigm shift in the choice of entity process that enables professionals with knowledge of the laws of multiple entities, and the entity laws of multiple states, as well as tax laws, to provide much quicker and more targeted entity choices for the client.
The Good, the Bad and the Ugly
The New LLC Act and its mother, the Uniform LLC Act (RULLCA), are a mix of good and bad when being considered for the desired choice of entity. A review of some attributes will highlight a few of the distinctions:
A. Secrecy & Anonymity.
If secrecy and anonymity are the goal, the New LLC Act is tops! It requires no disclosures about an LLC on the public file except its name, its registered agent and, when its first annual report is filed one year after formation, its principal office address. Nothing else. All other LLC data is private, including:
- the LLC purpose
- the LLC management structure (manager-managed or member-managed)
- identity of LLC members and managers
To say it another way, if transparency is your LLC’s goal, the New LLC Act is not for you!
If disclosure on a public file is the goal, a limited partnership or LLLP formed under UULPA or ULPA are better than an LLC formed under the New LLC Act. UULPA, adopted as part of SB 131, requires more public disclosure than the New LLC Act. A certificate of limited partnership must include the name and address of each general partner of a limited partnership. [§48-2d-201(1)(c)] Thus, the ‘manager’ of a limited partnership cannot be a secret.
B. 50/50 Ownership.
For an LLC with 50/50 ownership, the New LLC Act is the worst since it omits all deadlock remedies and provides no exit remedy for a 50/50 LLC.
Where certainty and predictability are desired, the New LLC Act is a bad choice. By dethroning statutory apparent authority [See “NCCUSL’s Struggle With ‘Apparent Authority’“] (which in Utah practice has become actual authority due to Internet access), by endorsing the private operating agreement as the primary embodiment of critical LLC data (purpose, management structure, identity of members/managers, limits on authority to bind, etc.), by deleting default guidelines for member meetings, by deleting guidelines for determining the fair market value of a member interest in an LLC, by allowing the operating agreement to be oral, implied or written–or any combination thereof, by deleting the duty of a member to return mistaken distributions, by including no default rules for allocating profits and losses, by enabling fiduciary duties to be diminished or eliminated and ‘other’ unspecified fiduciary duties to be created, and by failing to provide rules to distinguish between a distribution of profits and a return of capital, the New LLC Act has created a monster of uncertainty for anyone dealing with an LLC formed under that law. As a consequence, due diligence efforts will be far more time-consuming and more costly for an LLC formed under the New LLC Act than for an LLC under the Existing LLC Act.
The king of all uncertainty is that SB 131 repealed the Existing LLC Act in its entirety, effective July 1, 2012, but, absent an affirmative election by an existing LLC, the New LLC Act will not become effective for existing LLCs (formed before July 1, 2012) until January 1, 2014, 18 months later. Thus, there will be no statutory default rules or LLC enabling statute for existing LLCs during that 18-month gap. Hopefully, once the sponsor of SB 131 and the Utah legislature discover this major oversight, they will take immediate action to correct it.
D. Reduce or Eliminate Fiduciary Duties.
For an LLC whose control people want no fiduciary duties (or diluted fiduciary duties), the New LLC Act is an excellent choice since it enables that goal as well as any other LLC statute except Delaware’s.
E. Putting Creditors On Their Heels.
The New LLC Act is disadvantageous to creditors in many ways:
- It creates an environment of uncertainty regarding critical LLC rules [See Paragraph C. above].
- It increases the time and cost to creditors of conducting due diligence.
- It slows down foreclosure of a charging order lien against the judgment debtor’s LLC interest by requiring a predicate showing to the court that the debt would not otherwise be collected “within a reasonable time” before the court may allow foreclosure to proceed.
- It fails to provide default rules for allocating LLC profits and losses and for distinguishing between a distribution of LLC profits and a return of LLC capital.
- In effect, its defects and omissions require more details to be included in an LLC operating agreement than ever before in order to create more certainty of outcome.
- By inducing LLC advisors to look to LLC statutes that are clearer and more comprehensive than the New LLC Act, many LLCs that would otherwise be formed in Utah will be formed in states outside Utah, and that situation will require Utah lender personnel to review and consider the laws of multiple states in granting loans and in conducting due diligence.