Form an LLC or a Statutory Close Corporation

April 13, 2006

	Visited: 151
	Not rated
	Rate:

The management structure and operating rules for the limited liability company (LLC) and statutory close corporation are extremely flexible. There are only a few rules imposed on these entities by statute. This can be a real advantage in terms of asset protection.

The failure to follow mandatory rules imposed on business entities makes up one of the main bases courts use in invoking the alter ego theory in order to pierce the veil of limited liability. A lack of mandatory rules should, to a certain extent, immunize the LLC and statutory close corporation from the application of this theory.

In contrast, a conventional corporation is governed by what are sometimes termed the "corporate formalities." The management structure and operating rules for a conventional corporation are imposed by statute. These mandatory statutory rules dictate that the corporation be governed by three classes: shareholders, directors and officers. The rules divide authority among these three groups. The rules also require shareholders and directors to hold meetings, at least on an annual basis. The rules define notice and quorum requirements for meetings, and provide strict procedures for waiver of meetings. Adequate records must be kept of all meetings.

It is not difficult to run astray of these rules. Salary, lease and loan agreements might be authorized by the wrong group, or not authorized at all. Scheduled meetings may not be held or formally waived. These failures are prime ingredients that may allow a creditor to make a claim based on the alter ego theory.

On the other hand, one group can manage the LLC and statutory close corporation: the owners (or a select number of owners). The management form is selected in the articles of organization (note that, in the case of the statutory close corporation, the necessity of a board of directors would have to be waived in the articles of organization). This eliminates the confusion that can arise when authority is divided among three groups (shareholders, directors and officers), each with its own specific authority.

Further, the LLC is not required, by statute, to hold any meetings. In the statutory close corporation, generally the articles can waive the necessity of a shareholder's meeting.

In each case, the entity is managed by an operating agreement signed by all of the owners. The absence of the division of authority among separate groups, and the absence of mandatory meeting requirements, should make it difficult for a creditor to prove a claim based on the alter ego theory.

Work Smart

Nearly all of the cases in which courts have applied the alter ego theory have involved conventional corporations.

Planners know that this theory will also apply to LLCs, but exactly how it will apply involves some degree of speculation. The argument advanced above, that the theory is less likely to apply to LLCs and statutory close corporations, because of a lack of statutory formalities, is not yet tested. In short, while this argument is likely to prove out in practice, there is no guarantee that every court will accept this argument.

Note, too, courts can invoke this theory in other ways that will apply to LLCs and statutory close corporations, such as when an owner: