Overview on Business Structures 2012-02-19T06:04:55+00:00

Fri 20th Aug 2010

Overview on Business Structures

Overview on Corporations & LLC’s and The Theory of Asset Protection

Corporations, specifically “S”-designated corporations, are very similar to limited liability companies (LLC) in terms of protection and structure. For instance, corporations are run by directors, which is the equivalent of the management of the LLC’s by managers and managing members.[1] Another similarity includes distributions to both shareholders and members from profits of the business of their respective company.[2]

One interesting comparison is how both allow for piercing the corporate veil (even though an LLC is not a corporation).[3] They also both provide for the application of certain case law to determine whether a company can be pierced.[4]

Yet, the most important similarity is the limitation of liability for the shareholders and members. The limitation of liabilities for corporations and LLC’s provide for protection of shareholders and members against actions taken by the company.[5] Should the company be placed in a litigious position, liability of shareholders and members is limited to their investment in company, regardless of the kind of investment (e.g., cash, equipment, real estate, etc.). Additionally, directors for corporations and managers (including member managers) for LLC’s are indemnified for the majority of actions taken while performing their roles in the company.[6]

However while many similarities exist between the two structures as contained in the statutes, there are a few notable differences. The first obvious difference is suffix to the name of the company. For corporations, all companies must end in “Corp.,” “Co.,” or “Inc.” If the corporation is a professional corporation, such corporation requires the suffix, P.A. LLC’s, instead, are required to have a suffix of “LLC” following the name or LLP in the case of a professional limited liability company.[7] Filing fees are also different. For corporations in the State of Florida, the incorporation filing costs are $70.00 which includes $35.00 for filing the articles of incorporation and $35.00 for filing the registered agent.[8]

Also, corporations in the State of Florida are required to file an annual report of $61.25 for each subsequent year after the year of incorporation.[9] LLC’s though, require $125.00 for creating an LLC, which includes $100 for filing the articles of organization and $25.00 for filing the registered agent.[10] Like their corporate counterparts, an LLC also has an annual report fee which is $50.[11] (It should be noted that both corporations and LLC’s each charge a supplemental fee of $88.75.[12]) Additionally, the documents to setup both formal structures are different: corporations use articles of incorporation and LLC’s use articles of organization.[13]

Transfer of Ownership and The Issue of Asset Protection

The biggest difference between corporations and LLC’s is the transfer of ownership. While no specific section discusses transfer of ownership, Chapter 607 does discuss transfer of ownership within various sections to create an implicit conclusion that one may transfer his/her shares to another individual without the consent of the other shareholders (barring a restriction).[14] LLC, conversely, have standard restrictions on transferring ownership requiring a majority (if not unanimous) vote of members in order to admit members into to the partnership.[15] In addition, absent a provision in the articles of organization or operating agreement, members cannot resign from the LLC prior to dissolution of the partnership.[16]

As stated earlier, both corporations and LLC’s share limited liability towards their shareholders/members, thereby not holding them jointly liable for actions resulting from the company’s dealings. However, what would happen if the shareholder/member was to incur liability as a result of his/her own personal actions which was unrelated to the company? If a shareholder/member were unable to satisfy the debt obligation, there would be nothing stopping the creditor from attaching the shareholder’s/member’s interest in the company. And then, use his/her interest to plunder the company in order to satisfy the debt at the expense of the company.

Although members may transfer their interest in the partnership, it may only be with respect to the receipt of profits and distributions.[17] In contrast, shareholders in corporations may restrict the alienability of shares through shareholder agreements.[18] Though not explicitly stated, the restrictions on alienability of shares are not automatic requiring pro-activity on the part of the shareholder(s).[19]

Despite the fact that Florida law does seemingly protect the LLC from harm resulting from personal actions by the members unrelated to the business, there seems to be a discrepancy within the law itself, specifically between §§ 608.432, 608.402 and 608.431. According to § 608.402, membership interest includes “a member’s share of the profits and the losses of the limited liability company, the right to receive distributions of the [LLC’]s assets, voting rights, management rights, or any other rights under this chapter or the articles of organization or operating agreement.”[20]

According to section 608.431, a member’s interest in an LLC is personal property.[21] When combining these two statutes, it could lead one to conclude that membership interest likely includes a property right sufficient to give voting power. It was from this perspective that one should analyze LLC’s and see if a creditor could still gain voting rights through the debtor’s interest of the LLC. However, the lack of case law regarding LLC’s leaves this discussion very much open for debate.

Corporations, meanwhile, may restrict the transfer of shares like LLC’s.[22] However, under certain conditions, it may not prevent a transfer of ownership leaving the company exposed to looting by creditors.

II. The LLC

An LLC’s main attribute is its asset protection characteristics. Absent a decision by a unanimous vote of the other members, a member’s ability to transfer interests to another is limited to profits, distributions, and any other funds owed to the member.[23] Therefore, a member would not be able to transfer voting rights to another absent approval by the other members. In essence, this feature shields the LLC from the actions of its members which is the LLC’s attractive feature.

Section 608.402(23)

As stated earlier, the problem with easily concluding the transfer limits of an LLC lies in the definition of membership interest as per § 608.402. In the section, one could conclude the interest may not necessarily be limited to distributional interest but may also be expanded to include additional interests such as voting powers. Additionally, the Florida statutes do not provide for an exception to the definitions contained within the sections since the section used the phrase “As used in this chapter” instead of using language such as “unless otherwise stated in the chapter.”[24] Therefore, it was important to determine if the definition was meant to be inclusive or if it was meant to allow for deviations such as those stated in §§ 608.432 (discussed later) and 608.433.

§ 608.432

This particular statute discussed the area of assignment of interest. According to the statute, it claimed the only interest transferable was the right to receive profits and distributions.[25] However, when cross-referenced with §§ 608.402 (discussed earlier) and 608.431, a contradiction seemed to emerge since an interest was not limited to just economic.

Single Member LLC’s Not Considered

It should also be pointed out a recent Florida Supreme Court decision created more doubt as to the extent of asset protection. In Shaun Olmstead v. Federal Trade Commission, the Court decided the entire interest held by a member of single-member LLC including “all right, title, and interest” could be included as part of the member’s personal assets to satisfy a judgment against the individual.[26] The Court’s decision, while focused on single-member LLC’s may open the door to re-examining the strength of asset protection of multi-member LLC’s in the future.

Corporations

According Florida Law, shareholders’ powers can be limited if so stated in the articles of incorporation.[27] The question is to what extent can those powers be limited and do those limitations include restrictions on transfer of shares? The following seeks to determine whether or not that is the case.

1. Notable Discussions Prior Transfer Discussions

Before continuing, it is important to note certain points such as those discussed in Werber v. Imperial Golf Club, Inc., which discussed how a corporation could reacquire stocks.[28] However, reacquiring stocks is an act that must be included within the articles of incorporation to be valid.[29] Additionally, the general concept is that any agreements, if legal, within the articles amounted to a contract between the state, the company, and the shareholder(s).[30] Both these points play into the discussion of transfers of shares since transfers could occur within the confines of the shareholder(s) and the company itself.

Another issue deals with amending the articles of incorporation to allow for share transfer restrictions if none exist. An amendment to the articles may be made by the majority (or unanimous) vote of the shareholders and takes effect as set forth in the amendment.[31] If not set forth in the amendment, the amendment would take effect as having occurred when the articles of incorporation were originally filed.[32] Amending the articles of incorporation would mean that if a shareholder agreement were not in place in the beginning, one could add such an agreement as part of the articles of incorporation well after the formation of the company and have the same validity as if it was entered when the original articles were first filed.

2. Transfer of Shares

It is important to note “a shareholder generally may not withdraw from a stock corporation. A holder of shares cannot withdraw the value of his or her shares from the capital of the corporation without the consent of the corporation, unless the ‘winding up’ stage of the corporation’s existence has been reached.”[33] This serves as the first restriction on shares on shareholders. A sale must occur for the transfer to take place including one with the corporation which may amount to nothing more than giving money back to a shareholder in exchange for his/her shares.

Another possible restriction deals with the accounting regarding the shareholder’s amount invested. According to Wall, since the articles of incorporation and by-laws were silent as to the process for a shareholder to resign, he may do so but he is not entitled to an accounting as to his portion of the amount invested.[34] In essence, one could say there may be an inherent restriction on alienability of shares should no agreement be included in the articles. Reason being, while individuals may wish to sell their shares they are not entitled to an accounting of their capital interest in the company absent an agreement.

However, the best and clear restrictions on transferring shares lie with shareholder agreements. Shareholder agreements can take many forms and normally involve the shareholders’ control within the corporate structure.[35] However, the pertinent shareholder agreements are those written within the articles of incorporation stipulating how the shares owned by a shareholder can be transferred by the shareholder. According to the Florida law, so long as the agreements are within the articles of incorporation or by-laws the shareholders could enter into these agreements “even if these agreements may be inconsistent with certain provisions of ch. 607, F.S.”[36] In fact, in Weissman, the court stated how language in the bylaws, articles of incorporation, and stock certificates provided ample authority to restrict alienability.[37]

In McTeague, shareholder agreements were binding so long as shareholders reviewed and understood such an agreement.[38] Furthermore, the court in Hammond created a restriction on the alienability of shares by restricting shareholders who had an outstanding debt to the company from selling their shares until the debt was satisfied; they could not use the value of the shares of stock to offset the debt.[39]

Yet, there is always the possibility that any new shareholders may end up with majority voting rights if the debtor shareholder had majority voting power. This would, of course, render this entire analysis moot as they could simply amend the by-laws and/or articles of incorporation accordingly allowing them to obtain an accounting as to value of the shares.

Because of the possibility of a majority shareholder becoming a debtor to another, most corporations have a restriction in place within their corporation’s articles of incorporation and by-laws on shares known as the Right of First Refusal. Under the Right of First Refusal, the corporation and/or existing shareholders have the right to purchase the shares of the selling shareholder before the shareholder may offer them for sale to the public. This restriction helps remove the absolute of risk posed by creditors of debtor shareholder. Additionally, the Steinberg ruled that despite no set price for right of first refusal was provided, restrictions are still valid since the third party’s offer “triggered right of first refusal” and created the set price.[40]

While generally effective, restrictions on shares are not a complete bar to preventing creditors from reaching control of shares and some loop holes may exist. In Coleman v. Coleman, it ruled how the contract, establishing authority to create such restrictions on alienability of stocks, is limited since too much restriction on ownership rights can be unreasonable.[41] The court went on to say how bylaws may become so restrictive that they may even be waived, amended, or repealed under the theory of equitable intervention.[42]

III. Conclusion

After reviewing both structures, it is evident that they are very similar in their protection of both the member/shareholder from the operations of the company as well the vast majority of other provisions. However, the differences in protecting the company from the shareholder/member remain. While, ultimately, both can and should protect companies from an insolvency and/or judgment levied directly against the shareholders/members independent of the company’s operations, the possibilities still exist for both structures to be negatively impacted.

For LLC’s, the partnership inherently restricts transferability of voting rights. Of course, in Florida there are discrepancies since its definition of a member’s interest found in one section conflicts with statements in another section. What’s worse, no Florida court to date has addressed this discrepancy. However, the possibility exists for a creditor to influence the decision of debtor members to vote in a particular way opening the flood gates for new issues with the LLC form of organization. And, of course the LLC’s lack of ease of transferability to remove members makes it difficult to swiftly resolve the problem. Also, unlike corporations, they must pay anyone who is successfully removed a fair market value.[43]

As for corporations, absent a shareholder agreement, a corporation could still find itself in a compromising position of having to deal with creditor shareholders who may wish to loot the company to recover damages against the predecessor shareholder. This could happen from simply having had a shareholder not receiving notice of the restriction or having restriction overly burdensome.

It is important to note a distinct advantage LLC’s maintain over corporations (specifically “S” corporations). LLC’s have the ability to have unlimited members within the organization regardless of citizenship and residency.[44] S corporations, while having tax advantages similar to LLC’s, are limited in the number of shareholder that can be in the company to 100 shareholders and they must all be either U.S. citizens or U.S. residents.[45] Therefore, LLC’s are clearly the optimum company if one plans on having more than 100 owners.

Selecting the best form of organization must be done on a case by case basis. While an LLC seems attractive, many of the benefits that are found in the LLC exist in the “S” designated corporation. Additionally, more case law and law in general exist on corporations reducing the uncertainties that are sure to come in the courts as the LLC continues to legally develop as was the case in the decision regarding single-member LLC’s. However, the recent SECA Tax being proposed in Congress to tax S corporations could sway the decision well in favor of LLC’s. Finally, for those forming a company in Florida and considering an LLC, the discrepancy that exists in the law is enough to consider corporations to avoid future problems that may erupt as the law on LLC’s develops.

[1] Fla. Stat. § 607.0205 (2010); Fla. Stat. § 608.422 (2010); Fla. Stat. § 608.4225 (2010).

[2] Fla. Stat. § 607.06401 (1990); Fla. Stat. § 608.426 (1999); and Fla. Stat. § 608.4261 (1999).

[3] Fla. Stat. § 608.701 (1999).

[4] Id.

[5] Fla. Stat. § 607.0622 (1997); Fla. Stat. § 608.4227 (2002); Fla. Stat. § 608.4228 (2002).

[6] Fla. Stat. § 607.0850 (1997); Fla. Stat. § 608.4229 (2002).

[7] Fla. Stat. § 607.0204 (1989); Fla. Stat. § 608.406 (2007).

[8] Fla. Stat. § 607.0122 (2003).

[9] Id.

[10] Fla. Stat. § 608.452 (2005).

[11] Id.

[12] Fla. Stat. § 607.193 (2007).

[13] Fla. Stat. § 607.0202(2)(b)(3) (1993); Fla. Stat. § 608.407 (2007).

[14] Fla. Stat. § 607.0621(5) (2010); Fla. Stat. § 607.0627 (2010); Fla. Stat. § 607.0732 (2010), [hereinafter “FN14”].

[15] Fla. Stat. § 608.432 (2010).

[16] Fla. Stat. § 608.427 (2010).

[17] Id.

[18] FN14, supra note 14.

[19] Id.

[20] Fla. Stat. § 608.402 (23) (2010).

[21] Fla. Stat. § 608.431 (2010).

[22] Fla. Stat. § 607.0627 (2010).

[23] Fla. Stat. § 608.433(1) (2010).

[24] Fla. Stat. § 608.402 (23).

[25] Fla. Stat. § 608.432.

[26] Shaun Olmstead v. Federal Trade Commission, 35 Fla. L. Weekly S 357 (Fla. 2010).

[27] Fla. Stat. § 607.0202(2)(b)(3).

[28] Werber v. Imperial Golf Club, Inc., 413 So. 2d 41 (Fla. 2d DCA 1982).

[29] Id.

[30] 26 Fed. Digest 4th, Corp., Cert. or Art. of Asso. (Supp. 2007).

[31] C.J.S. Corporations §§ 25-27, 33, 41, & 76, 82 [hereinafter “CJS”].

[32] Id.

[33] CJS, supra note 30, at 376 part 2.

[34] Wall v. Bureau of Lathing & Plastering of Dade County, Fla., Inc., 117 So. 2d 767 (Fla. 3d DCA 1960).

[35] Fla. Stat. § 607.0732 (2010); Fla. Stat. § 607.0731 (2010).

[36] H. 1825, 281th Leg., Reg. Sess. (Fla. 1993) , Fiche 93-279-93-284 (1990 FL Leg. Staff Analyses, St. Thomas Univ. Microform).s

[37] Weissman v. Lincoln Corp., 76 So. 2d 478 (Fla. 1954).

[38] McTeague v. Treibits, 388 So. 2d 309 (Fla. DCA 1980).

[39] Id.

[40] Steinberg v. Sachs, 837 So. 2d 503 (Fla. 3d DCA 2003).

[41] Coleman v. Coleman, 191 So. 2d 460 (Fla. DCA 1966).

[42] Id. at 470.

[43] Fla. Stat. § 608.427 (1999).

[44] Fla. Stat. § 608.4232 (1999).

[45] I.R.C. § 1361 (b)(1)(A) (2007).