Basics of North Carolina limited liability companies
Limited liability companies (“LLC”) are extremely popular in North Carolina, due in large part to their flexibility and ease of operating. It is important that you understand some basics, however so that you make the right decision about starting an LLC and operating it correctly under North Carolina law.
I. BASIC STRUCTURE OF AN LLC
The owners of the LLC are the “members” as defined in the North Carolina Limited Liability Company Act (the “Act”), found at Chapter 57D of the North Carolina General Statutes. The LLC may be managed by its members, or it may be managed by one or more managers elected by the members (the “managers”). The governing agreement for the LLC is called an “Operating Agreement”. In a member-managed LLC, each member has the power to bind the LLC. However, in a manager-managed LLC, no member has the power to bind the LLC (just as no shareholder of a corporation can bind the corporation); only a manager or authorized officer of the LLC can bind the manager-managed LLC.
Management duties include decisions about key policies, LLC transactions, and establishment of guidelines within which the business of the LLC will be conducted. The managers can hire officers and employees to perform the LLC’s day-to-day business.
The principal distinguishing feature of an LLC is the limitation of liability which the members of the LLC enjoy (like a corporation), as well as the pass-through income tax treatment enjoyed by the LLC and members (like a partnership). So long as the LLC is properly formed and in existence, and is properly operated, the members will not be personally liable for the LLC’s debts, obligations, and liabilities. In other words, if the LLC’s debts exceed the value of the LLC’s assets, the LLC’s creditors should not be entitled to seek repayment from the members’ personal assets.
Of course, a personal guarantee of an LLC obligation by an LLC member would give rise to personal liability of that member to the extent specified in the guarantee (as it would for a shareholder in a corporation). Failure by a member to remit employee withholding taxes can provide another basis for personal liability of a member (as it would for a shareholder in a corporation). Liability based on the personal tortious behavior of a member would of course provide the basis for personal tort liability of that member (as it would for a shareholder in a corporation). But generally, the LLC liability shield, like the corporation’s liability shield, should protect individual members from LLC debts, obligations, and liabilities.
The following is a brief description of the roles of the major players in an LLC – the members and the managers. Although the following is written as if members and managers are separate persons, the same individuals could serve as members and managers.
A. Members
The members own the LLC and provide the capital with which the LLC commences its business. In a member-managed LLC, members by definition manage the business of the LLC. In a manager-managed LLC, members as a group often do not take an active role in running the business. Normally one or two members will be intimately involved in day-to-day operations of the LLC, and other members will be passive, non-active investors. Beyond electing the managers and voting on certain key events in the LLC’s life, the members of a manager-managed LLC entrust management of the LLC to the managers (much like the shareholders of a corporation entrust management of the corporation to the directors and officers of the corporation). Matters requiring member votes are discussed in “Member Votes” below.
B. Managers
Managers are elected by the members. At the outset managers can simply be specified in the operating agreement, which is of course approved and signed by all members. Thereafter, if the operating agreement so permits, members can hold annual or other regularly scheduled meetings to elect managers. Managers manage the business and affairs of the LLC and exercise the LLC’s powers. Managers may either perform these responsibilities themselves or these responsibilities can be performed by officers and employees under the direction of the managers.
In performing these responsibilities, the Act imposes on managers the same fiduciary duty with respect to the LLC and its members that a general partner owes to a general partnership and the other partners of that partnership. It is permissible to modify and otherwise refine the fiduciary duty of the manager in the operating agreement. Indeed, it is advisable to do so. Typically the operating agreement will specify fiduciary duties such as the “duty of loyalty” and the “duty of care” for LLC managers.
The duty of loyalty dictates that a manager must act in good faith and must not allow personal interests to prevail over interests of the LLC and the LLC’s members. A standard example that raises these issues is a proposal that the LLC enter into a transaction which benefits a manager, or involves the manager in a conflict of interest between the manager and the LLC or its members. Such transactions are often called “self-dealing” transactions. They are not prohibited, but such transactions must be predicated upon (i) full disclosure, (ii) proper approval from disinterested managers and members, and (iii) fairness to the LLC and its members.
The duty of care requires a manager to be diligent and prudent in managing the LLC’s affairs. This is sometimes referred to in corporate law as the “business judgment” rule. If a manager makes a decision, conscientiously and without fraud or conflict of interest, such manager will not be second-guessed by courts based on how that decision happens to work out for the LLC. A manager is not held liable merely because a carefully made decision turns out badly.
C. Officers
Like a corporation, the LLC members and managers can appoint officers for the LLC who serve at the pleasure of the managers, subject to contracts of employment (if any) such officers may have with the LLC. The officers perform the bulk of the day-to-day operation of the LLC’s business. Normally an LLC will want at least a General Manager (or President), a Chief Financial Officer, and a Secretary. More than one of these offices can be held by the same individual. An LLC may have additional officers. These additional officers are either appointed by the General Manager or another officer if such officer has been delegated authority to make such appointments.
The following is a brief summary of the standard duties of the following officers. All of these could be modified by the managers.
General Manager or President. The General Manager is the Chief Executive Officer and general manager of the LLC unless the LLC has a Chairman of the Board and has designated the Chairman as Chief Executive Officer. The General Manager has general supervision, direction, and control over the LLC’s business and its officers. The General Manager can also be called the President of the LLC.
Chief Financial Officer. The Chief Financial Officer keeps the books and records of account of the properties and business transactions of the LLC. These duties include depositing corporate funds and other valuables in the name of the LLC and disbursing funds as directed by the managers. The Chief Financial Officer also typically serves as the “tax matters partner” for the LLC as required under the Internal Revenue Code.
The Secretary of an LLC keeps the LLC’s Articles of Organization, Operating Agreement, record of members’ addresses and holdings in the LLC, and written minutes (if any) of the proceedings of the LLC’s members and managers. The Secretary usually has the duty of giving notices to members and managers of members’ and managers’ meetings.
II. MEMBER VOTES; MANAGER ACTIONS
A. Member Votes. Certain fundamental changes in the life of an LLC, such as a merger or liquidation of the LLC, require a vote by the members. These fundamental changes include amendment of the Articles of Organization, amendment of the Operating Agreement, merger or consolidation of the LLC, and winding up and dissolution of the LLC.
B. Manager Action. Matters of general operating policy should be considered and authorized by the General Manager or managers of the LLC. Although there is no statutory requirement with respect to how frequently the managers should act, it is advisable that the managers meet at least quarterly. In addition, a specially convened meeting of the managers may be called if action is required before the next regular meeting of the managers. Action by the managers may also be taken by the unanimous written consent of the managers. Although it is likely that most manager actions will be taken by unanimous written consent without a meeting, it may prove useful to schedule regular managers’ meetings to address significant matters which have arisen on a quarterly or, at least, annual basis. Manager meetings can be held either in person or by telephone conference so long as all managers in attendance can hear each other simultaneously.
Matters appropriate for manager action, which can be immediately approved by written consent or which might arise and be accumulated, pending approval by the managers, include the following:
Appointment of officers, setting of salaries, and declaration of bonuses (at least annually, typically at a meeting of the managers immediately following the annual meeting of members).
Appointment of manager committees, if any.
Opening of LLC bank accounts and the designation and change of LLC managers and officers authorized as signatories.
LLC borrowing and delivery of collateral in connection with such borrowing.
Consummation of material contracts for the purchase or lease of significant assets or services or the disposition of LLC assets or for the rendition of services outside the ordinary course of the business of the LLC.
Policy decisions with respect to the construction of material assets or the investment of material amounts in research and development projects.
The adoption of pension, profit-sharing, bonus and other employee benefit plans.
The repurchase of LLC interests.
Amendment of LLC bylaws (if any).
Review of financial statements of the LLC.
Appointment of auditors, if any.
Any action which requires a member vote.
The issuance and sale by the LLC of additional interests in the LLC.
In the case of any such actions, the Secretary of the LLC should prepare minutes of the meeting at which such actions were approved or prepare the form of written consent evidencing any such manager or member actions.
III. SEPARATION OF LLC AND PERSONAL ASSETS
It is important for any company to respect the difference between the company’s bank accounts, property, equipment, and other assets and personal assets owned by the company’s owners. An LLC, like a corporation or other legal “person,” is a separate legal entity with assets that are owned by the LLC. Any attempt by an LLC member to dispose of or use LLC property would be no more proper than an attempt by that member to dispose of or use another member’s personal property. Members must respect the fact that the LLC’s assets are the property of the LLC, not the members. Similarly, an LLC member should not intermingle such member’s personal assets with the company assets of the LLC.
The Company’s books, records, and financial statements should be maintained clearly to reflect the separation of the Company’s assets from the personal assets of the members. The Company must conduct business in its own name (not in the individual name of any manager or member). All letterhead, business card, bills, checks, invoices, and other Company forms should show the Company’s full legal name (and fictitious business name, if any), and the Company’s current address, telephone number, and telefax number.
As a statement of sound business practice the observations made about separation of personal assets from company assets are fairly obvious. There is an additional, less obvious reason to follow those rules.
Creation of an LLC shield from liability for LLC members inevitably gives rise to attempts to pierce that shield by creditors of the LLC. This has long been the case for the liability shield of corporations. As long as there have been corporations, there have been attempts to “pierce the corporate veil.” Published cases in which such attempts have been successful usually involve a recitation by the court of a list of factors in support of the court’s ruling that the shareholders of the corporation should be held personally liable for the debts, obligations, or other liabilities of the corporation. Those factors are summarized in the relevant jury instruction (NCPI Civil 103.40) as follows:
Whether the LLC was inadequately capitalized;
Whether the LLC’s officers, members, managers or partners complied with the formalities typical of organizations of its kind;
Whether the defendant completely dominated and controlled the LLC so that it had no independent identity;
Whether the defendant’s business was a single enterprise that was excessively fragmented into multiple companies;
Whether the LLC had made distributions;
Whether the LLC was insolvent;
Whether the defendant had siphoned funds from the LLC;
Whether the officers, members, managers or general partners of the LLC were actually functioning and performing the duties of their respective offices in the LLC; and
Whether the LLC was properly maintaining ordinary and necessary company records.
LLC members and managers are well advised to bear in mind the foregoing observations about piercing the corporate veil.
IV. ADEQUATE CAPITALIZATION
The Company should be adequately capitalized to carry on the Company’s business activities. This is of course an obvious statement of sound business practice. A less obvious reason to assure that the Company is and remains adequately capitalized concerns the piercing-the-corporate-veil case law discussed above. One of the factors enunciated by some of the courts that have ruled that creditors of a corporation should be allowed to hold the shareholders personally liable for debts and obligations of the corporation is that the corporation was not adequately capitalized. Hence, adequate capitalization is an additional, very important factor relating to the shield from personal liability provided by the LLC for its members.
V. OTHER POST-FORMATION MATTERS
Although it is not intended to be exhaustive, the following checklist summarizes some of the legal requirements applicable to a new LLC. Some of the requirements arise as a consequence of formation of the LLC; others apply to all new businesses regardless of the form of organization. Certain requirements are highly formal and technical; many must be satisfied within a specified time period. Care must be taken to comply with these matters as they arise because in many cases there are serious penalties which can be assessed for failure to comply.
A. Local Business License. The LLC may be required to obtain a business license from the city in which it intends to operate.
B. Employer Identification Number. Every employer must obtain an employer identification number which will be used on federal tax returns and certain other documents.
C. Annual Report. Each year, the LLC must submit an annual report with the North Carolina Secretary of State.
D. State and Federal Income Taxes. I recommend that you consult with a trusted accountant on all matters pertaining to taxation of your LLC at both the state and federal level.
E. Payroll Withholding. If the LLC has employees, state and federal law may require you withhold income tax and social security tax from taxable wages paid to employees. I recommend you consult with your accountant or payroll company on any applicable withholdings.
F. Workers’ Compensation. You may be required to carry workers’ compensation insurance to cover any covered employees. Check with your insurance agent to see if that is required for your LLC.
G. Trademarks; Trade Names; Trade Secrets. Company trademarks and trade names should be registered in the Company’s name with the U.S. Patent and Trademark Office. Trade secrets of the Company should be protected by obliging Company employees to sign confidentiality agreements.
H. Securities Law Matters. If all members of the Company are actively involved in the management of the Company, and have the experience and ability necessary to manage the Company, then the interests in the Company would likely not constitute “securities” under North Carolina or federal law. If any of the members are “passive” investors, then the offer and sale of an interest in the Company to such investor would constitute the offer and sale of a “security.” Normally such offers and sales can be structured to satisfy the requirements for exemption from registration under federal and state securities laws. If no exemption is available, then the securities would require registration pursuant to federal and state securities laws.
I. Fictitious Business Names. If the Company intends to transact business using a name other than that specified in its Articles of Organization, the Company must file a fictitious business name statement with the register of deeds of the county in which it has its principal place of business. You can get more information about the process, as well as forms, on the North Carolina Secretary of State website by going here: https://edpnc.com/start-or-grow-a-business/start-a-business/business-forms/
J. Qualification in Other States. States universally require a “foreign LLC” (one not incorporated in that state) to “qualify” before “doing business” in such state. Qualification usually consists of the filing of documents, payment of a fee, and appointment of a resident agent for service of process. “Doing business” is more often defined by the exceptions than by an enumeration of specific acts which are covered by that term. However, if the LLC elects to do business (e.g. open an office) in another state, it will be required to qualify in that state. Failure to qualify may result in financial penalties as well as the inability to bring suit in the courts of the state with respect to acts and transactions in the state during the period of the violation.
VI. GENERAL
A. Signing on Behalf of the LLC
Whenever the LLC members, managers or officers are signing agreements, documents, or correspondence on behalf of the LLC, care should be taken to include the LLC’s name in the signature block and to indicate the title of the person signing. An example of an appropriate signature block is included below:
[LLC name]
By: __________________________
Name: [name of individual]
Title: [Member, Manager, etc.]
Failure to do so may lead, in the context of litigation involving a signed document, to including the person who signed the document in the lawsuit in his or her individual capacity.
B. Bylaws
The Operating Agreement and Articles of Organization of the LLC are the authoritative source of advice as to how to do certain things that will come up from time to time. For certain types of LLCs (normally those with a larger number of members), a form of bylaws similar to the type of bylaws applicable to a corporation may be advisable or useful.
C. Official Documents
A number of small LLCs have found it useful to designate one of the officers, usually the Secretary, to be the recipient of all “official” correspondence concerning the LLC and its relationships with the various government agencies with which it deals. This helps to avoid forgetting to submit certain of the regularly filed forms, which are simple documents but can lead to trouble if they are not taken care of promptly.
Questions?
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This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.
