COMMENTARY CONCERNING THE NEW YORK LIMITED LIABILITY COMPANY OPERATING AGREEMENTS
By: Lauris G. L. Rall
and Rich Williams
PLEASE NOTE THAT THESE FORMS ARE SAMPLES OF OPERATING AGREEMENTS THAT MAY BE USEFUL TO A PRACTICIONER WHO NEEDS TO FORM AND ORGANIZE A LIMITED LIABILITY COMPANY IN THE STATE OF NEW YORK. THE LIMITED LIABILITY COMPANY LAW OF THE STATE OF NEW YORK IS COMPLEX AND FORMATION OF A NEW YORK LIMITED LIABILITY COMPANY SHOULD ONLY BE UNDERTAKEN BY A PRACTICIONER WITH SUBSTANTIVE KNOWLEDGE AND EXPERIENCE WITH THE APPLICABLE LAWS. NOTHING IN THESE FORMS OR IN THIS COMMENTARY IS INTENDED TO BE OR SHOULD BE CONSTRUED AS LEGAL ADVICE AND IT IS THE SOLE RESPONSIBILITY OF THE USER OF THESE FORMS TO ENSURE COMPLIANCE WITH ALL APPLICABLE LAWS.
There are four forms of operating agreement included: Form 1A (Single Member), for a single member limited liability company (“LLC”) managed by its single member, Form 1B (Single Member), for a single member LLC managed by a manager, Form 2A (Multiple Members), for an LLC that is managed by a board of managers, and Form 2B (Multiple Members), for a multiple member LLC that vests management in one or more of its members. An LLC formed using either Form 2A or Form 2B is intended to be treated as a partnership for federal and New York State income tax purposes, unless it elects to be treated as a corporation. An LLC formed using Form 1A or Form 1B is disregarded as an entity separate from its owner for federal and New York State tax purposes, unless it elects to be treated as a corporation. See “Some Income Tax Aspects of Owning and Operating an LLC,” below.
Form 2A includes certain interlineated language between brackets ([ ]) that may be useful to a practitioner forming an LLC to purchase and finance the acquisition of real property. Those provisions could be adapted for use by the practitioner in the other Forms as well.
Form 2A may be used by a practitioner whose client desires an LLC with some traditional “corporate” characteristics, including use of a board of managers. The board may include members, non-members or some of each. Alternatively, a third party “manager” may be substituted for the board. The “manager” may be an individual or another entity, including another LLC. Form 2A also denominates membership interests as “shares” and includes certain provisions regarding transfer of “shares” analogous to rights and obligations of shareholders under shareholder agreements (see Sections 11.11 (Drag Along Rights) and 11.12 (Tag Along Rights) for example).
Forms 1A and 1B may be used for ownership of an asset or operation of a business by an LLC owned by a single member. The single member may be an individual or another entity, including another LLC, so that the LLC formed by another entity using Form 1A or 1B becomes a wholly owned subsidiary of that other entity. However, as noted above, for income tax purposes, the new LLC would be disregarded as a separate entity and would be treated as a “branch or division” of that other entity. If an additional member is added to a single member LLC, the members will need to adopt a new LLC operating agreement appropriate for a multimember LLC.
The use of managers who are not members, or the selection of less than all of the members to be managers, may cause membership interests to be securities under federal or state securities or “blue sky” laws. The Forms 2A and 2B each impose restrictions on transferability if compliance with applicable securities laws is not demonstrated. However, professional advice regarding compliance with securities laws in connection with the formation of an LLC or the issuance of membership interests is the responsibility of the practitioner advising thereon.
1. Name. The name of the LLC must contain the words “Limited Liability Company” , or the abbreviations “L.L.C.” or “LLC” without periods. The laws of any other state in which the LLC will qualify to do business should be examined to determine whether the use of abbreviations is permitted in that state.
2. Effective Date. An LLC is formed at the time of the filing of the initial Articles of Organization with the Department of State or at any later time specified in the Articles of Organization, not to exceed 60 days from the date of such filing.
3. Managers or Managing Members. Although Form 2B presumes that the LLC will be managed by one or more of its members, it is adaptable for an LLC that is managed by non-member managers. If non-member managers are selected, the references to “managing member” should be replaced with “manager,” a definition for manager (replacing managing member) should be added to Article I and other conforming changes should be made. Form 2A provides for management by a board of managers and is otherwise intended for use by persons who prefer to operate an LLC in a manner generally similar to the operation of a corporation.
4. Publication. Unlike limited liability company laws in other states, the New York Limited Liability Company Law (the “Act”) imposes a publication requirement, similar to that for New York limited partnerships.
5. Purpose; Nature of Business (Article III). The purpose clause can be completed with either a general business clause or with a specific purpose clause. However, before using a general business clause consideration should be given to the fiduciary duties of a managing member which may require that future business opportunities unrelated to the business actually conducted at any particular time be shared with, or disclosed to, the non-managing members.
6. Management Rights. Member consent to certain actions should be either unanimous or by some lesser stated percentage. Other actions, including a “catch-all” provision for any material decision not in the ordinary course of the LLC's business, can be considered for member consent, similar to provisions requiring limited partners' consent in a limited partnership agreement.
7. Standard of Care for Managers or Managing Members. Under the Act, it is unclear whether the members can contract among themselves for a different standard of care than that set forth in the law. However, Section 409 of the Act suggests that a managing member who acts " in good faith and with that degree of care that an ordinarily prudent person in a like position would use under similar circumstances" should have no liability by reason of being or having been a manager of a LLC.
8. Capital Contributions (Article VIII in Form 2A and Form 2B). Form 2A and Form 2B each requires additional capital contributions under certain circumstances. These Forms each permits the judicial enforcement of the capital call. Additional or alternative remedies are available such as buyout or dilution of the defaulting member's interest.
9. Allocations of Profits and Losses; Distributions of Cash Flow (Article IX in Form 2A and Form 2B). Form 2A and Form 2B each provides for the tax allocation of profits and losses, subject to certain special allocations mandated by federal tax laws. These Forms provide that tax allocations of profits will be made in accordance with distributions of cash flow, which may be preferable when provisions for cash flow distributions are complex. Of course, different allocations of profits and losses may be necessary to reflect the business bargain among the members, which will be permissible so long as the allocations comply with the federal tax laws. Because of the complexities of the tax laws, each practicioner using these Forms must consult with a tax practitioner at the time of formation of an LLC. See “Some Income Tax Aspects of Owning and Operating an LLC,” below.
10. Transfers; Admission of Substitute Members (Article XI in Form 2A and Form 2B). Form 2A and Form 2B each requires the consent (which may be unreasonably withheld) of other members holding at least a majority of the membership interests to a transfer of a member's interest (except for transfers to certain permitted transferees), other than an interest in profits, losses and distributions, as well as to the admission as a “substitute member” of a transferee of such an interest. Form 2A provides the members with a right of first refusal with respect to a proposed transfer of a member's interest. This provision could also be added to an LLC formed using Form 2B if desired.
11. Dissociation (Article XII in Form 2A and Form 2B). Form 2A and Form 2B each provides that upon the withdrawal or other dissociation of a member from the LLC, the LLC shall pay such member the “fair value” of such member's interest in the LLC. There are many alternatives to choose from to provide a “value” including independent appraisal as suggested by Form 2A and Form 2B or use of a formula or a fixed price. Form 2A and Form 2B should be supplemented with appropriate terms to reflect the members' agreement as to the alternative chosen. Furthermore, the Act provides that the operating agreement can vary the right of a member to withdraw (Section 606), and the amount to be paid to the dissociating member (Section 509), other than the final distribution for the period ending with the date of dissociation. If a dissociation is in breach of an operating agreement, any amounts distributable to a dissociating member may be offset by damages caused by the dissociation.
12. Dissolution (Article XIII in Form 2A and Form 2B). Form 2A and Form 2B each provide that the LLC will dissolve upon the first to occur of (a) the expiration of the term of the LLC agreement (unless the LLC is continued with the consent of all of the members) and (b) the written consent of the members holding at least two-thirds of the membership interests.
13. Company Regulations (Appendix I in Form 2A). Form 2A contemplates the inclusion (by appendix) of Company Regulations, which contain various provisions relating to the conduct of meetings, the election of the Board of Managers and various other matters, either suggested or permitted by the Act. Alternatively, Form 2A can include some or all of the provisions included in the Company Regulations. It is not required to include such provisions in the operating agreement of a New York LLC unless the members so desire.
14. Some Income Tax Aspects of Owning and Operating an LLC. The following is a brief discussion of some income tax aspects of owning and operating an LLC to conduct a business and of some of the provisions of the LLC forms. This Commentary including without limitation the discussion in this paragraph 14 is not intended to be tax advice. Tax matters are very complicated and you should consult your tax advisor for a full understanding of the federal, state, local and non-U.S. tax consequences of using the forms and conducting business through an LLC.
For income tax purposes, an LLC with more than one member is treated differently from an LLC with only one member, as discussed below. An LLC with multiple members can become a single member LLC because of a reduction in membership (e.g., the sale or redemption of membership interests). Conversely, a single member LLC can become a multiple member LLC (e.g., through the admission of an additional member). Such changes may have income tax consequences, and a tax advisor should be consulted in connection therewith.
(a) LLCs with more than one Member . A New York LLC with more than one member has a choice of being treated as either a partnership or a corporation for both federal and New York State income tax purposes. Most LLCs prefer to be treated as partnerships because, as discussed below, income taxes are generally not imposed on entities taxed as partnerships. To accommodate this preference, the income tax regulations do not require any action to be taken to achieve partnership treatment. That is, the tax “default” characterization of an LLC is that of a partnership, and only an LLC that wishes to be treated as a corporation need take any action to be so treated. The balance of this discussion assumes that the LLC will not elect to be treated as a corporation and, accordingly, will be treated as a partnership for tax purposes.
(i) Tax Treatment in General. In general, an LLC that is treated as a partnership is not a taxable entity. Instead, its income, deductions, credits, and other tax items are passed through as allocations, and the members report such allocations on their own tax returns. Such an LLC files partnership tax returns, which show the nature and amount of the items that are reportable by each member on the member's tax return. For tax years starting in 2018 and later, pursuant to the revised partnership audit rules, an LLC treated as a partnership is required to designate a partner, or other person, with substantial presence in the United States as the “partnership representative.” The partnership representative has the sole authority to act on the LLC’s behalf for purposes of, among other things, U.S. federal income tax audits and judicial review of administrative adjustments by the Internal Revenue Service.
(ii) Tax Allocations of Profit and Loss. Some of the provisions of Form 2A and Form 2B (for example, Article IX of each Form ) are highly technical and are designed to insure compliance with tax laws regarding the tax treatment of appreciated property contributed to the LLC and the allocations of deductions attributable to certain types of loans (for which the LLC is a borrower) among the LLC members. You should consult with your tax advisor before deleting or modifying any such provision.
(iii) Non-resident Members. Non-residents of New York State should consult with their own tax advisors as to liability for any New York State estimated taxes.
(b) LLCs with only one Member . For federal and New York State tax purposes, a New York LLC that has only one member will be disregarded as an entity separate from its owner, unless it elects to be treated as a corporation. If an LLC is disregarded for tax purposes, its activities, assets and liabilities are generally treated as those of its single owner, e.g., as those of a single proprietorship if the single owner is a natural person, or as those of a branch or division if the single owner is a corporation, and transactions between the entity and its single owner are ignored for tax purposes. Such an LLC generally does not file income tax returns, and items of LLC income, deduction, credit, etc. are, in general, reported solely in the return of the single member. However, the LLC is recognized as a separate entity with limited liability for certain tax and non-tax purposes. Thus, a single member LLC should provide the same limited liability for the single member as a multiple member LLC does for its members.
|5154-1A New York Member Managed Single Member Operating Agreement, with Statement of Organization, Consent of Members, Consent of Directors, Notice of Publication, 13 pp.|
|5154-1B New York Manager Managed Single Member Operating Agreement, with Statement of Organization, Consent of Members, Consent of Directors, Notice of Publication, 13 pp.|
|5154-2A New York Manager Managed Multiple Member Operating Agreement and Company Regulations, with Statement of Organization, Consent of Members, Consent of Directors, Notice of Publication,56 pp.|
|5154-2B New York Member Managed, Multiple Member Operating Agreement, with Statement of Organization, Consent of Members, Consent of Directors, Notice of Publication, 44 pp.|