Memorandum on Operation and Taxation of Newly Formed California LLC

MEMORANDUM ON OPERATION AND TAXATION OF NEWLY FORMED
CALIFORNIA LIMITED LIABILITY COMPANIES

[Date]

The purpose of this memorandum is to discuss certain procedures and operations relevant to a newly formed California limited liability company ("LLC"). The summaries below are not a complete analysis of the areas discussed, but rather they are provided to give a basic understanding of the legal requirements which a California LLC should follow. Because this discussion is general in nature, it should not be relied upon as exhaustive. Please feel free to contact our office if you have any questions.

The owners of an LLC are not called shareholders or partners but instead are referred to as members.

[Choose Alternative 1 or 2]:

1. [Your LLC is managed by its members and each member has authority similar to that of partners in a general partnership and may be referred to as a manager of the LLC.]

2. [Your LLC is manager-managed and will be managed by less than all of its members or by nonmembers, and only those persons with management authority are referred to as managers.]

Depending upon the structure of the LLC, the managers may have authority to act in a manner similar to general partners of a limited partnership or in a manner similar to a board of directors of a corporation. An LLC may, but is not required to, have officers.

II.  Articles of Organization

A California LLC is formed when its Articles of Organization have been filed with the Secretary of State’s office and the members have entered into an agreement regarding the affairs of the LLC and the conduct of its business. The Secretary of State’s office has created a simple preprinted form for the Articles which was used to form the LLC. However, there are many matters that the LLC might choose to include which are not required to make the Articles effective.

The Articles were required to include: (1) the name of the LLC; (2) a statement that the purpose of the LLC is to engage in any lawful act or activity permitted by law; (3) the name and address of the LLC’s initial agent for service of process; and (4) if the LLC is to be managed by one or more managers and not by all of its members, a statement to that effect.

The Articles also may contain any other provision not inconsistent with law, such as provisions limiting or restricting the business in which the LLC may engage or the powers that the LLC may exercise; governing the admission of members; setting forth events that will cause a dissolution of the LLC; stating whether there are limitations on the authority of mangers or members to bind the LLC and a description of those limitations; and prescribing the number and qualifications of managers. [These provisions, while not included in your Articles of Organization, could be added if appropriate.]

A Certificate of Amendment to the Articles must be filed with the Secretary of State’s office to effect a change in the LLC name; a change in the manner in which the LLC is managed (e.g., a member-managed LLC becomes manager-managed); a change in the time stated in the Articles as the latest date upon which the LLC will dissolve; or if the Articles describe the events that will cause a dissolution, any change in those events.

California law also allows an LLC to amend its Articles in any way it desires, so long as the Articles as amended contain only those provisions that would be lawful to insert if the Articles were filed at the time of the filing of the amendment.

III.  Operating Agreement

The agreement among the members regarding the affairs of the LLC and the conduct of its business is referred to as the Operating Agreement. The Operating Agreement not only defines the business relationship among the members, but also sets forth various procedures and matters affecting the governance of the LLC. The Operating Agreement may set forth the responsibilities of the members and managers, the number of managers, the manner of calling meetings of the members and managers (including the required notice for the meetings), the maintenance of LLC records, allocations of profits and losses, distribution rights, the issuance of reports to members, voting and proxy procedures, the regulation of the transfer of membership interests, and other general LLC matters. In connection with the formation of your LLC, an Operating Agreement was prepared.

[As California law mandates many of these provisions in the event that the Operating Agreement is silent, a "short-form" Operating Agreement which does not address all of these issues has been prepared for your LLC. Thus, the LLC must refer to applicable California law, rather than the Operating Agreement, for determining the method for compliance with various procedures and other matters.]

[The Operating Agreement may be adopted, amended, or repealed by the vote of the members; however, the terms of your Operating Agreement require [unanimous approval or the approval of a super majority of the voting interests of the members] before it may be adopted or changed.]

IV. Following Formalities

LLC status generally shields the members of the LLC from personal liability for the acts of the LLC. However, California law provides that members of an LLC will have personal liability for the acts of the LLC to the same extent that shareholders of a corporation have personal liability for the acts of the corporation.

California courts have respected the limited liability of shareholders of a California corporation as long as the corporation remains properly organized, adequately capitalized, and completely separate as a legal entity. If a court finds that the corporate privilege has been abused, the corporate entity may be disregarded for the purpose of remedying the specific abuse and the corporate shareholders may be liable for the corporation’s acts relating to that abuse.

The legal theory upon which shareholder liability is based is generally called the "alter ego doctrine." An individual attacking the corporate status to achieve shareholder liability will try to "pierce the corporate veil," to prove that the corporation is merely an agent of the individuals behind it. An individual trying to pierce the corporate veil and assert the alter ego doctrine must generally prove two things: first, that there is a unity of interest and ownership between the corporation and the shareholders, such that the corporation and the shareholders are no longer separate or individual; and second, that an injustice or fraud will occur, if the corporation’s actions are treated solely as the acts of the corporation.

An LLC can reduce the possibility that the individual members will be subject to liability for the LLC’s actions under the alter-ego doctrine by following the guidelines listed below:

1. The LLC should ensure that it is adequately capitalized to enable it to carry on its business.

2. The LLC should obtain adequate insurance to meet all of its insurance needs. It is suggested that the LLC consider coverage including general liability insurance, fire and casualty insurance, life and disability insurance for key personnel, insurance to fund repurchases of a membership interest in the event of death or disability of a member, business interruption insurance, and workers’ compensation insurance.

3. The LLC should observe all post formation formalities, including but not limited to, holding annual meetings if such meetings are required by the Operating Agreement; keeping minutes of such meetings and clear records of all LLC activities; maintaining separateness and arm’s length dealings between the LLC and the managers and/or principal members and requiring full disclosure of any competing interests; and assuring approval of the LLC’s transactions either by the members or the managers as appropriate. If the Operating Agreement does not require the holding of meetings of members or managers, the California limited liability company act provides that the failure to hold meetings or observe formalities relating to the calling or conduct of meetings shall not be considered a factor establishing that a member should be subject to personal liability for the LLC’s actions. Your Operating Agreement presently [does not] require[s] meetings of the members.]

4. Authorized persons.…