Texas Limited Liability Companies

Limited Liability Companies are a newer form of business entity that became widespread among the states in the 1980s.  Like S Corporations, limited liability companies offer the liability protection most often associated with corporations and flow-through partnership taxation.  Limited liability companies have became the preferred entity form for small businesses due to the fact that they are not subject to the strict rules associated with S Corporations.

Formation of Limited Liability Companies

For purposes of state law, limited liability companies are recognized as separate legal entities from its owner(s).  At a minimum, a Certificate of Formation, also known as Articles of Organization, must be filed with the state to officially form a limited liability company.  Additionally, owners(s) should draft and adopt an Operating Agreement to govern a limited liability company’s affairs.

Taxation of Limited Liability Companies

Taxation of limited liability companies depends on how many members are involved in the business and whether the limited liability company has elected to be treated as a corporation for taxation purposes.  Furthermore, a single-member limited liability company (SMLLC) is generally treated as a disregarded entity for Federal taxation purposes, but may also elect for treatment as a corporation.  Generally, the income of an LLC is reported on the owner’s personal federal income tax return and a separate tax return for the limited liability company is not needed.

A multi-member limited liability company is treated as a partnership for Federal taxation purposes, unless it elects to be treated as a corporation.  This provides the multi-member limited liability company with flow-through taxation benefits often associated with partnerships.

Control of a Limited Liability Company

Control of a limited liability company is primarily determined by the entity’s Certificate of Formation (Articles of Organization), Operating Agreement, and another other agreements made between members.  The Texas Business Organizations Code provides a default set of rules that apply in situations that are not governed by the documents, and rules that apply in the absence of an Operating Agreement.

Generally, Texas law allows for two types of limited liability company structures.  First, a Member Managed Limited Liability Company is managed by the members as a whole.  This means that each member has the right to act on behalf of the company and a simple majority vote is used to determine most company affairs.  Additionally, Texas LLC law provides that a company may be Manager Managed Limited Liability Companies.  In this structure, the non-managing members are treated like passive investors, or passive partners in a limited partnership, and have either limited or no rights to manage the day-to-day affairs of the entity.

Capitalization of a Limited Liability Company

Limited liability companies are initially capitalized by the transference of property to the entity in exchange for a membership interest in the company.  Limited liability companies can have different classes of membership interests, each with their own unique rights to voting and distributions, depending on class.

Owner Liability in Limited Liability Companies

Generally, members of a limited liability company are protected from liability for any obligations that the limited liability company incurs.  The limited liability company is treated as a separate legal entity and is solely responsible for its own obligations and debts.  However, this veil of protection can be pierced under certain circumstances.  If members engage in fraudulent behavior, commingle company and personal funds, or fail to adequately capitalize the limited liability company to the determent of creditors, the members can be held personally liable.  Additionally, members are also considered personally liable for any loans, debts, or obligations that they personally guarantee on behalf of the limited liability company.

Protection of Limited Liability Company Assets from Owner’s Personal Creditors

State law allows for creditors of a limited liability company to petition for a charging order against the debtor member’s membership interest.  A charging order is issue by a court and directs that any distribution of profits or income that would be otherwise paid to the debtor member should instead be paid to the debtor member’s creditor.  The intent of charging orders is to protect other owners of a limited liability company from loss due to a single debtor member’s personal debts.  However, this rationale does not always apply in instances of single-member limited liability companies, as some bankruptcy courts have set aside charging order protection where an entity had only one owner.  Thus, if protection of company assets from a member’s personal creditors is an important factor in entity formation, one should highly consider forming a multi-member limited liability company.

In many states, a charging order is the only remedy creditors of a limited liability company can pursue.  Generally, this means that limited liability companies offer more protection of entity assets from a member’s personal creditors.

Privacy in a Limited Liability Company

The formation documents of a limited liability company and annual reports are routinely filed with the Texas Secretary of State, and can be viewed by third parties.  However, the Operating Agreement, resolutions, minutes, and other books and records of a limited liability company are not publicly accessible, but may be obtained and reviewed by members of the entity according to the Operating Agreement and the Texas Business Organization Code.

Terms of Existence and Dissolution of a Limited Liability Company

Depending on which state you file in, a limited liability company can exist in perpetuity until they are dissolved by the members, either by majority or unanimous consent, or the company can be dissolved by the simple withdrawal of a member, even if the other members continue to operate the company.  In Texas, Section 101.107 of the Business Organizations Code indicates that a member of a limited liability company may not withdraw or be expelled from the company.  As a result, this means that a member wishing to leave the entity must either sell their membership interest, meet the requirements for withdrawal in the company’s Operating Agreement, or agree with other remaining members to wind up the company.