Published in NH Bar News (12/16/2020)
The key practice tools for New Hampshire lawyers who form LLCs for their clients are their LLC forms—i.e. the blank model operating agreements that they use as starting points in drafting tailored operating agreements for the specific LLC members and managers they are representing. Starting on Jan. 7, 2021, I will be teaching a series of five one- or two-hour CLEcredit webinars for the New Hampshire Bar Association on LLC formation practice. (See page 22 for more information.)
The first webinar will be on best practices in drafting operating agreements for multi-member LLCs. That webinar will be based on Form 6.2, the template form for multi-member LLC operating agreements in Drafting Limited Liability Company Operating Agreements, my Wolters Kluwer LLC formbook and practice manual. You can access the summary table of contents and detailed table of contents of this form by clicking on the “Form 6.2” button on the home page of my website, www.llc199A.com. My best-practices webinar will discuss three key questions about forms for operating agreements for multi-member LLCs and about the agreements themselves. If you won’t be attending that webinar or if you would like a preview of it, I’ll summarize this discussion here.
The first question you need to ask about LLC forms is how many of them you need in order to be fully equipped for your LLC formation practice. The key to answering this question is to understand that every LLC, including the more than 50,000 New Hampshire LLCs currently in good standing, has three—and only three—principal structures. These are their ownership structure, their management structure and their federal tax structure.
• An LLC’s ownership structure may consist of one member, two members, or three or more members.
• Single-member LLCs may have any of three basic management structures—management by the member, management by the member and a non-member assistant manager (for continuity of management if, for some reason, the member is unable to manage), and management by a nonmember.
• Multi-member LLCs, too, may have any of three basic management structures—a general partnership structure, in which all the members are also managers; a limited partnership structure, in which one or more members are managers and the other members are not; or a corporate structure with the equivalent of shareholders, directors, officers and employees.
• Most single-member LLCs should be taxable either as sole proprietorships or as S corporations. Most multi-member LLCs should be taxable as partnerships under Internal Revenue Code Subchapter K although a few should be taxable under Subchapter S. A key factor in choosing among these structures for single-member and multi-member LLCs is often Internal Revenue Code section 199A. Section 199A provides owners of pass-through businesses, simply because their businesses are pass-through, with annual federal income tax deductions of up to 20 percent of their “qualified business income” (roughly the equivalent of their net business income). Pass-through businesses include sole proprietorships, S corporations and entities, such as most multi-member LLCs, taxable as partnerships. Section 199A is overwhelmingly complex. However, deciding how to apply it is indispensable in any LLC formation.
Once you’ve determined the ownership, management and tax structure of the LLC your client wants to form, it will become clear to you that there are 10 basic kinds of LLCs with these structures and that, in order to be fully equipped to form these LLCs, you need 28 forms. (See Exhibit A under the Form 6.2 button in www.llc199A.com.)
The second question is what legal and tax issues your forms should cover. The answer varies significantly among the various types of single-member LLCs. However, for most multi-member LLCs, the answer is generally 28 issues. These issues are identified in the captions to Sections 1 through 28 in the summary table of contents in Form 6.2. However, as you’ll see from the detailed table of contents of that form, these 28 sections address, either by themselves or in numbered subsections, 205 subsidiary issues. Why 28 and 205 rather than other numbers? The answer is empirical: In any form, you need to address all of the relevant legal issues (a total of about 20 issues), consisting of issues under the governing LLC act and any other legal issues that you know may be important for your clients from your own practice experience, from operating agreements by other LLC lawyers with which you happen to review, and from discussions with other LLC lawyers. And you need to address all relevant federal and state tax issues (a minimum of about eight issues).
The third question is what should be the contents of the provisions set forth under the captions of each of the above 28 sections and 205 subsections. In order to answer this question, you need to know that on the basis of their purposes and the chief characteristics of their members, there are five main types of LLCs. These are:
• LLCs for corporate joint ventures and other entity joint ventures (e.g. joint ventures of two or more LLCs);
• “Protected series” LLCs, which are permitted under the laws of Delaware and several other states but not under New Hampshire law (but which can nevertheless be useful to many New Hampshire business owners);
• LLCs which contain complex financial provisions for LLC income- and losssharing among the members (and which also must normally contain complex federal tax provisions);
• LLCs for use by venture capital investors; and
• “Main Street LLCs.”
Form 6.2 can be used as the basis for operating agreements for any of the above types of LLCs. However, most LLCs formed by even the largest and most sophisticated New Hampshire law firms are Main Street LLCs. The chief characteristics of Main Street LLCs are as follows:
• One or more members of most or all Main Street LLCs (whom I’ll refer to here as “unrepresented members”) are unable or unwilling to hire their own personal lawyers to protect their interests in their LLCs; rather, they rely for this understanding on lawyers drafting operating agreements for the LLC itself, in joint representations or for other individual members. However, it is critical for unrepresented members to obtain a specifically personal understanding of the impact on them of the legal and tax rules that will govern their LLC membership rights and duties under their LLC’s operating agreement. Otherwise, they may unknowingly face serious penalties for violating operational or estate planning requirements set forth in these agreements, such as non-competition and business opportunity requirements and membership right distribution requirements if they die or become disabled while they are members. You can’t play soccer if you don’t know the rules.
However, very few unrepresented members are likely to know their LLC rights and duties when they set about forming their LLCs. Thus, they must learn them—and must identify them when post-LLC formation issues arise—from the “off-the-shelf” operating agreements implicit in the governing LLC act as explained to them by a lawyer who does not represent them or –the much better option--in written operating agreements by these lawyers.
• If the LLCs of these unrepresented members have written operating agreements, these agreements must be written by the lawyers drafting them in plain English, with only a minimum of taxese and legalese, in short, simple sentences and paragraphs, and with an intuitively logical structure reflected in single-level and twolevel tables of contents. . If lawyers draft them in accordance with these guidelines, then, to the maximum extent possible, they can be understood by the above un-represented members on a careful first reading.
A fuller discussion of the above three questions will be set forth in the 40 pages of the sentence outline I’ll provide to attendees of the Jan. 7, 2021 best-practices LLC webinar.
John Cunningham is a New Hampshire lawyer licensed to practice in New Hampshire and Massachusetts. He is the principal of his own law firm, the Law Offices of John M. Cunningham, PLLLC, and he is of counsel to the firm of McLane Middleton, P.A. His practice is focused on LLC law and tax, Internal Revenue Code section 199A and estate planning. His telephone number is (603) 856-7172. His e-mail is [email protected] The link to his website is www.llc199a.com.