Frequently Asked Questions on LLCs
The following questions are some of those frequently asked on LLCs. Many of these topics deserve an extensive discussion. The "answers" are included only to alert the practitioner to certain issues and to give him or her a start on the analysis.
1. How do you perfect a security interest in an LLC interest?
A limited liability company interest consists of contract rights. Accordingly, the method for perfecting a security interest should be the same as that for general intangibles. Note, however, that it is possible for an LLC to issue certificates representing interests. In that case the secured party should take possession of the certificate along with an appropriate transfer instrument designed to have the same effect as a stock power. The practitioner should also consider requiring that its security interest be noted on the LLC’s books and that the LLC agree not to effect transfers of the pledged interest.
2. When lending to an LLC, how should a lender attempt to establish the proper authority?
The lender should examine the Articles of Organization to determine whether the entity is manager-managed. A statement to that effect will negate the inherent agency authority of the members. If there is no such statement, each member has authority to bind the LLC, so the signature of any member should be sufficient. It would be prudent to obtain a representation (in the loan documents or in a separate certificate) that the member signing is in fact a member. If the Articles of Organization state that the entity is manager-managed, each manager has authority to bind the LLC so the signature of any manager should be sufficient. Again, it would be prudent to obtain a representation that the signing manager is in fact a manager. Although it is not required, the customary procedure of obtaining an "incumbency" certificate -- signed by a member or manager who is not the signatory on the loan documents and attesting that the member or manager signing the loan documents is who she says she is -- likely will be followed. Further, it would be wise to examine a certified copy of the Operating Agreement to confirm the identity and scope of authority (to the extent established by the Operating Agreement) of the member or manager signing the loan documents.
3. Can a lender foreclose on an LLC interest?
Since a security interest can be granted and perfected in a limited liability company interest, the secured party should be able to exercise any remedies otherwise available in the event of a default. The LLC’s governing instruments should be studied carefully, however, to determine the effect of a "foreclosure." The transfer, or purported transfer, of an LLC interest to a lender in a foreclosure proceeding could result in dissolution of the entity, a forfeiture or mandatory repurchase of the interest, or other contractual remedies established by the governing instruments of LLC. These should be examined, therefore, as part of any loan transaction.
4. Can a nonmember-manager of an LLC be a tax matters partner?
No. The tax matters partner must be a member. The Code defines "tax matters partner" as the general partner designated as such or the general partner with the largest profits interest if there is no designated general partner. Although an LLC has no general partner, it would appear that any member of an LLC should qualify as a general partner for this purpose to the extent such member has the right to participate in the LLC’s management. It is good practice to designate the tax matters partner in the operating agreement and to provide procedures for removing and replacing the tax matters partner.
5. Which forms does an LLC use to file tax returns?
Assuming that it is properly classified as a partnership for tax purposes, an LLC will use IRS Form 1065 (U.S. Partnership Return of Income) for federal tax purposes and Georgia Form 700 (State of Georgia Partnership Income Tax Return) for Georgia purposes.
6. If a partnership converts to an LLC, does it need a new tax identification number?
No. Under the applicable revenue rulings, the conversion is not treated as a termination of the existing partnership.
7. Will the IRS give the tax identification number of an LLC over the telephone to a nonmember?
No. However, the SS-4 form can be completed by the organizer. The number will be mailed to the address indicated in the application or a member or manager can call in. The fax number is (404) 455-2660, but you need signature authorization if you are faxing. Call (404) 455-2480 to get the tax identification number after it has been faxed.
8. How is title to real estate held in an LLC? How does an LLC establish authority for purposes of conveying real estate?
Title to real estate is held in the entity itself. Authority would be established by reference to the Operating Agreement and the Articles of Organization (see the response to Question 2, above).
9. Is an LLC interest a "security?"
This issue is complex. The practitioner should start by reviewing the discussions in Carter G. Bishop & Daniel S. Klienberger, Limited Liability Companies -- Tax and Business Law ¶¶ 11.01-04 (1994), and Larry E. Ribstein and Robert R. Keatinge, Limited Liability Companies §§ 14.02-.03 (1994) ("Ribstein and Keatinge"). The courts will likely apply an "investment contract" analysis to the issue of whether an interest in an LLC is a security. See SEC v. W. J. Howey Co., 328 U.S. 293, 298-99 (1946) (An investment contract is "a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party . . .") At one end of the spectrum is a closely held LLC that is member-managed and in which each member actively participates in management. Under an investment contract analysis, interests in such an enterprise should not be "securities." At the other end of the spectrum, an LLC clearly may be used as a vehicle for a public offering of interests to passive investors. In those circumstances, such interests would likely constitute "securities." There is a substantial area between the extremes, and the careful practitioner will study the relevant case law and likely will proceed on the assumption that the interest is a security unless the facts are quite close to the closely held, member-managed LLC, where all managers participate actively in management.
10. Can an LLC issue "stock?"
Ownership interests in an LLC can be called stock, shares, units or any other name that is appealing to the parties. LLC interests may also be certificated. However, the interests are not the equivalent of corporate stock. The careful practitioner may wish to avoid the use of the term "stock", particularly when the members will include passive, relatively unsophisticated investors, because of its potential for misleading members as to the nature of the entity.
11. Can an LLC issue certificates for its shares?
Yes, but refer to Question 10 for some of the issues associated with doing this.
12. Can an LLC issue incentive stock options?
No. Incentive stock options may only be issued with respect to stock in an entity that is a corporation for federal tax purposes. Assuming an LLC qualifies as a partnership for tax purposes, it cannot meet this standard. However, an LLC may grant options or other rights to acquire interests in the LLC. The tax treatment of such options or rights can be quite complex, particularly if the options are granted in exchange for services.
13. How is an LLC treated for bankruptcy filing purposes?
The answer is uncertain. For a discussion of the application of the bankruptcy laws to LLCs see generally, Ribstein and Keatinge ¶ 14.04. It appears that the corporate rather than the partnership bankruptcy rules will govern how a limited liability company files for bankruptcy under the Federal Bankruptcy Code. Although the Bankruptcy Code does not specifically address LLCs, the definition of "corporation" for purposes of the Bankruptcy Code includes "a partnership association organized under a law that makes only the capital subscribed responsible for the debts of such association." 11 U.S.C. § 101(9)(A)(ii). The question remains open as to whether members or managers would then be considered "insiders" for purposes of the provisions of the Bankruptcy Code. Under the Bankruptcy Code, the officers and directors of a corporation and the general partners of a partnership are considered insiders. Id. § 101 (3)(B). Whether an LLC is treated as a corporation or a partnership, the LLC itself should qualify to be a debtor under either Chapter 7 or Chapter 11 of the Bankruptcy Code.
14. Does conversion of a corporation or partnership to an LLC under O.C.G.A. § 14-11-212 trigger liability for real estate transfer tax in connection with the recording of any deed?
There is little law on this subject. A widely circulated memorandum of the Department of Revenue Real Estate Transfer Tax Division indicates that there would be no transfer tax on a deed ancillary to a merger, which suggests that there should be no real estate transfer tax due on a conversion of a corporation or partnership to an LLC. At least one Georgia general partnership has converted to a Georgia LLC without incurring any transfer tax in Gwinnett County. Along with a quitclaim deed, an Affidavit Regarding Title to Real Property was filed which, among other things, recited O.C.G.A. § 14-11-212(c)(5) in its entirety. In addition, in Section E of the Real Estate Transfer Tax Declaration was typed: "Non-taxable. Filed solely to reflect partnership election of limited liability company status per O.C.G.A. § 14-11-212."