Synopsis: Limited liability companies represent the natural and logical progression of business entities. The LLC has been heralded as the best of both worlds -- pass-through taxation and limited liability. This entity may soon replace the corporation as a standard method of doing business. Small business applications need to be examined by attorneys. The Missouri LLC statute provides businesses the opportunity to avoid "double" taxation and structure the LLC in the manner most conducive to their situation and industry. The check-the-box regulations brought ease and certainty to the taxation of LLCs, but the traditional characteristics should still be evaluated in planning and formation.

The Missouri Limited Liability Company Act allows business owners the opportunity to receive pass-through taxation, flexible corporate structure, and limited personal liability.¹ The LLC has been praised as an "innovative form of business organization"² combining "the best of both worlds"³ --corporations and partnerships. It is "better alternative."⁴

The limited liability company, LLC, was originally created in 1977 by the Wyoming state legislature.⁵ LLC legislation, despite its current popularity, did not receive much attention until 1988, when the Internal Revenue Service issued Revenue Ruling 88-76, which granted LLCs organized under the Wyoming statute the advantages of pass-through taxation.⁶ All 50 states and the District of Columbia have enacted LLC statutes. Commentators are debating the social utility of LLCs and the ethical implications of removing personal liability from professional responsibility.⁷ The owners of small businesses want to know how they can avoid corporate taxation, limit personal liability, and at the same time not exclude themselves from the management of their own business. The knowledge of legal business forms and how to use, modify, and manipulate them to the advantage of clients is an important part of a business lawyer's stock in trade.⁸

The Missouri legislature authorized the formation of LLCs in 1993. The Missouri Limited Liability Company Act is codified in § § 347.010 to 347.187, RSMo.⁹

The act does not state a particular purpose. The anticipated goal is increased economic growth.¹⁰

The objective of this article is to aid practitioners who service the organizational needs of Missouri's small businesses. The author will examine the needs of small businesses in relation to LLC organization; demonstrate the useful and effective structure of the LLC; provide a model of LLC tax planning; and finally, examine special considerations associated with LLC formation and organization.

Section II will address the legal concerns of small businesses in six areas, including: (1) taxation, (2) control, (3) liability, (4) transferability, (5) capitalization, and (6) longevity, in conjunction with the federal and state statutes. In some situations an LLC will not be an entity of choice, but for others it is destined to become the hallmark of success.

Most of the analysis in this section will be adopted from IRS regulations, treatment of limited partnerships, revenue rulings, and case law. According to the IRS, LLCs are treated in substantially the same manner as limited partnerships despite variations in organizational structure. The reader, upon conclusion of this paper, should be able to properly advise any small business on formation of an LLC under Missouri law.

Individuals and groups who are interested in creating a business entity generally have six primary concerns: (1) the way the firm is taxed, (2) the degree of control owners may exert on decisions, (3) the liability of owners, (4) the ease of transferring ownership interests, (5) the ability to raise additional funds, and (6) the longevity of the business. This section will analyze the structural options and limitations that the Internal Revenue Service and Missouri law impose on an LLC organization.

The LLC is a quasi-corporate entity that must be planned to benefit its members.¹¹ The Missouri Limited Liability Company Act and the check-the-box regulations allow LLC organizers the freedom to possess any or all of the corporate characteristics.¹² Missouri taxes the LLC as either a corporation or a partnership based solely upon how the LLC is taxed by the federal government.¹³ Formally, in order for the LLC to qualify for pass-through taxation, a primary objective, it could possess only two of four corporate characteristics. For example, an LLC that possesses limited liability and centralized management is just as valid as an LLC that possesses limited liability and free transferability of interests, and both would have be taxed as pass-through entities. If an LLC possessed three characteristics, it would still be a valid Missouri LLC, but not be granted any of the advantages of pass-through taxation.

Despite the ease of the check-the-box regulations, planning an LLC is important.

Potential members, whether or not currently engaged in business, want to avoid corporate taxation, preclude personal liability for corporate debts, and still be allowed to actually manage their own business. The LLC should be tailored to fit the needs of its members, but corresponding requirements of limited liability and pass-through taxation may require the organizers to alter the substantive terms they have agreed upon.¹⁵ The lawyer should take special care when drafting LLC organization documents to ensure that the client's needs and expectations meet the form of the characteristics prescribed by the IRS.¹⁶ The LLC will only be beneficial if the organizers adhere to the state and federal limitations on structure.¹⁷ The IRS has created a rebuttable presumption that LLCs possess the characteristic of limited liability.

How does limited liability affect the members of an LLC? Limited liability is a characteristic that should be evaluated in light of the division between the entity form -- whether a C corporation, a S corporation, a limited partnership, a limited liability company, or a limited liability partnership -- and the individuals associated with that entity.¹⁸ Limited liability does not shield the entity from liability.¹⁹ Rather, the entity shields the individual(s) associated with that entity from liability arising from acts of the enterprise and the liability arising from the actions of individuals associated with the entity as long as those actions are generally not wrongful.²⁰ The most powerful effect of limited liability is the insulation of participants from individual liability arising from entity debts.²¹

"[L]imited liability is not absolute."²² When an individual intertwines personal and entity dealings so as to make the corporation an agent of the individual, the courts will pierce the veil of limited liability²³ and hold the individual liable along with the enterprise.²⁴ Furthermore, individual criminal and tortious actions are not shielded from liability.²⁵

Limited liability is a corporate characteristic that Missouri and other states have specifically allowed in the recognition of a new business entity, the LLC. The Missouri Limited Liability Company Act grants members and managers the advantages of limited liability.²⁶ However, due to the unique qualities of the limited liability company -- i.e., characteristics of both partnership and corporate law -- the question as to whether the common law doctrines of corporate law will be applicable to LLCs is unanswered.²⁷ For the Missouri LLC and many others, the problem is compounded because the state has not adopted the corporate common law doctrines or statutorily rejected the application of those doctrines to Missouri LLCs.²⁸ Piercing the corporate veil is a phenomenon unique to the closed corporation.²⁹ The doctrine of piercing the corporate veil, which could divest the members of the protection of limited liability and distribute liability arising from contract debts among the members, has not been applied to an LLC. "Most scholars assume that courts will not rely heavily on a firm's failure to follow formalities as a factor in holding investors liable, but one can interpret reoccurring bits of language in the veil-piercing case law to the contrary."³⁰ Scholars also argue that limited liability should not be interpreted under the same standards of partnership and corporate law, but rather that courts should fashion restrictions specific to limited liability companies.³¹ AThe expectation is that this new business form will spawn a body of law as to the governance of business associations substantially different than what we now know and one that emphasizes freedom of contract even more than the law for existing business forms."³² Unless the veil of the LLC is pierced, the members cannot lose any more money than the total amount of capital they contributed to the LLC.³³

The Missouri Limited Liability Company Act provides two exceptions to limited liability. First, any member who acts for an LLC without authority (or a good faith belief thereto) may be held liable for all of the debts arising from that event or action.³⁴ Second, a derivative suit may be maintained by members against an LLC or other members.³⁵

Although the benefits of limited liability may seem obvious, the LLC form allows many professionals the ability to limit liability resulting from their professions. Two prime examples are lawyers and certified public accountants who cannot incorporate because of ethical obligations and regulatory provisions.³⁶ Nevertheless, lawyers and certified public accountants are subjected to liability for negligence in their profession. The LLC may provide them with the ability to avoid the responsibility and corresponding liability associated with their profession.³⁷ Similarly, groups like the Houston-based mining interest that pioneered the first LLC legislation, adopted in Wyoming, now potentially have the ability to avoid environmental liability.

Because the LLC is so new, no one knows whether other sources of liability are precluded from application to it and its members. Some restrictions may transcend the boundaries of corporate vs. company form. State supreme courts, for example, may alter the rules regarding attorney LLCs. The Montana Supreme Court exercised its power over attorneys licensed to practice within its jurisdiction by promulgating an amendment to Rule of Professional Conduct No. 5.4; Montana now requires officers of professional corporations and the managers of LLCs to be lawyers.³⁸ Common law corporate liability theories, such as alter ego, individual wrongful acts, and guarantees of contractual liability, remain to be tested.³⁹

Kansas Public Employees Retirement Sys. v. Reimer & Koger Assocs., Inc., is an excellent example of the protection that the corporate characteristic of limited liability can provide to the members of an LLC.⁴⁰ In Kansas Public Employees Retirement System, the law firm of Blackwell, Sanders, Matheny, Weary & Lombardi, L.C., the proposed intervenor, appealed a district court's decision not to allow an LLC to intervene in a negligence suit to which some of its members had been named as parties.⁴¹ The appellate court reversed, holding that the LLC had a clear right to intervene in the suit under the Missouri Limited Liability Company Act.⁴² The proposed interveners, Blackwell Sanders, L.C., had converted their partnership into a LLC bearing the same name.⁴³ The Missouri Limited Liability Company Act provides for automatic conversion of general and limited partnerships. "[A] general or limited partnership merely has to provide the name of the former general partner in the LLC articles of organization and the date and place of the filing of the initial partnership certificate."⁴⁴ The conversion became effective before the Kansas Public Employees Retirement System announced its intention to sue the former Blackwell Sanders partnership or any partners thereof.⁴⁵ Section 347.125.3 vests the LLC with all of the former partnership's "rights, privileges, powers, debts, [and] causes of action."⁴⁶ The same section further specifies that the former partnership's "duties, debts, liens, liabilities and rights of creditors" attach to the LLC.⁴⁷ "Blackwell Sanders, L.C., has admitted its responsibility for paying any judgment against the former partnership."⁴⁸

The court allowed Blackwell Sanders to intervene in the suit because the LLC must assume the liabilities of the former partnership.⁴⁹ The LLC is responsible for the debts and liabilities incurred by the partnership before it converted into an LLC. The Kansas Public Employees Retirement System is not prohibited from continuing the suit against or collecting from the LLC. It is highly unlikely that the Kansas Public Employees Retirement System will prevail against them in addition to or in lieu of the LLC.

b. Taxation

Both the IRS and the Missouri Limited Liability Company Act give the organizers the option between corporate and partnership taxation.⁵⁰ Formerly, the organizer chooses between partnership and corporate taxation by structuring the characteristics of the company to conform with IRS regulations pertaining to pass through taxation.

Nevertheless, members of an LLC should not rely on the state statutory default provisions.⁵¹ ASuch reliance can result in unpleasant surprises for which the parties would not have bargained had they considered the possibility of such occurrences at the time of formation."⁵² The IRS currently requires LLC organizers to choose the manner of taxation, with partnership taxation as a default provision.⁵³ It is in this context that clients should be advised of the importance of decision-making in an LLC organization. Even though the LLC has less restrictions on formation than a corporation, the participation of a business lawyer in the forming of an LLC is as important as the lawyer's role in the formation of a corporation.⁵⁴

i. The LLC Tax Objective

Missouri LLCs are taxed by the state and federal governments according to their classification by the IRS. The flexible structure of the Missouri statute allows LLC organizers to choose characteristics that will help them by specifically meeting the particular needs of their industry or line of business.⁵⁶ The Missouri LLC statute provides domestic LLCs with an advantage over jurisdictions which have enacted so called "bullet-proof" statutes. Missouri LLCs may tailor company structure. Some of the specific examples of the advantages of tailoring LLC characteristics to the needs of each LLC will be discussed in the characteristic section. The Wyoming statute is called "bullet-proof" because any domestic LLC is granted automatic pass-through taxation by the IRS.⁵⁷ Under the old regulations, Missouri's LLCs were examined on a case-by-case basis to ensure compliance with the federal requirements for pass-through taxation. Currently, the advantages of flexibility are fully available under the check-the-box regulations. An LLC organized under Missouri law has the option of being taxed as a partnership or a corporation, and is not limited to certain predetermined characteristics.⁵⁸ The corporate option, however, is rarely used.⁵⁹ The primary benefit of being an LLC is that the company is taxed as a partnership, but retains the limitations on liability heretofore recognized as a corporate characteristic.⁶⁰

The adoption of corporate characteristics in the articles of organization and the operating agreement play a role in the taxation of an LLC, but the organizers' election is dispositive. Accordingly, provisions in the articles of organization or the operating agreement mandating or stating a particular tax status are ineffective.

ii. Partnership v. Corporate Taxation

Why is it better to be taxed as a partner than a shareholder of a corporation? The answer lies in the distinction between partnership and corporate taxation. "Based on the tax and operating considerations, LLCs are not the best fit for all businesses."⁶¹ Organizers should examine how the entity will be managed and analyze the distribution of income before assuming that pass-through taxation will confer any particular benefit to the members.⁶² Pass-through taxation for the LLC is beneficial to the members when the business distributes its income and the members are not active in the business.⁶³ A[I]f salaries to owners eliminate all taxable income, an LLC has no tax advantage over a C corporation."⁶⁴ Under the same circumstances, the distinction in tax treatment between LLCs, limited partnerships, and S corporations is blurred; the real issue for organizers becomes one of practicality.⁶⁵

The best use of an LLC should assume that the members are not active in the business and that the LLC distributes income to the members. Then partners receive better tax treatment because they are taxed only one time on income that corporate shareholders are taxed twice.⁶⁶ These distinctions are codified in § § 701 and 11 of the Internal Revenue Code.⁶⁷

Section 701 provides that: "A partnership as such shall not be subject to the income tax . . . . Persons carrying on business as partners shall be liable for income tax only in their separate or individual capacities."⁶⁸ The partnership entity is not subject to taxation.⁶⁹ Partners in a partnership are subject to taxation on the partnership's income⁷⁰ only in their separate or

individual capacities. At the end of the tax year the partnership only files an information return with the IRS⁷¹ describing the allocation of income among the partners.

Corporations are taxed as entities⁷² at varying rates ranging from 15% to 35%.⁷³ The highest marginal corporate rate is 35%, which also may be subject to a 4% "hump."⁷⁴ Corporate shareholders are also taxed as individuals on the income they receive from the corporation.⁷⁵ The shareholder is effectively taxed twice.

LLC members seek to take advantage of a substantial disparity that exists between pass-through and double taxation. Even at the lowest entity income tax rate, 15% for individuals and 15% for corporations, a shareholder is still taxed a total of 30% while a member of an LLC with the same income level would only be taxed at 15%. The highest rates are proportionately similar in effect, 74.6% for corporations and 39.6% for members, roughly double. The logical conclusion from a comparison of the corporate and partnership taxation is to choose pass-through taxation.⁷⁶ The appeal of pass-through taxation has made the partnership and limited partnership the most popular business entity.⁷⁷

Taxation of Missouri LLCs as partnerships is contingent upon the IRS classifying it as a partnership, as opposed to an association.⁷⁸ Associations are taxed as though they were corporations.⁷⁹ If an LLC is determined to be an association, then the tax benefits are certainly lost.⁸⁰ The lawyer who drafts the articles of organization and the Operating Agreement must carefully advise the organizers and examine their organizational requests and their expectations.

iii. LLC Classification

The LLC is an unincorporated association. The term "association" refers to Aan organization whose characteristics require it to be classified for purposes of taxation as a corporation rather than as another type of organization such as a partnership or trust."⁸¹ LLCs are taxed as partnerships if they meet the regulatory provisions of the IRC.

c. The Formalities of Creating an LLC

Missouri LLC formation is set forth in § 347.037, RSMo. First, anyone (whether a manager, member, or organizer) may sign and file the articles of organization with the Missouri Secretary of State.⁸² The articles must set forth the following: the company name; the purpose for which the LLC is organized; the address of the registered office and name of the registered agent; whether management is vested in one or all members; the date upon which the LLC will be dissolved; the rights of the members to continue the business, if any; and the name and address of each organizer.⁸³ The articles of organization may also set forth the other provision present in the operating agreement.⁸⁴

Second, the LLC is formed when the articles of organization are filed with the Secretary of State. The organizers should not transact business in the LLC name prior to filing, unless it is incidental to LLC formation. Otherwise the organizers, members or both may be held liable for the debts acquired.⁸⁵

d. Characteristics

Two of the characteristics -- associates and the objective to carry on business and split gain -- are common to LLCs, partnerships, and corporations.⁸⁶ Formerly, if a company had three or more of the remaining characteristics -- limited liability, centralization of management, continuity of life, and free transferability of interests -- then it was taxed as a corporation.⁸⁷ The IRS used to determine whether a characteristic was present on a case-by-case basis, and⁸⁸ the LLC's objective was to possess no more than two of the four dispositive characteristics.⁸⁹ Under the check-the-box regulations, the LLC chooses to be taxed as a partnership or a corporation. Nevertheless, the small business will be better equipped for management and operation if the articles of organization and the operating agreement are carefully drafted around the aforementioned characteristics.

Lawyers should examine the LLC's needs in terms of which characteristics should be provided for in the articles of organization and the operating agreement to yield the most benefit to the members. The organizer of an LLC may provide for any particular characteristic by the structuring of the rights, duties, and privileges of the members. The characteristics are gleaned from the provisions for structure within the articles of organization as they relate to the members' rights rather than a formalistic election. The IRS, however, presumes that the organizer of an LLC possesses limited liability.⁹⁰ In the confines of the LLC form, limited liability is the only characteristic that has a universal affirmative default. The other characteristics must be created within an LLC through the creation of rights and privileges of the members in the absence of a state or federal statute to the contrary. Although under the Missouri statute it is possible to form an LLC that does not possess the characteristics of limited liability, the benefits to the owners would be marginal and are vastly unexplored.⁹¹

In addition to limited liability, the organizers of an LLC may choose from the following three characteristics: (1) continuity of life (2) centralization of management, and (3) free transferability of interests. The articles of organization should express and conform not only to state requirements, but also to the federal non-tax requirements discussed infra.⁹² Missouri's LLC statute is based on the American Bar Association Draft Prototype Act.⁹³ Heretofore, the risk associated with the degree of flexibility offered by the ABA's draft "is that a business may choose to organize an LLC which is perfectly valid under state law, but may nonetheless fail to qualify as a partnership for federal tax purposes."⁹⁴ Most of the risk was abated with the passage of the check the box regulations, but any lawyer or a law firm that fails to adequately provide for pass-through taxation and organizational qualities may be sued for malpractice.⁹⁵

Before the check-the-box regulations, one approach to securing the advantages of pass-through taxation is to adopt the "bullet-proof" style of the Wyoming statute.⁹⁶ In addition to limited liability, the Wyoming statute mandates the corporate characteristic of centralized management.⁹⁷ A Wyoming like -- "bullet-proof" -- LLC would thereby lack continuity of life and free transferability of interests.⁹⁸ States with bullet-proof statutes -- built in inflexibility -- are at a disadvantage under the current IRS regulations.

The requirements, advantages, and disadvantages of adopting each of the three remaining characteristics will be examined in greater detail. Lawyers must seek out very clear statements from the organizers as to their expectations in order to achieve the desired tax status. The next three subsections examine corporate characteristics.

i. Centralized Management⁹⁹

The Missouri Limited Liability Company Act¹⁰⁰ grants Missouri LLCs the ability to choose the degree to which management is vested in each member.¹⁰¹ An LLC that provides for centralized management is similar to a corporation electing a board of directors.¹⁰² Centralized management, whether by a person or a small group of members or non-members, gives managers the power to make meaningful and significant decisions without the consent of the membership.¹⁰³ Members are bound by management's decisions, and the members must release control of company affairs. Centralized management is exclusive authority within the company.¹⁰⁴ Centralization is characterized by a "concentration of continuing exclusive authority."¹⁰⁵ Corporations always possess this characteristic, and general partnerships do not.

Partners share the power to manage equally. Any partner may bind the partnership. Under the check-the-box regulation, members may provide for or retain the power or authority (directly or indirectly) to unconditionally remove the general partner.¹⁰⁶ The courts and the IRS are no longer concerned about the member's influence on decisions of management by retaining too much of the ability to remove and control the general partner.¹⁰⁷

Many LLC statutes, including Missouri's centralized management default provision,¹⁰⁸ provide that the members will manage the company.¹⁰⁹ Managers can be member-managers or nonmember-managers. If all of the members retain the power to manage the LLC, then the LLC will lack centralized management.¹¹⁰ A small business LLC may possess centralized management as a function of its size, but not provide for the characteristic in the articles of organization or the operating agreement. The IRS, however, should not, under the aforementioned circumstances, consider centralized management to be a characteristic. A closer look into the formation of the Wyoming statute provides a point of analysis against which organizers should compare their own needs when considering centralized management as a corporate characteristic. The Wyoming LLC statute is the result of special interest legislation.¹¹¹ A mining concern backed the legislation in Wyoming after failing in Alaska.¹¹² The Wyoming LLC statute was established to offer limited liability to all equity participants while avoiding the imposition of entity-level tax.¹¹³ For the LLC organizer, the adoption of centralized management may be a function of size and industry.

The mining special interest represented a lot of investors. The miners wanted limited liability to shield the investors from personal liability.¹¹⁴ Centralized management was probably chosen (1) because the investors didn't want to manage the business and (2) any attempt to pierce the veil of limited liability would be much more difficult where the "partners" had given up their capacity to manage.¹¹⁵ Members of LLCs doing business in liability-prone areas may want the added protection of centralized management. The mere fact that an LLC has centralized management may make it harder for a court to take a stricter position when analyzing attempts to pierce the veil. Courts are generally unwilling to hold shareholders who did not participate in management liable for the acts of the managers.¹¹⁶ In this instance the LLC may seem more like a limited partnership, which may in the court's eyes limit members' liability to the assets or services that were originally provided to the LLC.

The application of the centralized management characteristic under the Missouri statute should follow some of the same analysis that the mining interests followed. The organizers should consider the number of present and potential investors, their desire to be a part of management, and the anticipated degree of difficulty that members may have in management. The Missouri statute offers members the ability to act like limited partners or the ability to participate as partners. A small LLC with member managers may already possess the characteristics of centralized management, but a provision in the articles of organization may act as another shield to liability. Responsibility for the day-to-day management of the LLC is a corresponding concern that may depend on the type of business. The foregoing issues should be addressed by the members and organizers to ensure that everyone's expectations are accommodated.

ii. Free Transferability¹¹⁷

If members have the power to transfer all of the attributes of ownership, including the right to participate in company management, then free transferability of interests exists.¹¹⁸ Corporate status expressly provides for free transferability of corporate shares. Corporate stock for example, may be sold on stock exchanges, or in any other way. Partnership status, on the other hand, provides that some partnership interests may be transferred, but that the right to management may not be transferred by a single partner without the unanimous approval of all partners. The Uniform Limited Partnership Act also requires the consent of all partners before the transferee gains the right to participate in management.¹¹⁹

The Missouri Limited Liability Company Act allows LLC members to reduce the restriction on transferability of interests through the specifications of provisions in the articles of organization and operating agreement.¹²⁰ Meaningful consent is construed to mean the ability of any member in interest to unreasonably withhold consent to transfer, i.e., any member can withhold its consent for any reason or no reason at all.¹²¹

Members of LLCs who are not related or trusting of the other members should consider this characteristic because they may find it more desirable to sell their interest in lieu of dissolution. Members of a family LLC may not benefit from free transferability as a corporate characteristic because there is likely to be a greater degree of trust, and family businesses tend to acquire both personal and economic significance to the members. The possibility of a member selling their interest to a "stranger" may be seen as reprehensible by the rest of the family. The same behavior can be seen in closed corporations where shareholders impose restrictions on transferability to control the identity of other participants.¹²²

Another concern in organizing an LLC is the ability to raise capital. If the company is new, it probably will not have any assets (other than those pledged by the members) that it may use as collateral. One way for the LLC to raise capital is to sell interest in the LLC, but it may not be publicly traded.¹²³ Depending upon the amount of capital needed, selling interest in an LLC may provide an opportunity to raise additional start-up capital.

Members personally may have to take out loans for the company. Because the liability of the company is limited to its assets, and the assets of the members cannot be reached without piercing the veil of the LLC,¹²⁴ most banks and lending institutions require the members to personally guarantee liability for the debt.¹²⁵ One advantage to assuming loan liability is that a member may claim a higher basis in the company's assets and thereby secure a greater deduction than other members.

iii. Continuity of Life¹²⁶

Continuity of life is a corporate characteristic. Regardless of what happens to shareholders, the corporation may continue to function. General and limited partnerships, on the other hand, are defined by the participation of their partners.

LLC statutes written in accord with the partnership rules usually lack the characteristic of continuity of life.¹²⁷ If the company has reserved the right to continue in the articles of organization or the operating agreement after an event of dissolution has occurred, then it will almost certainly need to limit the events of dissolution to those not excluded by state regulations. One sure way for the LLC to avoid conflicts with the statute is to refrain from making any elections in the company documents prior to an event of dissolution -- contingent continuity.¹²⁸

Glendsder Textile Co. v. Commissioner highlighted the distinction between contingent-continuity and continuity incorporated in the corporate charter.¹²⁹ Contingent-continuity is present where members must agree to continue the business following an event of dissolution. Attorneys and members alike should take care in excluding events, and be prepared with specific reasons for the exclusions, keeping in mind that a majority of members may agree to continue the venture after any given event of dissolution despite default rules and the provisions in the operating agreement and the articles of organization.

The United States Bankruptcy Court is the first court to address state statutory provisions of LLCs which dissolve an LLC upon the filing of a bankruptcy petition by one of its members.¹³⁰ The court examined the dissolution provisions of the Nebraska Limited Liability Companies Act.¹³¹ Whenever possible a parallel collateral citation to the Missouri act will be included in the footnote following the referenced section in an effort to facilitate ease in the comparison of the two acts and the applicability of the holding based on Nebraska law to domestic Missouri LLCs. The court held "that Nebraska law is not enforceable in a Chapter 11 bankruptcy case to terminate the limited liability company and the debtor's membership therein."¹³² Daugherty Construction, Inc., is a member of two LLCs formed to develop apartment complexes in Nebraska.¹³³ The LLCs were formed pursuant to and in accord with the Nebraska Limited Liability Companies Act,¹³⁴ which was incorporated into the articles of organization and operating agreements of both LLCs. Daugherty Construction, Inc., the debtor, is a Chapter 11 debtor.¹³⁵ Section 21-2621 of the Nebraska LLC statute, as incorporated into the articles of incorporation and operating agreement, "states that the bankruptcy of a member constitutes an act of dissolution, unless two thirds of the remaining partners vote to continue the LLC."¹³⁶ The non-debtors of the two LLCs of which the debtor was a member (1) treated the debtors filing bankruptcy as an event of dissolution, (2) voted to continue the LLCs, and (3) terminated the debtors' service contract.

The Nebraska Limited Liability Company Act is very similar to the Missouri Limited Liability Company Act.¹³⁷ Section 21-2622 of the Nebraska statute provides for the dissolution of the LLC upon:

The Nebraska statute provides that the LLC dissolves whenever a member files Chapter 11 bankruptcy.¹³⁹ The debtor member is excluded from voting and its interest is assigned.¹⁴⁰ The

bankruptcy of a member is treated the same way as the death or expulsion of a member.¹⁴¹ The LLC terminates unless the remaining members agree to continue the business. Under the Nebraska statute, the LLC properly excluded the debtor and lawfully continued the business without the debtor.

The bankruptcy court found that Nebraska's LLC statute conflicts with the federal bankruptcy laws in three ways:

In so holding, the court also cited Congress' intent to regulate relationships between Chapter 11 debtors, non-debtors, and the interests of the debtor in the estate.¹⁴³ According to the Supremacy Clause of the United States Constitution, the federal bankruptcy law must prevail. The court then ordered the LLC to continue its business as if the debtor had not declared bankruptcy.¹⁴⁴ The holding of In re: Daugherty Constr., Inc., may change the tax status of the affected LLC.

The holding from In re Daugherty Constr., Inc., suggests that LLCs currently formed must, if a member files Chapter 11 bankruptcy, follow the federal bankruptcy code. Future LLCs should specifically exclude Chapter 11 bankruptcy from the events of dissolution in the articles of organization and the operating agreement in spite of the state default provisions.¹⁴⁵ LLCs organized in states that do not have "bullet-proof" statutes will still be subjected to a stricter degree of scrutiny by the IRS.

In conclusion, the LLC may offer its members the advantages of pass-through taxation and limited liability. In Missouri, LLCs have the ability to choose which characteristics they will possess. Corporate characteristics remain important instruments to be used in complying with state and federal LLC statutes. The organizer of an LLC should seek the advice of a lawyer prior to organizing an LLC. One serious disadvantage of an LLC is that the relevant case law has not fully developed. The members of an LLC may find that they have limited liability and a partnership agreement that can literally change with each new case.

The LLC may be the business form of choice for individuals who want to avoid corporate taxation, preclude personal liability for company debts, and still retain the ability to manage their own business. The LLC will only yield the most benefit when members adhere to the state statute and federal regulations governing the operation and taxation of LLCs. The Missouri Limited Liability Company Act allows the LLC organizer to benefit by choosing corporate characteristics.

Taxation of an LLC is most beneficial when the members are not active in the business and the LLC income is distributed to the members. The specific needs and objectives should be addressed and provided for in the operating agreement and articles of organization on a case-by-case basis. LLCs are new entities and face confusion as to how they will operate. Tax law provides no exception to the confusion and, in fact, have caused commentators to question much of the reasoning upon which the current tax laws are based.¹⁴⁶ Kansas Public Employees Retirement System indicates that the trial courts did not know how to treat LLCs as legal entities. Issues concerning the LLC will be addressed in courts around the country.¹⁴⁷

1 Mo. Ann. Stat. § § 347.010-347.187 (Vernon Supp. 1997) (eff. Dec. 1, 1993). Reference as needed.

2 Carol R. Goforth, The Rise of the Limited Liability Company: Evidence of a Race Between the States, But Heading Where? 45 Syracuse L. Rev. 1193, 1198 (1995).

3 Marybeth Bosko, Comment, The Best of Both Worlds: The Limited Liability Company, 54 Ohio St. L.J. 175 (1993).

4 Richard M. Harwood and Jeffrey A. Hechtman, The Better Alternative: The Limited Liability Company, 20 J. of Real Est. Tax'n, 348 (1993).

5 Wyo. Stat. Ann. § 17-15-101 - 17-15-136 (Michie 1997).

6 Rev. Rul. 88-76, 1988-2 C.B. 360.

7 See generally Dirk G. Christensen & Scott F. Bertschi, LLC Statutes: Use By Attorneys, 29 Ga. L. Rev. 693 (1994).

8 William A. Klein & Eric M. Zolt, Business Form, Limited Liability, and Tax Regimes: Lurching Toward a Coherent Outcome?, 66 U. Colo. L. Rev. 1001 (1995).

9 Section 347.010-347.187, RSMo 1994.

10 See generally Carol R. Goforth, The Rise of the Limited Liability Company: Evidence of a Race Between the States, But Heading Where? 45 Syracuse L. Rev. 1193 (1995) (Professor Goforth argues that the dramatic increase in LLC legislation is due to competition between the states to attract business. Goforth questions the wisdom of departing from the uniform regulations of business entities).

11 See Dennis S. Karjala, Planning Problems in the Limited Liability Company, 73 Wash. U. L.Q. 455, 459-60 (1995).

12 Organizers may file the articles of organization with the Secretary of State in accordance with § 347.037, and form an LLC with Secretary's approval without complying with the IRS regulations.

13 Section 347.187(2), RSMo Supp. 1996.

14 Klein, supra, note 8.

15 Id. at 1002; see also Larry E. Ribstein, The Deregulation of Limited Liability and the Death of Partnership, 70 Wash U. L.Q. 417, 420-22, 457-61 (1992).

16 Id.

17 A. Fuller Glaser, Jr., Limited Liability Companies: The Entity of Choice in Missouri 55 (1994).

18 Robert B. Thompson, Unpacking Limited Liability: Direct and Vicarious Liability of Corporate Participants for Torts of Enterprise, 47 Vand. L. Rev. 1, 3 (1994).

19 Id. at 1.

20 Robert B. Thompson, The Taming of Limited Liability Companies, 66 U. Colo. L. Rev. 921, 940 (1995).

21 Robert B. Thompson, Unpacking Limited Liability: Direct and Vicarious Liability of Corporate Participants for Torts of the Enterprise, 47 Vand. L. Rev. 1, 6 (1994).

22 Id.

23 Id. at 7, n.24.

24 Id.

25 Id.

26 Section 347.057 provides:

27 Steven C. Bahls, Application of Corporate Common Law Doctrines to Limited Liability Companies, 55 Mont. L. Rev. 45, 43 (1994).

28 See generally Missouri Revised Statutes.

29 Bahls, supra note 27, at 57; see also Robert B. Thompson, Piercing the Corporate Veil: An Empirical Study, 76 Cornell L. Rev. 1036 (1991).

30 Dale A. Oesterle, Subcurrents in LLC Statutes: Limiting the Discretion of State Courts to Restructure the Internal Affairs of Small Business, 66 U. Colo. L. Rev. 881, 899 (1995).

31 Robert B. Thompson, The Taming of Limited Liability Companies 66 U. Colo. L. Rev. 921, 945-46 (1995); Steven C. Bahls, Application of Corporate Common Law Doctrines to Limited Liability 55 Mont. L. Rev. 43, 77 (1994); see also Dale A. Oesterle, Subcurrents in LLC Statutes: Limiting the Discretion of State Courts to Restructure the Internal Affairs of Small Business 66 U. Colo. L. Rev. 881 (1995) (questioning whether the courts will make any distinction.).

32 Robert B. Thompson, The Taming of Limited Liability Companies, 66 U. Colo. L. Rev. 921, 922 (1995).

33 Id.

34 Section 347.059, RSMo 1994.

35 See § § 347.171-347.175, RSMo 1994.

36 Robert B. Thompson, The Taming of Limited Liability Companies, 66 U. Colo. L. Rev. 921, 929 (1995).

37 Dirk G. Christensen & Scott F. Bertschi, LLC Statutes: Use By Attorneys, 29 Ga. L. Rev. 693 (1994).

38 Limited Liability Companies Subject to Professional Rules, Mont. Law, Mar. 19, 1994, at 11.

39 See Glaser, supra note 28.

40 Kansas Public Employees Retirement System v. Reimer & Kroger Assocs., Inc., 60 F.3d 1304 (8th Cir. 1995).

41 Id.; § 347.069, RSMo 1994.

42 Id.; § 347.075, RSMo 1994.

43 Id. at 1308, n.6; § 347.125, RSMo 1994.

44 William E. Sinder, Practical Aspects of Converting Existing Entities Into Limited Liability Companies, 74 Mich. B. J. 60, n. 20 (1995).

45 Id.

46 Id.; (construing § 347.125.3, RSMo 1994).

47 Id.; (construing § 347.125.4, RSMo 1994).

48 Kansas Public Employees Retirement System v. Reimer & Koger Assocs., Inc., 60 F.3d 1304, 1308 n.6 (8th Cir. 1995).

49 Section 347.125.4, RSMo 1994.

50 Glaser, supra note 17, at 56.

51 Karjala, supra note 11, at 456.

52 Karjala, supra note 11, at 456.

53 Treas. Reg. § 301.7701-2(b)(2) (1986).

54 Karjala, supra note 11, at 457.

55 Section 347.187, RSMo 1994.

56 Compare Wyo. Stat. Ann. § § 17-15-101 to 17-15-136 (Michie 1997); with § §  347 to 347.187, RSMo 1994.

57 Rev. Rul. 88-76, 1988-38 I.R.C. 1.

58 Glaser, supra note 17, at 56.

59 H. Wayne Cecil et al., The Choice of Organizational Form, J. Acct. Dec. 1995, at 45.

60 Professor Booth hypotheses that the IRS allowed the recognition of LLC as pass-through entities because they realized that limited liability is "no . . . big deal." Richard A. Booth, Profit-Seeking, Individual Liability, and the Idea of the Firm, 73 Wash. U. L.Q. 539, 541 (1995). By judging from all of the excitement from the business world to law reviews, 1imited liability is a "big deal" to the business community. There are a lot of businesspeople who are happy to see that the IRS finally allows business entities to choose the most efficient means of formation.

61 H. Wayne Cecil et al., The Choice of Organizational Form, J. Acct. Dec. 1995, at 45.

62 Id.

63 Id. at 50.

64 Id.

65 Id. at 50-51.

66 Id. at 50.

67 I.R.C. § § 11 and 701- 1 (1986).

68 I.R.C. § 701 (1986).

69 Id.

70 Treas. Reg. § 1.701-1 (1986).

71 See I.R.C. § 6698 (1986) (partnerships must file form 1065, no matter how much or how little income the partnership has. No tax computations are made on the form. Its primary purpose is to show the allocation of income and losses attributable to each partner.).

72 I.R.C. § 11 (1986).

73 I.R.C. § 11 (1986).

74 I.R.C. § 11(b) (1986).

75 I.R.C. § 61 (1986).

76 Index Tax Planning-Business (CCH) & 880.01, at 12,603 (1995).

77 Id.

78 Section 347.187, RSMo 1994.

79 Morrissey v. Commissioner, 296 U.S. 344, 357 (1935) ("The inclusion of associations with corporations [in the Tax Code] implies resemblance; but it is resemblance and not identity."); see also Rev. Rul. 95-10, 1995-3 I.R.B. 23.

80 The company may also lose the benefits of what has traditionally been corporate planning. LLCs and corporations use different methods of business planning. Members who planned (wanted) the benefits of pass-through taxation may be very disappointed to realize that the income from their LLC will be taxed as an association - corporation.

81 Treas. Reg. § 301.7701-2(a)(1) (1986).

82 Section 347.037, RSMo 1994 (the state also requires a $105 filing fee).

83 Id.

84 Section 347.039(2), RSMo 1994.

85 Section 347-059, RSMo 1994.

86 Glaser, supra note 17, at 57.

87 Id. at 58; Index Tax planning-Business (CCH) & 1010.05, at 12,674 (1995).

88 Treas. Reg. § 301.7701-2(a)(1) (1986).

89 Goforth, supra note 2, at 1211.

90 Rev. Rul. 95-10, 1995-3 I.R.B. 24.

91 Goforth, supra note 2, at n.87; It should be specifically noted that, without the benefit of pass-through taxation, the LLC is nothing more than a restricted corporation. The loss of the corporate form without the corresponding benefit of pass-through taxation creates a LLC that may most effectively be described as possessing the benefit of neither corporate or partnership law. See generally, H. Wayne Cecil et al., The Choice of Organizational Form, J. Acct., Dec. 1995.

92 Id. at 1206.

93 Id.

94 Id.

95 Although there are no published cases specifically addressing whether lawyers will be liable for malpractice for negligent provision of pass-through taxation, the issue could quickly make lawyers wish that they had the limited liability of a LLC, with or without the tax advantages. In fact, lawyers and certified public accountants have been the primary force pushing LLC legislation through the various state legislatures. See generally Goforth, supra, note 2; (Professor Goforth examines the progression of the LLC legislation through state legislatures concluding that lawyers and CPAs have been the primary force behind LLC legislation).

96 See generally Wyo. Stat. Ann. § § 17-15-101 to 17-15-136 (Michie 1997).

97 Wyo. Stat. Ann. § 17-15-113 (Michie 1997).

98 Wyo. Stat. Ann. § § 17-15-122 and 17-15-123 (Michie 1997).

99 See Treas. Reg. § 301.7701-2(c) for a conceptual foundation.

100 Supra note 1.

101 Sections 347.079 and 347.001, RSMo 1994.

102 Treas. Reg. § 301.7701-2(c) (1986).

103 Glaser, supra note 21, at 62.

104 Treas. Reg. § 301.7701-2(c)(1) (1986).

105 Treas. Reg. § 301-7701-2(c)(3) (1986).

106 Zuckman v. Unites States, 524 F.2d 729 (ct. cl. 1975); Rev. Rul. 95-10, 1995-3 I.R.B. 20.

107 Rev. Rul. 95-10, 1995-3 I.R.B. 20-22.

108 Section 359.745(l), RSMo 1994.

109 Goforth, supra note 2, at n.78.

110 Rev. Rul. 95-10, 1995-3 I.R.B. 24 at 23.

111 Goforth, supra note 2, at 1199; citing Thomas Long, The Wyoming Limited Liability Company, at 7 (Feb. 15, 1989, with 1991 addendum) (unpublished paper).

112 Id.

113 Goforth, supra note 2, at 1199.

114 Id. No doubt the mining investors sought protection from both business debt and liability arising from environmental pollution - tort victims.

115 The underlying uncertainties of LLC law may warrant errors on the side of caution.

116 See generally Robert B. Thompson, Piercing the Corporate Veil: An Empirical Study, 76 Cornell L. Rev. 1036 (1991).

117 See generally Treas. Reg. § 301.7701-2(e) (1986).

118 Treas. Reg. § 301.7701-2(e)(1) (1986).

119 Section 27(1), RSMo 1916.

120 Section 359.768(2), RSMo 1994.

121 Rev. Rul. 95-10 1995-3 I.R.B. 23.

122 Sylvester J. Orsi, The Limited Liability Company: An Organizational Alternative for Small Business, 70 Neb. L. Rev. 150, 164 (1991).

123 Rev. Rul. 95-10, 1995-3 I.R.B. 23.

124 See Section II of this article.

125 Karjala, supra note 11.

126 See generally Treas. Reg. § 301.7701-2(b) (1986).

127 See, e.g., Wyo. Stat. Ann. § 17-15-123 (Michie 1997).

128 Goforth, supra note 2, at 1212.

129 Glendsder Textile Co., v. Commissioner, 46 B.T.A. 176, 185 (1942).

130 In the Matter of Daugherty Constr., Inc., 188 Bankr. 607 (D. Ne. 1995); §  347.123, RSMo 1994.

131 Id.; see also Neb. Rev. Stat. § 21-2601-2653 (Cum. Supp. 1996).

132 In re Daugherty Constr., Inc., supra note 130.

133 Id.

134 Id.

135 Id. The court made a distinction between a debtor filing for Chapter 11 -- for reorganization -- and Chapter 7 debtors for liquidation of the company.

136 Id.; see § 347.123, RSMo 1994.

137 Id.

138 Compare Neb. Rev. Stat. § 21-2622 (Cum. Supp. 1996); with § § 347.123 and 347.137. The differences in the requirements for majority consent are not important.

139 In re Daugherty Constr., Inc., supra note 130.

140 Id.

141 The treatment of members differs in Missouri in that the death of a member results in his interest being assumed by an assignee who has all of the rights and powers of the deceased member. Section 347.117, RSMo 1994.

142 In re Daugherty Constr., Inc., supra note 130, 4. All cites in the quote are to sections in the Bankruptcy Code.

143 Id.

144 Id.

145 In re Daugherty Constr., Inc., supra note 130.

146 See Karjala, supra note 11.

147 See In re Daughterty Constr., Inc., 188 Bankr. 607 (Bankr. D. Neb.) (the bankruptcy court determined that if bankruptcy is an event of dissolution that requires the member to lose his interest in a LLC, then despite the continuation of the LLC by a majority vote in the debtor's absence federal bankruptcy law preempts state law.).

©1997, Nimrod T. Chapel, Jr.