It would hardly be noteworthy to announce the importance of limited liability companies in 2011. Almost matter-of-factly, the LLC (like W.P. Carey & Co., LLC, NYSE: WPC and Fortress Investment Group, LLC, NYSE: FIG) has emerged as the entity choice for doing business, with many syndicated real estate investments taking on this form. Perhaps when you look at the tax and liability treatment this form provides, the reasons for its emergence are easily explained: 1. members enjoy limited liability (compare the liability exposure of a general partner in a limited partnership for perspective) and income is “passed-through,” thereby avoiding double taxation. This much is understood and accepted. For purposes of characterization then, it’s a corporation-partnership hybrid, right? Well, generally speaking, yes. And that’s fine for a layperson. But that’s hardly a workable approach for the legal system/courts.
Yet, until recently that’s exactly the approach taken. Despite being recognized as a legally distinct and separate entity at the state level, courts have struggled (see here and here) to place it within the proper context. The result? Gaps in LLC law have been “filled in with either partnership law or the law of corporations, rather than crafting an LLC-specific set of rules”–and as Professor Larry Ribstein notes, “they sometimes apply the wrong analogies.” Aside from the obvious problem of ignoring the entity structure, this is especially troubling when one considers the costs associated with derivative suits and the potential liability resulting from corporate “veil piercing.” As such, I agree with Professor Josh Fershee, when he writes:
…where state LLC laws are silent, the court should carefully consider the legislative context and history, as well as the policy implications of the possible answers to the questions presented. Courts should put forth cogent reasons for their decisions, rather than blindly applying corporate law principles in what are seemingly analogous situations between LLCs and corporations.
But I would go one step further. Rather than attempt to shoehorn corporation (and partnership law for that matter) into a LLC context, a distinct set of rules should be made at both the legislative and judicial levels. Hopefully the ruling of CML V, LLC v. Bax, is just the beginning of a larger, growing movement.
Reprint from llenrock Blog By Matt Welter