7.2 Limited Liability Companies

The limited liability company (LLC) is the most popular entity for new small businesses because it combines the corporation's liability shield with the partnership's pass-through taxation and management flexibility. LLC law is entirely statutory — every state has an LLC act, many based on the Uniform Limited Liability Company Act (ULLCA) — and the NALA CP exam tests the formation, management, and creditor-remedy mechanics that paralegals handle daily.

Formation: Articles of Organization

An LLC comes into existence only when articles of organization (called a certificate of organization or certificate of formation in some states) are filed with the secretary of state. The filing is typically minimal:

• The LLC's name, which must include a designator such as "LLC," "L.L.C.," or "Limited Liability Company"
• The name and street address of the registered agent for service of process
• The principal office address
• In some states, whether the LLC will be member-managed or manager-managed

One or more persons, called organizers, sign and file the articles; an organizer need not be a member and often is the paralegal's supervising attorney or a formation service. Because the requirements are so light, most of the real governance work happens in the operating agreement.

The Operating Agreement

The operating agreement is the LLC's internal rulebook — analogous to a partnership agreement plus corporate bylaws. It is not filed with the state, and most statutes allow it to be written or oral, though a paralegal should always treat a written agreement as essential. It typically covers:

• Capital contributions and each member's percentage interest
• Allocation of profits, losses, and distributions
• Management structure and voting thresholds
• Restrictions on transferring membership interests
• Procedures for adding members, dissolution, and buyouts

Critically, the operating agreement overrides the statute's default rules. If the agreement is silent, the state LLC act fills the gap — for example, ULLCA's default rule allocates profits per capita (equally among members), not by capital contribution. That default surprises clients and makes a good exam question.

Member-Managed vs. Manager-Managed

The agency point is the exam favorite: in a manager-managed LLC, a non-manager member generally has no apparent authority to sign a contract binding the company.

Limited Liability

Members and managers are not personally liable for the LLC's debts and obligations solely by reason of being members or managers. The shield is strong but not absolute: members remain liable for their own torts, for debts they personally guarantee, and where a court pierces the veil (see Section 7.3). Members can also be liable for distributions received when the LLC was insolvent.

Taxation: Pass-Through by Default

Under the federal check-the-box regulations (Treasury Regulation § 301.7701), an unincorporated domestic entity with:

• One member is a disregarded entity — its income is reported directly on the owner's return (Schedule C for an individual), like a sole proprietorship.
• Two or more members is taxed as a partnership — Form 1065 informational return, Schedule K-1s to members.

An LLC may instead elect to be taxed as a corporation by filing Form 8832, and if it qualifies, it may further elect S corporation status on Form 2553. The LLC's legal form under state law does not change — only its federal tax treatment. Active LLC income allocated to members is generally subject to self-employment tax, which is one reason some owners elect S corporation taxation.

Charging Orders

The charging order is how a creditor collects a judgment against an individual member (not against the LLC itself). The court orders the LLC to pay the creditor whatever distributions would otherwise go to the debtor-member. Key points:

• The creditor gets economic rights only — distributions as and when made. The creditor gets no voting or management rights and cannot force distributions.
• In most states the charging order is the creditor's exclusive remedy; the creditor cannot seize the member's interest or force a sale.
• Some states permit foreclosure of the charged interest, and for single-member LLCs a few courts (famously in the Olmstead case under Florida law) have allowed creditors to take the entire interest, because no innocent co-members exist to protect.

Paralegal scenario: a judgment creditor of Member A obtains a charging order against A's 40% interest in a three-member LLC. The LLC keeps operating under Members B and C; the creditor simply receives A's share of any distributions. The creditor cannot attend meetings, vote, or compel a distribution — which is exactly why LLCs are a favored asset-protection tool.

Common exam traps: (1) Saying an LLC is formed by agreement alone — the articles must be filed. (2) Treating the operating agreement as a public filing — it is internal. (3) Assuming a creditor with a charging order can manage the LLC — economic rights only. (4) Assuming an LLC is always partnership-taxed — remember the single-member disregarded-entity default and the Form 8832 corporate election.