Unincorporated Entities

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As I continue my mission to solidify the limited liability company (LLC) as its own entity, and not a corporation or corporate derivative, I have come to realize that U.S.-based distinctions are usually easier than international ones. One challenge we have is that we often try to find direct entity analogies from country to country, when none may exist.  

Case in point: Over at Lexology.com lat week, an article titled Is litigation funding in peril? appeared.  The article states, “In its ruling (KKO 2015:17), the Finnish Supreme Court found that under certain criteria it is possible to hold the shareholders of a limited liability company liable for the company’s liabilities.” So, if this were a U.S. LLC, we’d know there are no “shareholders” of an LLC.  We have members (or should).  But, I am no expert in Finnish law, but it is different than U.S. law.  According to Wikipedia (that all-knowing source), Osakeyhtiö, abbreviated Oy, means “stock company,” thought others sources says it means “limited company” or limited stock company.” Nonetheless, the shareholder characterization appears acceptable for a Finnish (but not a U.S.) entity.    

Finnish entities do not break down the same way as U.S. entities (this is not surprising).  Thus…

Facebook (not surprisingly) and other social media blew up when Facebook CEO, Mark Zuckerberg, and his wife, Dr. Priscilla Chan, released an open letter to their new baby daughter, Max. (Congratulations to all, by the way.) The Chan Zuckerberg family announced that they would be giving a ton of money to support important causes, which caused people to get excited, get skeptical, and get mad.

One big complaint has been that the family chose a limited liability company (LLC), which is not a corporation (more on that later), rather than a not-for-profit entity to do the work.  Some say this makes it a scam.  I say hooey.  Even if it were a scam, it’s not because they chose an LLC. 

  1. First, without knowing the LLCs members or structure, there’s no reason to say the LLC cannot be a 501(c)(3). But, more important, the Letter to Max never says they will give money to charity.  Never. 

The letter says: 

As you begin the next generation of the Chan Zuckerberg family, we also begin the Chan Zuckerberg Initiative to join people across the world to advance human potential and promote equality for all children in the next generation. Our initial areas

…

This post concludes the Contract Is King, But Can It Govern Its Realm? Micro-symposium.  The symposium was hosted as part of the AALS section on Agency, Partnership, LLCs and Unincorporated Associations in advance of the section meeting on January 7th at 1:30 where the conversation will be continued.

I summarized the conversation and provided links to all of the individual posts.  Bookmark this page– there is great commentary at your finger tips on a range of topics.  Please keep reading (and commenting) on these great contributions by our insightful participants to whom we are very grateful.

Jeffrey Lipshaw kicked off the symposium conversation with his post (available here) questioning, in practice, how different LLCs are from traditional corporations.  He used a great map analogy to talk about the role of formation documents and default rules as gap fillers. 

“The contractual, corporate, and uncorporate models are always reductions in the bits and bytes of information from the complex reality, and that’s what makes them useful, just as a map of Cambridge, Massachusetts that was as complex as the real Cambridge would be useless.” 

After asserting that LLCs differ from corporations only in matters of degrees, Jeff went on to…

Guest Post by Daniel Kleinberger

Part IV– Delaware’s Implied Contractual Covenant of Good Faith and Fair Dealing

Delaware case law applying the implied contractual covenant of good faith and fair dealing to a limited partnership dates back to at least 1993,[i] and Delaware’s limited partnership and limited liability company acts have expressly recognized the covenant since 2004.[ii] However, the contents of the implied covenant have not always been crystal clear.[iii]

     A passage from a 2000 Chancery Court decision is illustrative:

The implied covenant of good faith requires a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits of the contract.  This doctrine emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party.  The parties’ reasonable expectations at the time of contract formation determine the reasonableness of the challenged conduct.  [C]ases invoking the implied covenant of good faith and fair dealing should be rare and fact-intensive.  Only where issues of compelling fairness arise will this Court embrace good faith and fair dealing and imply terms in an agreement.[iv]

     This…

The micro-symposium has generated interest in a broad range of topics, so we are adding the following post by Peter Molk & Verity Winship discussing their recent scholarship on dispute resolution in LLC operating agreements and its intersection with the “contract is king” discussion this week.

Guest post by Peter Molk & Verity Winship:

This post highlights a particular area of private ordering within the LLC and other alternative entities: contractual provisions within the operating agreement that set the rules for resolving internal disputes.  These terms determine how disputes are resolved, such as by specifying when claims must be submitted to arbitration, where disputes can be heard, and whether parties waive the jury right or impose fee-shifting of litigation costs.  They apply to internal disputes, meaning they govern the dispute process among the LLCs’ members, managers, and the LLC itself.

How do these provisions fit with the debate over whether contract should be king?  The broadest connection is straightforward.  Dispute resolution provisions allocate rights and duties within LLCs, so the debate about the proper bounds of freedom of contract in the LLC space has implications for them as well.  But how firms set the rules for internal disputes is also…

Part III Another Major “Not” and the Uniform Act’s More (!) Contractarian Approach

C. Not Whatever is Meant by a Contractual Provision Invoking “Good Faith”

Some limited partnership and operating agreements expressly refer to “good faith” and define the term.[1] As the Delaware Supreme Court held in Gerber v. Enter. Products Holdings, LLC (Gerber), such “express good faith provisions” do not affect the implied covenant.[2] In Gerber, the Court rejected the notion that “if a partnership agreement eliminates the implied covenant de facto by creating a conclusive presumption that renders the covenant unenforceable, the presumption remains legally incontestable.” [3]

The rejected notion arose from on an overbroad reading of Nemec v. Shrader [4] – namely that “under Nemec, the implied covenant is merely a ‘gap filler’ that by its nature must always give way to, and be trumped by, an ‘express’ contractual right that covers the same subject matter.”[5] Invoking Section 1101(d) of the Delaware Revised Uniform Limited Partnership Act,[6] the Gerber opinion stated: “That reasoning does not parse. The statute explicitly prohibits any partnership agreement provision that eliminates the implied covenant. It creates no exceptions for contractual eliminations that are ‘express.’”[7] 

Some agreements contain express good faith provisions but omit…

Guest post by Mohsen Manesh:

In my previous post, I suggested that we are unlikely to see Delaware ever step back from its statutory commitment to freedom of contract in the alternative entity context. And that is true even if Chief Justice Strine, Vice Chancellor Laster, and others might believe that unlimited freedom of contract has been bad public policy.

Why? To be cynical, it’s about money.

It is well known that Delaware, as a state, derives substantial profits, in the form of franchise taxes, as a result of its status as the legal haven for a majority of publicly traded corporations. In 2014 alone, Delaware collected approximately $626 million—that is almost 16% of the state’s total annual revenue—from corporate franchise taxes. (For scale, that’s almost $670 per natural person in Delaware.)

Less well documented, however, is that Delaware also now derives substantial—and growing—revenues as the legal home from hundreds of thousands of unincorporated alternative entities. My chart below tells the story. Over the last decade, while the percentage of the state’s annual revenue derived from corporate franchise taxes has been flat, an increasingly larger portion of the state’s annual revenue has been derived from the taxes paid…

 Guest post by Sandra Miller:

The ratio of LLC filings to corporate filings in Delaware from 2010 to 2014 was over 3 to 1.  Alternative business entities are no longer the province of a relatively small number of sophisticated investors.  Increasingly, corporations are becoming the “alternative” and LLCs and other unincorporated entities the norm.  Mom and Pop business as well as sophisticated real estate syndicators use alternative business entities.  Additionally, as discussed below, publicly-traded limited partnerships and LLCs are now being aggressively marketed. 

Accordingly, the assumptions that might once have justified greater reliance on private ordering in LLCs and alternative business entities should be revisited.  Not all investors are highly sophisticated parties and a relentlessly contractual approach to business entity governance is not appropriate for unsophisticated parties.   Nor is it appropriate for those without sophisticated legal counsel.  In backhanded fashion, this point was recognized by Larry E. Ribstein who advocated the removal of restrictions on waivers of fiduciary duties in limited partnerships when these entities were used by sophisticated firms that were unlikely to be publicly traded.   Ribstein expressly stated that limited partnership interests may be less vulnerable than corporate shareholders and are unlikely to be publicly traded.  (…

Guest post by Daniel Kleinberger:

Part I – Introduction

My postings this week will seek to delineate Delaware’s implied contractual covenant of good faith and fair dealing and the covenant’s role in Delaware entity law

An obligation of good faith and fair dealing is implied in every common law contract and is codified in the Uniform Commercial Code (“U.C.C”). The terminology differs:  Some jurisdictions refer to an “implied covenant;” others to an “implied contractual obligation;” still others to an “implied duty.”  But whatever the label, the concept is understood by the vast majority of U.S. lawyers as a matter of commercial rather than entity law.  And, to the vast majority of corporate lawyers, “good faith” does not mean contract law but rather conjures up an important aspect of a corporate director’s duty of loyalty.

Nonetheless, Delaware’s “implied contractual covenant of good faith and fair dealing” has an increasingly clear and important role in Delaware “entity law” – i.e., the law of unincorporated business organizations (primarily limited liability companies and limited partnerships) as well as the law of corporations.

Because to the uninitiated “good faith” can be frustratingly polysemous, this first blog “clears away the underbrush” by explaining what Delaware’s…

Guest post by Mohsen Manesh:

First, I want to give a big thanks to Anne and the rest of the Business Law Professor Bloggers for graciously hosting this mirco-symposium! As a longtime BLPB reader, it is a privilege to now contribute to the online conversation.

In this post, I want to explore the boundaries of the proposal recently made by Delaware Chief Justice Strine and Vice Chancellor Laster to address the problem, as they see it, that has been created by the unbound freedom of contract in the alternative entity context.  In their provocative “Siren Song” book chapter, the judicial pair advocate limits on the freedom of contract by making the fiduciary duty of loyalty mandatory.[1] But, importantly, they limit their proposal to publicly traded LLCs and LPs. [2]

This limitation is striking because it makes their proposal, in one respect at least, so very modest. There exists literally hundreds of thousands of Delaware LLCs and LPs. (121,592 LLCs were formed in Delaware in 2014 alone!) Only around 150 are publicly traded. [3] Thus, the Strine and Laster proposal for curtailing the freedom of contract affects only a tiny fraction of the alternative entity universe.

But in…