More than 12,500 Illinois businesses have chosen to organize as Limited Liability Companies (LLC’s) instead of corporations since the state first enacted an LLC statute. (805 ILCS 180, original effective date January 1, 1994.) The reasons for such use are fairly simple. They include:
• Elimination of organization level taxation, for LLC’s that choose to be taxed as individuals or as partnerships instead of as business associations;
• No Illinois franchise tax on LLC membership interests;
• Limited liability without the requirement of a separate corporate general partner, for LLC’s structured in ways similar to limited partnerships; and
• No Subchapter S corporation limits on foreign ownership, multiple classes of stock, number of owners, etc...
The limited liability company is and has been designed to facilitate closely held business organization operations. Federal tax regulations imposing corporate tax treatment on publicly traded partnerships mean that most large businesses continue to operate as subchapter C corporations or in other business forms. With LLC laws in all 50 states, most new businesses evaluate both LLC and corporation organization before deciding on a choice of entity.
II. Reasons for Change
Senate Bill 1020, enacted as P.A. 90-424, became effective as of January 1, 1998. Its passage was the result of several years of work by a subcommittee of Secretary of State George Ryan’s Corporation Laws Advisory Committee, which I chaired.
Business organizational laws follow the needs of the business community. If ours were to remain competitive, uniformity and an LLC act without the substantial defects inserted in our model during the course of original enactment were significant reasons to look at new LLC legislation. The two major reasons for change were:
A. Customers and Investors Need Uniformity:
A business organization that needs to operate in 50 states of the Union, to raise capital in markets outside its home town, and to cross international borders in the course of contracts, sales, and manufacturing operations needs to conform, in most respects, to what investors and potential contracting parties expect to encounter when they deal with a specific organizational form.. For this reason, the Model Business Corporation Act, the Revised Uniform Limited Partnership Act, and other uniform organizational laws have often been followed by all 50 states in whole or in significant part, whether or not local lawyers could do a "better" job writing specific provisions into law. In the course of the four years following the enactment of the first Illinois LLC law, all the states that lacked the new organizational form adopted their own LLC statutes, and several major jurisdictions produced substantial amendements to their initial laws. In addition, the National Conference of Commissioners on Uniform State Laws produced a model act with several provisions not consistent with existing Illinois law, or not covered and defined by same. To allow Illinois-based LLC’s to compete effectively, we needed to look at a second generation law.
B. The Existing Law Had Some Defects:
Otto von Bismarck, the "Iron Chancellor" who put together the 19th century German empire, said that you shouldn’t ask too many questions about how two things were made: laws – and sausages. The 1994 bill lacked any provision for merger into or out of another Illinois business organization, and it needlessly confused the LLC form with corporation laws by specifying that members of LLC’s would have liability "to the extent that a shareholder of an Illinois business corporation is liable in analogous circumstances under Illinois law", and that managers would be personally liable "to the extent that a director of an Illinois business corporation is liable". (Previous Section 10-10.) These defects resulted from concerns expressed during the legislative process about potential revenue loss and about outside business and judgement creditor ability to obtain recourse against the new entity form.
The track record since enactment justified elimination of these defects. Max Rockhold and Helen Conlee, directors of the LLC/LP and Corporations divisions of the Department of Business Services, presented data to the Secretary’s advisory committee in 1997 that showed the new organization had actually resulted in a net revenue increase to the Department, which administers and collects both franchise taxes for corporations and LLC fees. The law affecting shareholder liability also changed in the interval, and not for the better. The Hagshenas v. Gaylord case and its progeny (199 Ill. App. 60, 145 Ill. Dec. 546, 557 N.E. 2d 316 (1990) increased the potential liability of departing shareholders from an Illinois business corporation. This made deal-specific liability rules for member and manger debts to an LLC, and rules for liability to outsiders that could be conformed to the limited partnership – like structure of most LLC laws and organizational agreements, a significant potential improvement in any new bill. The new Act allows mergers, and significantly improves the definition of both internal and external liabilities for LLC managers and members.
Major changes in the new LLC Act included:
A Single Member LLC’s: These were permitted, which was not allowed under the prior law. (805 ILCS 180/15-1(b).)
B. Nonprofit LLC’s: The original Act specified that a limited liability company could "carry on any lawful business" except banking, nonsyndicate insurance, dentistry unless all members were dentists, or medicine unless all members were physicians (805 ILCS 180/1-25). The new Act specifies that an LLC may be "formed for any lawful purpose or business" (805 ILCS 180/1-25), and defines "Business" to include "every trade, occupation, profession, and other lawful purpose, whether or not carried on for profit. (805 ILCS 180/1-5.)
C. Member and Manager Liability To Third Parties: Unless a member or manager consents in writing to a provision in the Articles of Organization which changes the default rule, he or she is not liable for the contract, tort, or other liabilities of the company solely by reason of being or acting as a member or manager. (805 ILCS 180/10-10.)
D. Authority to Deal with Third Parties: Unless limited by the Articles of Organization, any member in a member-managed LLC or manager in a manager-managed LLC has apparent authority to bind the company as to transactions within the ordinary course of the company’s business. (805 ILCS 180/13-5.) This was not defined under prior law.
E. Internal Governance: Amendments to Section 15-5 specify that operating agreements may not unreasonably restrict certain information rights; vary some requirements to wind up the organization; restrict the rights of persons not members, managers, or their transferrees; restrict dissociation rights; or eliminate (though it may better define) member and manager fiduciary duties. (805 ILCS 180/15-5(b).)
F. Distributions: Default rules specifying distribution in equal shares if any distributions are made prior to the winding up of the LLC, and better defining liability for wrongful distributions, are enacted in a new Article 25.
G. Fiduciary Duties: We tried to clarify fiduciary duties in new 85 ILCS 180/15-3. Note that the duties of a manager or member "include" the duties of loyalty and of care referred to in subsections (b) and (c) of Section 15-3. The new Act also specifies something which would, in a common law state like Illinois, be true unless specifically modified in any case: Section 1-43 states that "Unless displaced by particular provisions of this Act, the principles of law and equity supplement this Act."(805 ILCS 180/14-3.) This should put all affected persons on notice that the law of equity, ordinary principles of agency, and the law of contracts will apply to LLC deals unless specifically changed by agreement or by the provisions of statutory law.
H. Transfers of Interests: Member interests are clearly defined to be interests in distributions, and not property interests in the LLC. Distributional interests are permitted to be transferred in whole or in part. Such interests can be evidenced by certificates. Transfers do not, by themselves, confer a right to participate in the management and affairs of the LLC. They merely provide for a transfer of whatever right the transferring member had to distributions. (805 ILCS 180/30-1, 30-5, 30-10.)
I. Dissociation and Dissolution: Events causing a member to be or permitting a member to rightfully or wrongfully dissociate him or herself from the LLC are defined, as are the effects of dissociation. (805 ILCS 180/30-45, 30-50, 30-55.) Dissolution is no longer required on the death, resignation, bankruptcy, or incompetence of a member. Dissociation is made mandatory only under certain limited legal circumstances, unless by agreement, and the process of and liabilities and rights associated with winding up the enterprise are better defined. (805 ILCS 180/35-1, 35-3, 35-4, 35-7, 35-10, 35-20, 35-30.)
J. Merger and Conversion: LLC’s are permitted to be merged with domestic and foreign corporations, foreign LLC’s, and other foreign entities, and to be converted to limited partnerships or general partnerships. (Business Corporation Act, 805 ILCS 5/11.39, LLC Act Article 37.)
K. Fees: Initial filing of Articles of Organization now costs $400, instead of $500. Changes of registered agents and registered offices now cost $25, instead of $100. Annual report fees have been reduced to $200 from $300. Articles of Merger will cost $100 plus $50 for each party to the merger in excess of 2 parties to file, and Articles of Conversion or statements of conversion will cost $100. Other filing fees remain the same. (805 ILCS 180/50-10.) Note that changes in membership of an LLC are not interpreted to be amendments to the Articles of Organization, and so do not require interim filings and filing fees.
L. Transition Rules: Before January 1, 2000, the amendatory Act only applies to LLC’s organized after January 1, 1998 that are not carrying on the business of a dissolved LLC under the Act, and to other LLC’s which elect to be covered by the provisions of the new Act. For other LLC’s, the provisions of the original Illinois LLC Act are still in full force and effect. (805 ILCS 180/55-15.)
III. Why go To Delaware?
The simplest reason to use your domestic LLC organizational statute is money saved. If you decide to create a corporation or LLC in Delaware, or any other foreign jurisdiction, that organization will have to pay the initial Delaware fees, and will then need to pay the fees and have the forms prepared to qualify to do business in Illinois.
If your client needs some of the more arcane provisions of Delaware or other statutes, he or she probably would benefit from time on task and attention to detail on your part in drafting buy-sell, investment rights, or other deal-specific terms in the operating agreement that would match or exceed the benefits of default rules built into foreign state law.
Absent the "your money stays in the deal until dissolution" terms of something like the Georgia Limited Partnership statute, which may or may not be appropriate to qualify for minority interest discounts under IRC Section 2704, few or no deals I and my colleauges on the working group have analyzed could not be done, and done well, under Illinois law.
Careful study of the legislation adopting the new Act, of the new forms provided for under same, and of the Secretary of State’s regulations is suggested, to avoid having your drafts of Articles or other documents bounced unnecessarily.
Copies of the Act as amended, of forms, and of regulations can be obtained from the Secretary of State, Limited Liability Company Division, Rm. 359, Michael J. Howlett Building, Springfield, IL 62756, tel. (217) 524-8008.
The Secretary of State’s website is accessible at www.sos.state.il.us
William A. Price is engaged in business representation in Wheaton. He is a Professor of Business Law at IIT/Stuart Graduate School of Business. He may be reached at email@example.com.