[Please read Part I and Part II before reading this article.]
The second of this group of articles on series limited liability companies addressed the question of whether a series is an entity under Indiana law and concluded that the best answer is probably, yes, even though it lacks some of the attributes that one would ordinarily expect of an entity. But exactly what is it that makes up a series?
The definition of “series”
[This is the second of several articles on series LLCs, especially Indiana series LLCs. Go here for Part I, which includes an introduction to the concept of series LLCs and some terminology.]
Is a series an entity?
That’s the question almost every lawyer asks when first introduced to series LLCs. It is really shorthand for a lot of other questions: Can a series enter into its own contracts? Can it sue and be sued in its own name? Can assets be titled in the name of the series, as opposed to the name of the master LLC? And so on.
This is the first of several articles about series limited liability companies in general and Indiana’s new series limited liability company statute in particular – a “series series” of articles. (Sorry. I couldn’t resist.)
Even as lame as that joke is, it demonstrates that terminology in this area can be very confusing, and the confusion is compounded by the fact that the series LLC statutes in different states use different words for the same concepts. Here are some rules I’ll follow throughout these articles.
This is the final installment in a series of articles dealing with Indiana’s new benefit corporation statute in general and its applicability to small businesses in particular, and we now arrive at the ultimate question: Is it a good idea for a small businesses to incorporate as (or to convert to) a benefit corporation?
In our opinion, the best choice of entity for most small businesses is a limited liability company, not a corporation, and the new benefit corporation statute does not change that opinion. Although we think the benefit corporation statute is an excellent addition to Indiana corporate and business law, we believe the Indiana LLC statute already has enough flexibility to permit LLCs to adopt the same governing principles, policies, and procedures that are pre-packaged in the benefit corporation statute without giving up the other advantages that LLCs have over corporations in general.
First, the Indiana Business Flexibility Act allows LLCs to be organized for “any business, personal, or nonprofit purpose,” which certainly seems broad enough to include the combination of business and public benefit purposes for which benefit corporations are created. Second, all of the governance, transparency, and accountability provisions of the benefit corporation statute can be incorporated into a limited liability company’s operating agreement. Finally, certification as a B-Corp is not restricted to benefit corporations – essentially any form of business entity is eligible to be certified as a B-Corp, including LLCs.
[This article is written by Rep. Casey Cox (R-Fort Wayne), the author of Indiana’s new benefit corporation statute and an attorney in the Fort Wayne office of Beers Mallers Backs & Salin, LLP, where he practices in the areas of business and corporate matters, real estate, and local government law. As we developed this series, Rep. Cox was very generous with his time and his insights into the new statute. For that and for this article, we are grateful, and we thank him. — MS]
The last few decades have seen a dramatic increase in the number of investors who not only seek a financial return but also want to invest their money is socially and economically responsible businesses, as well as an increase in the number of consumers who want to purchase goods and services from those businesses. Many of them are frustrated by the number of companies who claim to be good corporate citizens but do not provide the transparency for investors and consumers to prove it.
The Potential Drawback to Transparency
Part I of this series briefly discussed Indiana’s new benefit corporation statute as well as certification of a company as a B Corp by B Lab and some of the their possible advantages. Part II began a closer look at the details of the benefit corporation statute, including the question of whether the benefit corporation is a good choice for small businesses.
The “Benefit” Part of a Benefit Corporation
As we’ve mentioned before, a benefit corporation is one with purposes in addition to making money for its shareholders. All benefit corporations share the purpose of creating a general public benefit, defined as having an overall material positive impact on society and the environment. In addition, benefit corporations may also establish for themselves the purpose of creating a specific public benefit that serves one or more public welfare, religious, charitable, scientific, literary, or educational purpose or another purpose that goes beyond the strict interests of the shareholders.
Part I of this series briefly discussed Indiana’s new benefit corporation statute as well as certification of a company as a “B Corp” by B Lab and some of the possible advantages of certification and of incorporation under the new statute. Part II begins to look more closely at the details of the new law and to consider whether it makes sense for small businesses to incorporate under the new statute.
From a corporate law perspective, benefit corporations are, first and foremost, corporations subject to the Indiana Business Corporation Law, just like any other Indiana for-profit corporation. In our view, a corporation is not the best choice of the form of entity for most small businesses. For a number of reasons, including the tax alternatives available to LLCs, the “pick-your-partner” and charging order provisions of the Indiana LLC statute, and the fact that LLCs have fewer corporate formalities that must be observed (which decreases the possibility that the liability shield that protects the assets of owners from the creditors of the business will be disregarded through so-called veil-piercing), we believe that a limited liability company is a better choice than a corporation for most small businesses.
The above advantages of LLCs over corporations are the same – or even greater – for benefit corporations. For example, partnership taxation is not an option for benefit corporations; if that is important enough, a benefit corporation is not a viable alternative. In addition, the benefit corporation adds more required corporate formalities on top of those already imposed by the Indiana Business Corporation law, increasing the administrative burden and the possibility of weakening the liability shield protecting the assets of owners from the company’s creditors. In other words, for most small businesses, a benefit corporation will not be the best choice of entity for most small businesses, unless the advantages of incorporating as a benefit corporation outweigh the advantages of organizing as a limited liability company.
On January 1, 2016, Indiana will join nearly 30 other states with statutes authorizing a relatively new form of for-profit corporations known as a benefit corporation. The Indiana statute was created by House Enrolled Act 1015, which was authored by Rep. Casey Cox (R-Fort Wayne), and will be codified at Ind. Code 23‑1‑1.3.
Indiana’s benefit corporation statute, like most (maybe all) others, is based on a model statute developed by B Lab, a nonprofit organization that certifies businesses that meet certain standards for social and environmental performance, accountability, and transparency. There are currently 1287 businesses certified by B Lab, including some companies that were well known for their social responsibility long before they were certified, such as Ben & Jerry’s.
Sorting out the terminology
The issuance or sale of securities is subject to regulation by the United States Securities Exchange Commission and by authorities in every state, including the Securities Division of the Office of the Indiana Secretary of State. Depending on the situation, a member’s interest in a limited liability company may or may not be within the definition of a “security” and, therefore, may or may not be subject to federal and state securities laws. If the securities laws apply, the consequences can be signficant because, as my friend and retired securities lawyer Steven Lund says, “There are three types of securities: registered, exempt, and illegal.”
Contrary to what you may sometimes hear, there is no exemption for securities that are issued or sold to family members or close friends, and there is no sale of securities that is exempt solely because the value is less than a certain amount. In addition, certain parts of the securities laws, such as those prohibiting securities fraud, apply to every securities transaction, even if it is exempt from registration requirements. An illegal sale of securities can have serious ramifications, including civil lawsuits and potentially even criminal charges. And there can be ramifications even if there is never a lawsuit or governmental enforcement action For example, a debt incurred through a securities violation cannot be discharged in bankruptcy. Owners of small businesses who set up new LLCs, or bring new members into existing LLCs, without obtaining the advice of a lawyer with experience in corporate and LLC law expose their businesses and themselves to signficant risk.
I sometimes run across small business owners who have set up their business as a corporation, and I often ask why they chose a corporation rather than a limited liability company (or LLC). Sometimes the answer is that the business was incorporated before LLCs existed, or when LLCs were new and the lawyer who advised the owner was not familiar with LLCs or was not comfortable with using them, and that makes sense. Another relatively common answer is that the owner’s lawyer or, more often, accountant advised the owner that there were advantages to being taxed as a Subchapter S corporation rather than being taxed as an LLC, so the business was organized as a corporation rather than a limited liability company. That doesn’t make as much sense, at least not since 1997.
Although the history of LLCs can be traced back to earlier statutes in Germany and other European countries, there were no LLCs in the United States until 1977 when Wyoming passed the first LLC statute in the country. For several years after that, the use of LLCs was suppressed by uncertainty surrounding their status for income tax purposes.
The Internal Revenue Code did not (and still does not) include provisions specifically written for taxing LLCs. The question was whether they would be taxed as partnerships or as corporations, and the answer was not clear. In 1995, the IRS issued guidance identifying four specific attributes Continue reading ›
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