Choose Your Entity: LLC v. LLP
Posted Oct 7, 2020
By Washington State Business and Real Estate Lawyer David C. Tingstad
This post compares the limited liability company (“LLC” – RCW 25.15) and limited liability partnership (“LLP” – RCW 25.05.500).
The LLC is perhaps the youngest and most popular entity of choice for entrepreneurs looking to start their business. An LLC combines tax and management flexibility with a liability shield for members. Nevertheless, there are pitfalls lurking in the dark.
First, RCW 25.15 (the “LLC Act”) serves as the “default rules” for Washington LLCs. The default rules govern the LLC unless an “LLC agreement” (which does not need to be in writing) provides rules to the contrary. However, certain default rules may not be modified by agreement. See RCW 25.15.018, .038(7).
Under the LLC Act’s default rules, there are many important considerations. One consideration involves the recognition that certain provisions within the LLC Act may conflict with one another, such as the dissociation provisions of RCW 25.15.131 and the transfer provisions of RCW 25.15.250. I wrote about this contradiction at length in the past, which you can read here. Another consideration involves understanding that certain default rules in the LLC Act may not be in the client’s best interest, such as the default rules requiring the consent of all members for certain actions like the admission of a new member. After all, how practical could this rule be for LLCs with 10+ members? Certainly such a rule would seriously inhibit the LLC’s ability to bring in new members for purposes of obtaining additional capital.
Second, Washington LLCs are structured in two fundamentally different manners: manager-managed and member-managed. Manager-managed LLCs maintain a manager appointed by the LLC, usually for purposes of carrying out the day-to-day affairs of the LLC. Member-managed LLCs almost always do not have a manager, and therefore maintain some form of voting process when the LLC must make decisions.
Within the structural component are two significant considerations frequently overlooked by practitioners: differences in members’ fiduciary duties and potential for deadlock due to poor planning.
As to fiduciary duties, managing members in a manager-managed LLC hold fiduciary duties to the other members and the company, while the non-managing members hold no fiduciary duties at all (outside of the implied contractual duty of good faith and fair dealing). See Dragt v. Dragt/DeTray, LLC, 139 Wn. App. 560, 574-575, 161 P.3d 473 (2007) (holding that non-manager members of a manager-managed LLC do not owe each other a fiduciary duty). On the other hand, all members in a member-managed LLC owe fiduciary duties to one another and the LLC. RCW 25.15.038(1)(a). The significance of fiduciary duties cannot be understated, yet business owners often undertake them with little-to-no consideration.
As to deadlock, poor business planning often times results in LLC’s the inability to make business decisions. This deadlock may, unfortunately, result in the ultimate dissolution of the LLC. For those interested, I highly recommend this older post where Peter Mahler discusses in depth how the deadlock of a start-up developer of abuse-deterrent opioid pain medications resulted in the LLC’s eventual dissolution.
Contrary to LLCs, general partnerships are as old as the day is long. LLPs are merely general partnerships with limited liability due to the filing of an application.
RCW 25.05.500 gives general partnerships the ability to become LLPs by delivering to the secretary of state for filing the following:
[A]n application stating the name of the partnership; the address of its principal office; the name and address of a registered agent for service of process in this state which the partnership will be required to continuously maintain in accordance with Article 4 of chapter 23.95 RCW; the number of partners; a brief statement of the business in which the partnership engages; any other matters that the partnership determines to include; and that the partnership thereby applies for status as a limited liability partnership.
Limited liability is the primary difference between general partnerships and LLPs. As such, LLPs are still subject to the same pitfalls that come with general partnerships. For example, a partner’s dissociation (which may occur at any time—RCW 25.05.230) without the dissolution of the partnership triggers a mandatory buy-out of that partner’s interest pursuant to RCW 25.05.250. The LLC Act does not provide members that same right, and for good reason. The notion that partners can dissociate on demand and be entitled to payment for their interest creates significant uncertainty for businesses and their owners.
Your choice of entity is a significant one, with significant consequences. I have written previously that LLCs are not corporations. LLCs are not LLPs either. Choose carefully!
For more Washington business entity law considerations, refer to this blog every Wednesday at 12 PM, noon.
BERESFORD BOOTH PLLC has made this content available to the general public for informational purposes only. The information on this site is not intended to convey legal opinions or legal advice.