LLCs Are NOT Corporations
Many “good ideas” today take direction from other “good ideas” before them. This blog, for example, takes inspiration from other “bloggers” in the legal community, such as my friend Tom Rutledge, an expert in business entity law from Kentucky. I will certainly refer to Mr. Rutledge’s blog in future posts as he offers unique insight into business entity legal issues.
One aspect of Mr. Rutledge’s blog I enjoy is his recurring posts citing examples of judicial opinions identifying LLCs, as “limited liability corporations.” Limited liability corporations, of course, do not exist. However, these errors are nevertheless quite humorous (and, for the most part, may be harmless) and serve as a reminder that even “experts” of law—judges— do not understand that an LLC is not a corporation (and members are not “shareholders”).
Judges Can Make Mistakes
A search of Washington’s case law database reveals 121 examples of “limited liability corporation” being used by judges in written opinions. Just last month in a marital dissolution case, In the Matter of the Marriage of Miller, No. 79625-9-I, 2020 WL 2843508 (Wn. App. June 1, 2020), the judge identified an LLC owned by one spouse as a “limited liability corporation.”
LLCs v. Corporations
While errors such as these may not significantly impact the outcome of cases, they do provide an important opportunity to remind interested individuals that an LLC is not a corporation. Significant differences exist between LLCs and corporations. Corporations are creatures of statute — in Washington that statute is RCW 23B, the Washington Business Corporation Act (the “WBCA”). LLCs, on the other hand, are creatures of contract. While a statute allows LLCs to exist in Washington — RCW 25.15, (the “LLC Act”) — an LLC can avoid almost every provision in the LLC Act by a contract, an LLC agreement.
Here are a few differences between an LLC and a corporation:
Death of a Member/Shareholder
While there a many significant differences between LLCs and corporations, there is one difference I face frequently in my practice worth noting here: LLCs treat the death of an interest holder (i.e. a “member”) differently than a corporation treats the death of a shareholder.
In an LLC context, unless the LLC agreement states otherwise, upon the death of a member the deceased member’s personal representative becomes a transferee per RCW 25.15.251(5), and loses the right to vote. In other words, the default provisions of the LLC Act do not terminate a member’s economic interest upon their death. Rather, a member’s management interest does terminate upon the member’s death.
Corporations, on the other hand, treat the death of a shareholder very differently. When a shareholder of a corporation dies, the deceased shareholder’s shares pass in accordance with the decedent’s will or pursuant to the laws of intestate succession. All rights associated with the shares owned by the deceased, either economic- or management-related, survive the death of the shareholder. This aspect of corporations can be very problematic as the death of a “cooperative” shareholder may bring about another “less cooperative” shareholder.
In this sense, LLCs provide members with greater freedom to choose who manages the LLC – the so-called “pick-your-partner principle”, upon which I have written previously. In general, a transferee of a member’s interest only becomes a member upon the consent of all members. RCW 25.15.116.
Other Events of Dissociation Only Affect Members, Not Shareholders
In addition to the death of a member, the LLC Act lists other “events of dissociation.” I discussed dissociation and withdrawal of members specifically in a blog post you can find here. Amongst the LLC Act’s “events of dissociation” are a couple important events to consider in this brief discussion of the differences between LLCs and corporations: bankruptcy of a member and the incapacitation of a member. A member of an LLC dissociates from the LLC if that member files for bankruptcy or becomes incapacitated.
It is crucial to understand that this is not the case with shareholders of a corporation. Shareholders are not “dissociated” from a corporation if they file for bankruptcy or become incapacitated.
Considerations for Professionals
For lawyers and other professionals stuck in the web of issues surrounding business entity law, it is vital to understand the fundamental differences between each entity. Counsel your clients on the differences, so they make an informed decision.
For more Washington business entity law considerations, refer to this blog every Wednesday at 12 PM, noon.