Although the concept of a limited liability company has been around since 1977 when Wyoming enacted a limited liability company act, the popularity of the limited liability company has primarily grown during the last 15 years. In August 1994, the Uniform Limited Liability Company Act was adopted by the National Conference of Commissioners in an effort to create more uniformity among state limited liability company legislation. The Uniform Limited Liability Company Act was amended in 1996 to adapt to certain Internal Revenue Service guidelines.

The allure of the limited liability company business model is its unique ability to bring together in a single business organization the best features of all other business forms -- properly structured, its owners obtain a corporate-styled liability shield, flexibility in establishing rules governing internal affairs and the pass-through taxation of a partnership. General and limited partnerships do not offer all their partners a corporate-styled liability shield; Subchapter C corporations do not offer their shareholders the pass-through taxation of a partnership; yet all state limited liability company acts contain provisions for a liability shield and the pass-through taxation of a partnership. With the greater uniformity among state limited liability company statutes and the increased comfort of business owners and lawyers in understanding the value of the limited liability company business model, more and more limited liability companies have been created to conduct a wide variety of business enterprises.

The number of prospective borrowers that are limited liability companies (“LLC”) has grown over the years, but understanding how to evaluate whether the LLC is properly authorized and empowered to enter into and perform under a loan from a financial institution is not as well understood. Some financial institutions treat an LLC borrower the same as a corporate borrower for purposes of the required documentation. However, LLCs are not corporations and should be evaluated as a distinct type of business organization.

In conjunction with the loan officer’s review of the all important financial information and its credit analysis of a proposed borrower, the loan officer must confirm that the borrower is properly organized and that it will continue to exist beyond the maturity date of the loan. To do this the loan officer should visit the website of the secretary of state¹  (or other comparable state agency) of the state in which the LLC borrower is organized to determine its exact name and whether it is in good standing. As support for this determination, the loan officer should request the borrower to provide a current certified copy of the articles of organization (or certificate of formation in Delaware), as amended, and a certificate of good standing (or certificate of existence) from the secretary of state. The articles of organization should specify whether an LLC was created as a perpetual entity or for a stated number of years. If the life of the LLC is for a stated number of years then the loan officer will want to confirm that the term of the loan is significantly less than the LLC’s term of existence. The articles of organization will have more or less information depending on the state in which the LLC is organized. For example, a certificate of formation for a Delaware LLC will only reveal the name of the registered agent and whether the LLC is created for a perpetual term or will terminate upon a date certain or term of years. However, a certificate of organization for a West Virginia LLC will also establish whether the LLC is member-managed or manager-managed and the identity of the persons or entities having authority to bind the LLC.

After making sure that the LLC is properly formed, in good standing and with a perpetual existence or adequate term of years, then an analysis of the LLC’s scope of authority to borrow money and the identity of one or more persons who have authority to enter into binding agreements on behalf of the LLC is appropriate.

When interacting with an LLC, as the borrower or guarantor, the loan officer, in addition to the articles of organization, as amended, and good standing, should request a copy of the operating agreement, as amended (also sometimes referred to as a limited liability company agreement).² 

Operating Agreement for LLC Loans

If the members of the LLC have entered into an operating agreement, then the loan officer will need to review the operating agreement for the following information:
 

The relevant variations in an operating agreement include requiring a super-majority or unanimous vote for certain actions by the LLC and limiting the types of actions that the manager or managers are authorized to take to bind the LLC.

If the members of the LLC have not entered into an operating agreement, then the limited liability company act of the state of organization controls the powers and limitations of the members and manager(s) of the LLC. In such a circumstance, the loan officer should consult with counsel for assistance in understanding the statutory provisions governing the operation and management of the LLC.

The loan officer should require the LLC to provide written evidence consistent with the operating agreement of its authority to enter into the loan documents, including the amount of the loan and the security interests being granted thereby, and identifying the person or entity authorized to execute the documents on behalf of the LLC. For manager-managed LLCs the written evidence should be either a written consent in lieu of meeting signed by the manager or all the managers, or a certificate signed by a duly authorized member or manager evidencing that such authorization was approved at a duly held meeting of the manager(s) or members at which a quorum was present. Similarly, for member-managed LLCs the written evidence should be a written consent in lieu of meeting signed by all the members or a certificate signed by a duly authorized member evidencing that such authorization was approved at a duly held meeting of the members at which a quorum was present.³

The loan officer should also obtain evidence that the LLC is qualified to transact business in each state in which it transacts business requiring such qualification.⁴ This is done by requiring certificates of authority of a foreign LLC to transact business from the state’s secretary of state or equivalent.

While these business organizational details may appear to be less important than the underwriting analysis, assuring that the LLC is appropriately authorized and in good standing and identifying the member, manager or officer with the needed authority to bind the LLC is critically important. In the worst case, the failure to perform the steps necessary to confirm the legal status of the LLC and authority of the signatory could result in the loan obligation being unenforceable against the LLC and the collateral. This concern is particularly true where an LLC files bankruptcy and the trustee of the bankrupt estate is attempting to avoid any and all liabilities of the debtor company for the benefit of its other creditors.

Because LLC operating agreements vary dramatically depending upon the skill and experience of the drafter, questions regarding (i) the term of the LLC, (ii) the management of the LLC and (iii) the authority reserved to the members often arise that will require a loan officer to consult with counsel for assistance in determining the level and detail of documentation that may be necessary for a particular loan transaction. Spilman, Thomas & Battle is well-equipped to help financial institutions navigate the challenges related to adequately documenting the authority of LLCs to enter into loan transactions. We look forward to the opportunity to assist you.

IRS CIRCULAR 230 NOTICE: In order to comply with the rules of Circular 230 imposed upon us by the Internal Revenue Service, we inform you that (i) any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of avoiding tax-related penalties under the Internal Revenue Code; and (ii) any such tax advice cannot be used in promoting, marketing or recommending to another party any transaction or tax-related matter addressed herein.

¹  While the secretary of state is the office responsible for maintaining business records in most states, the office has a different name in some jurisdictions. For example, the office that maintains business records and issues certificates of good standing or existence is the Corporations Commission in Virginia and the Division of Corporations of the Department of State in Delaware.
²  In contrast, the more traditional corporate form will have articles of incorporation instead of the articles of organization and bylaws instead of the operating agreement.
³  The format of the written evidence of authority will be similar in form to the corporate resolutions that are generally used in the case of corporate borrowers.
⁴  Certificates of authority to transact business in other states are necessary to the extent failure to be registered in such state would have an adverse affect on the borrower’s or guarantor’s business.