When parties have a conflict and they choose us for their mediation or arbitration needs, they expect subject-matter specialists, creative problem-solving skills, and practical experience.  Michael Ledyard is one of our many neutrals who consistently exceeds these goals.  He is one of the leading authorities on Delaware entities, and there is not a better mediator who understands their intricacies, flexibility, and their uses.  In fact, he literally wrote the law on the Delaware Statutory Trusts, was responsible for billions of dollars in financing for his clients, and advised countless Delaware LLCs and corporations.  He is the creative, knowledgeable problem-solver that our clients look to when they have business issues to solve.  Here, Michael is sharing his thoughts as to why Delaware is the preferred state for the formation of limited liability companies.

Why Delaware Is the Preferred State of Formation for Limited Liability Companies

Delaware has emerged as a leader in providing cutting-edge alternatives to the traditional corporation. One example of this leadership is Delaware’s enactment of the Delaware Limited Liability Company Act (the “DLLC Act”)[1], which governs the most popular “alternative” business entity, the Delaware limited liability company (“DLLC”). The DLLC is rapidly becoming an entity of choice for business advisors and investors and can provide many tax and business advantages over the corporation.

A DLLC may carry on any lawful business, purpose or activity, other than the business of banking. The principal advantages of a DLLC are avoidance of double taxation of income, unmatched contractual flexibility and limited liability of its owners and managers. A DLLC may be structured in virtually any manner that best suits the business needs of the parties. This flexibility can make the DLLC preferable to the traditional corporation.

Formation of a Delaware Limited Liability Company

A DLLC is easy to form and maintain. Formation requires only: (1) a limited liability company agreement of the member or members (which need not be written); and (2) the filing of a certificate of formation with the Delaware Secretary of State. A DLLC is deemed to have been formed at the time the certificate of formation is filed with the Delaware Secretary of State. The certificate of formation must set forth the name of the DLLC and the name and address of the DLLC’s registered agent and registered office in Delaware (which office may be the office of the registered agent). A DLCC does not need to have any other office in Delaware. No other information is required, and the certificate of formation may be executed by any person authorized by the DLLC.

A limited liability company agreement is a private contract and not a public document. Therefore, under the DLLC Act the identity of a DLLC’s owners and managers, the terms of their relationships and the financial affairs and business of the DLLC can remain confidential. The DLLC Act does not specify any minimum capital investment. Non-U.S. businesses and individuals generally are free to form and operate DLLCs because the DLLC Act does not require an owner or manager of a DLLC to be a natural person or a citizen or resident of the United States. Additionally, a DLLC’s records need not be located in Delaware; such records may be located wherever is most convenient for the parties, including any jurisdiction outside the United States. Furthermore, such records may be maintained in electronic or other non-written form.

No Delaware Business Activities Required

There is no requirement that a DLLC carry on business activities or establish or maintain any place of business in Delaware. A DLLC is required, however, to maintain a registered agent and registered office in Delaware, which requirements may be provided by a commercial agent for a nominal annual fee.

Limited Liability

The DLLC Act generally refers to owners of a DLLC as “members,” and to persons designated to manage the business and affairs of the entity as “managers.” The DLLC Act also permits a DLLC to be managed by its members instead of by a manager. The DLLC Act provides that no member or manager is personally liable for any debt, obligation or liability of a DLLC solely by virtue of such party’s status as a member or manager. In addition, the DLLC Act expressly empowers a DLLC to “indemnify and hold harmless any member or manager or other person from and against any and all claims and demands whatsoever.” This limitation on personal liability and the broad scope of permissible indemnification compare favorably with the corresponding protections enjoyed by stockholders, officers and directors of a Delaware corporation.

Contractual Flexibility

The DLLC Act is often referred to as a “default statute”. That is, the parties to a limited liability company agreement are granted broad discretion set forth the business relationships among themselves in the limited liability company agreement (often referred to as an operating agreement), and the DLLCA provides rules for those matters not addressed in the limited liability company agreement. A stated policy of the DLLC Act is to give maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements. This important policy means that the parties can predictably create and maintain the relationships that best suit their business needs. For instance, a limited liability company agreement may provide for various classes of members, with each class enjoying different rights, powers, and duties, including separate voting rights and economic rights. In fact, the parties may by agreement determine nearly all aspects of their relationship with one another. To the extent that a member or manager has duties (including fiduciary duties) to the DLLC or to another member or manager, the DLLC Act provides that the limited liability company agreement may expand or restrict or eliminate such duties (other than the implied contractual covenant of good faith and fair dealing[2]).

Management Flexibility

The principle of contractual freedom manifests itself particularly in management flexibility, a cornerstone of the DLLC Act. The parties can select the management arrangement that works best for them. Under the DLLC Act, members of a DLLC can participate in management without jeopardizing their limited liability, or they may elect to have the DLLC managed by someone else, or fashion a blend of these two approaches. The limited liability company agreement may provide for different classes of managers, each having such rights, powers, and duties as are provided therein. The limited liability company agreement also may contain provisions relating to the exercise of voting rights, including provisions relating to notice of the time, place, or purpose of any meeting at which any matter is to be voted on, waiver of any such notice, action by consent without a meeting, quorum requirements, and rules for voting in person or by proxy. Members and managers of a DLLC generally are free to transact business with the DLLC.

Business Combination Flexibility

In addition to flexibility at the creation and operational stages of a DLLC’s existence, the DLLC Act offers the parties a number of ways to restructure the DLLC. For example, under the DLLC Act, a DLLC may merge or consolidate with another DLLC or with an “other business entity” (including, but not limited to, corporations, statutory trusts, and partnerships), whether any such other business entity is formed or organized under the laws of Delaware or another jurisdiction. Delaware offers additional flexibility by permitting reorganization of a DLLC by way of asset sales, “conversions,” “transfers” and “domestications.”

Federal and State Taxes

Other than an annual tax (currently $300) payable to the Delaware Secretary of State, a DLLC is not obligated to pay taxes to either the United States federal government or to the State of Delaware solely because the DLLC is formed under the laws of Delaware.

In general, a DLLC may become subject to income taxes by the State of Delaware if it conducts business in the State of Delaware or it receives income from a source in the State of Delaware, and similarly, a DLLC may become subject to income taxes by the United States government if it conducts business in the United States or it receives income from a source in the United States.

 

DISCLAIMER

The foregoing information is for general informational purposes only and is NOT intended to constitute legal or business advice of any nature. Readers are advised to seek competent Delaware legal counsel before relying upon any of the information set forth above.

[1] The Delaware Limited Liability Company Act is set forth at 6 Del. C. § 18-101, et seq.

[2] The Delaware Supreme Court has held that the implied duty of good faith and fair dealing is “a limited and extraordinary legal remedy.” Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC, Del. Supr. No. 536, 2018 (Jan. 17, 2019). The covenant to act in good faith and deal fairly applies in two common situations: (1) where a situation has arisen which was unforeseen by the parties and where the agreement’s express terms do not cover what should happen, and (2) where a party to an agreement is given discretion to act in a certain situation, and the party uses such discretion in a way which is impliedly proscribed by the agreement. Id.