Transcript Document

Common Mistakes in the Formation
of Alternative Entities
Scott E. Waxman
Eric N. Feldman
Nicholas I. Froio
World Services Group Net Meeting
March 7, 2008
Main Entities
 Statutory Trust (ST)
 Limited Partnership (LP)
 General Partnership (GP)
 Limited Liability Company (LLC)
 Limited Liability Partnership (LLP)
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Brief Descriptions
ST
An unincorporated
association created
by a governing
instrument under
which property is
or will be held by a
trustee or
trustees for the
benefit of such
persons as are or
may become
entitled to a
beneficial interest
The Delaware
Statutory Trust Act,
12 Del. C. § §
3801, et seq.
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LP
A partnership
formed by two or
more persons
having one or
more general
partners and one
or more limited
partners.
The Delaware
Revised Uniform
Limited Partnership
Act, 6 Del. C. § §
17-101, et seq.
GP
LLC
LLP
An association of
two or more
persons that (1)
carry on as coowners a business
for profit
regardless of
whether or not the
persons intended
to form a
partnership, or (2)
carry on any
activity not for
profit where the
persons intended
to form a
partnership.
An entity formed by
one or more
members.
A general
partnership the
partners of which
have approved
qualification of the
entity as a limited
liability partnership.
The Delaware
Revised Uniform
Partnership Act, 6
Del. C. § § 15-101,
et seq.
The Delaware
Limited Liability
Company Act, 6
Del. C. § § 18-101,
et seq.
The Delaware
Revised Uniform
Partnership Act, 6
Del. C. § § 15-101,
et seq.
Formation
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ST
LP
GP
LLC
LLP
Certificate of
Trust signed by
all Trustees,
which is filed
A Governing
Instrument,
which is not filed
Unless a RIC,
must have 1
trustee who is a
resident of or
has a principal
place of
business in DE.
If a RIC, need a
registered agent
A beneficial
owner may
receive a
beneficial
interest without
making a
contribution
Relationship of
parties governed
by the Governing
Instrument,
which may
override the Act
in most respects
Certificate of Limited
Partnership signed by
all General Partners,
which is filed
A Limited
Partnership
Agreement (oral,
written or implied),
which is not filed and
may override the Act
in most respects
Must have at least 1
general partner and 1
limited partner
A person may be
admitted as a general
partner or a limited
partner without
making a contribution
or acquiring a general
or limited partner
interest
Registered Agent is
required
No formalities are
required to form. It is
the default entity
when two or more
persons engage in a
business for profit
May file a Statement
of Partnership
Existence, but not
required. If done, a
registered agent is
required
A person may be
admitted as a partner
without making a
contribution
Relationship of the
parties is governed
by an oral, written or
implied Partnership
Agreement, which is
not filed, may
override the Act in
most respects
Certificate of
Formation signed by
an “authorized
person”, which is
filed
A Limited Liability
Company
Agreement (oral,
written or implied),
which is not filed,
can be entered into
before, after or at
the time of filing (at
the time of filing is
preferred), and may
override the Act in
most respects
A person may be
admitted as a
member or a
manager without
making a
contribution or
acquiring a limited
liability company
interest
Registered Agent is
required
Same as a GP,
except (1) the
partners must
approve becoming
an LLP by either
the vote specified
for becoming an
LLP under the
Partnership
Agreement or by
the vote specified
to amend both the
Partnership
Agreement and
provisions, if any,
of the Partnership
Agreement
regarding capital
contributions, and
(2) a Statement of
Qualification must
be signed by a
partner or
authorized person,
which gets filed.
Formation Problems in Detail
 Section 17-201(d) and Section 18-201(d)
– Agreement is required
• “ … shall be entered into or otherwise existing …”
• “Short form” Agreement
• Governing law of Agreement
– Timing of retroactivity
• Ideally, back to the date of filing
– Makes clear that filing party was authorized
– Avoids concerns regarding limited liability for
pre-formation activities
• Problem with multiple tiered structures and nonexistence of necessary party on date of filing
• Status in the interim
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Formation Problems in Detail
• When is entity actually formed?
– Meaning of Section 17-201(b) and Section 18201(b)
» “… if … there has been substantial
compliance with the requirements of this
section ….”
Admission
– Use the magic words “is admitted as _____”
– Meaning of Section 17-301(a)(2) and Section 18301(a)(2)
» “The time provided in and upon compliance
with the … agreement or, if the …
agreement does not so provide, when the
person's admission is reflected in the records
of the [entity].”
• Effect of Subscription Agreements (and the like)
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Formation Problems in Detail
– Is admission linked to contributions?
• See above
– Corpus requirement for Statutory Trusts
• Import of Section 3809
» “Except to the extent otherwise provided in
the governing instrument of a statutory trust
or in this subchapter, the laws of this State
pertaining to trusts are hereby made
applicable to statutory trusts.”
– Consider standard language to override
 Capital Contributions
– Not required under Section 3802(a), Section 15-205,
Section 17-301(d), and Section 18-301(d)
– What does Agreement say?
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Formation Problems in Detail
 General Partnerships (LLPs)
– Default entity
• Entrepreneurs beware: intent and formation
– Choice of Law; is it really a Delaware partnership?
• Import of Section 15-106(c)
– Overrides
• Separate entity status – Section 15-201
• Property ownership – Section 15-203 and Section
15-501.
 Series Trust, Partnership or LLC
– Required language in filing
– Required language in organizational documents?
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Management
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ST
LP
GP
LLC
Extremely flexible
statute
Default rule is that
trust is managed by
its trustees, but this
can be altered to be
management by: (1)
one or more of the
trustees to the
exclusion of others,
(2) one or more
beneficial owners,
(3) a third party, or
(4) any other
structure
Note distinction
between delegation
and original
vestiture of
management rights
and the preference
for the latter
A person
appointed to
manage may have
such rights, titles,
duties and powers
as set forth in the
Governing
Instrument
Extremely flexible statute
Default rule is that the LP
is managed by its general
partners, but this can be
altered to be management
by: (1) one or more general
partners to the exclusion of
others, (2) a third party, or
(3) any other structure,
BUT limited partners may
not participate in control of
the business without
jeopardizing their limited
liability
Statute provides a broad
range of consent and other
rights for limited partners
that do not constitute
“participation in control”
Note distinction between
delegation and original
vestiture of management
rights and the preference
for the latter
A person appointed to
manage may have such
rights, titles, duties and
powers as set forth in the
Limited Partnership
Agreement
Extremely flexible
statute
Default rule is that
the partnership is
managed by its
partners, but this
can be altered to be
management by: (1)
one or more
partners to the
exclusion of others,
(2) a third party, or
(3) any other
structure
Note distinction
between delegation
and original
vestiture of
management rights
and the preference
for the latter
A person
appointed to
manage may have
such rights, titles,
duties and powers
as set forth in the
Partnership
Agreement
Extremely flexible
statute
Default rule is that
the LLC is managed
by its members, but
this can be altered to
be management by:
(1) one or more
members to the
exclusion of others,
(2) a third party, (3)
one or more
managers, or (4) any
other structure
Note distinction
between delegation
and original vestiture
of management
rights and the
preference for the
latter
A person appointed
to manage may have
such rights, titles,
duties and powers
as set forth in the
LLC Agreement.
LLP
Same
as GP
Liability
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ST
LP
GP
LLC
LLP
Beneficial
owners have the
same limitation
of liability as
stockholders of a
Delaware
corporation
(unless they
otherwise
expressly
assume liability
in the Governing
Instrument or
elsewhere). This
limitation applies
without regard to
whether they
participate in
management
Trustees are
not personally
liable for the
obligations of the
Trust (unless
otherwise
expressly
provided in the
Governing
Instrument)
Each general partner has joint
and several, unlimited liability
for obligations of the LP.
Liabilities must first be satisfied
out of LP property before
recourse may be had to a
general partner’s individual
property
Liability of general partner to
limited partners or other
general partners can be
modified by the Partnership
Agreement
Liability exposure for general
partners can be mitigated by
holding a general partner
interest through another limited
liability entity
Limited partners are not
personally liable for the
obligations of the LP unless
they (1) expressly assume
liability, (2) are general
partners, or (3) participate in
the control of the business.
The statute contains broad
“democracy” and consent rights
that a limited partner may
exercise that will not result in
such limited partner being
deemed to participate in control
Each partner has
joint and several,
unlimited liability
for obligations of
the partnership.
Liabilities must
first be satisfied
out of partnership
property before
recourse may be
had to a partner’s
individual property
Liability of
partners to other
partners can be
modified by the
Partnership
Agreement
Liability exposure
can be mitigated
by holding a
general
partnership
interest through
another limited
liability entity
Members and
managers are
not personally
liable for the
obligations of
the LLC
(unless they
expressly
assume
liability in the
LLC
Agreement or
otherwise); this
applies without
regard to
participation in
control of the
business
A Member
could be held
liable under
veil-piercing
theories, but
the bar is very
high and a
finding of
liability would
not be made
lightly by a
court
A partner is
not liable for
the obligations
of the LLP
(unless it
expressly
assumes
liability in the
Partnership
Agreement or
some other
agreement)
A partner is
also not liable
under
indemnification
, contribution,
assessment or
other theories
of potential
liability
A partner is
liable for its
own
negligence or
willful
misconduct
Fiduciary Duties
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ST
LP
GP
LLC
LLP
If not modified in a
Governing Instrument,
a Trustee generally
owes a duty of loyalty,
care and candor to the
Trust and its beneficial
owners, which are
derived from a
combination of
statutes and common
law.
The statute permits
the duties (including
fiduciary duties) of a
Trustee or anyone
else managing a Trust
to be restricted,
expanded or
eliminated in the
Governing Instrument,
subject to implied
contractual covenants
of good faith and fair
dealing.
One of the underlying
premises of the
statute is freedom of
contract, so well
drafted modifications
to fiduciary duties
should be enforced by
Delaware courts.
The statute does not
specify any specific
fiduciary duties for
general partners.
Courts have
analogized to a
director of a Delaware
corporation (good
faith, fair dealing,
loyalty, and care).
The statute permits
the duties (including
fiduciary duties) of a
general partner or
anyone managing an
LP to be restricted,
expanded or
eliminated in an LP
Agreement, subject to
implied contractual
covenants of good
faith and fair dealing.
One of the underlying
premises of the
statute is freedom of
contract, so well
drafted modifications
to fiduciary duties
should be enforced by
Delaware courts
Each partner owes to each
other partner and the
partnership a duty of loyalty
and a duty of care, which
must be exercised in good
faith and through fair dealing
The duty of care requires a
partner not to engage in
grossly negligent or reckless
conduct, intentional
misconduct or knowing
violations of law.
The duty of loyalty consists
of (i) refraining from
competing with the
partnership (unless the
Partnership Agreement
permits it), (ii) holding profits,
etc. as trustee for the
partnership; using
partnership property solely
for partnership purposes,
and (iii) after dissolution, not
dealing with the partnership
as or on behalf of one with
an interest adverse.
A Partnership Agreement
can eliminate fiduciary duties
but cannot eliminate the
duties of good faith and fair
dealing.
The statute does not
specify any specific
fiduciary duties for
those managing an
LLC. Courts have
analogized to a
director of a Delaware
corporation (good
faith, fair dealing,
loyalty, and care).
The statute permits
the duties (including
fiduciary duties) of
anyone managing an
LLC to be restricted,
expanded or
eliminated in an LLC
Agreement, subject to
implied contractual
covenants of good
faith and fair dealing.
One of the
underlying premises
of the statute is
freedom of contract,
so well drafted
modifications to
fiduciary duties
should be enforced by
Delaware courts.
Same
as GP
Some Special Features
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ST
LP
GP
LLC
No creditor of a
beneficial owner has
any right to interfere
with trust property
Except to the extent
set forth in a
Governing Instrument
(GI), a statutory trust
has perpetual
existence
Except to the extent
set forth in a GI, a
beneficial owner or
other person cannot
terminate or revoke a
statutory trust
Except to the extent
set forth in a GI, the
death, incapacity,
dissolution, or
bankruptcy of a
beneficial owner shall
not result in a
termination or
dissolution of the trust
No creditor of a
partner has any right
to interfere with LP
property; it can only
obtain a “charging
order”
Except to the extent
set forth in a Limited
Partnership
Agreement (LPA), an
LP has perpetual
existence
Except to the extent
set forth in an LPA, an
event that results in
the last remaining
general partner or
limited partner ceasing
to be a partner does
not result in dissolution
if a new general or
limited partner, as
appropriate, is
admitted pursuant to
the statute
Statutory default of
partnership being a
separate legal entity can
be opted-out of by so
providing in the
Partnership Agreement
and a Statement of
Partnership Existence
Statutory default of
partnership property
being owned by the
partnership and not by
its partners can be
opted-out of by so
providing in the
Partnership Agreement
and a Statement of
Partnership Existence
No creditor of a partner
has any right to interfere
with partnership
property; it can only
obtain a “charging order”
No creditor of a
member has any
right to interfere
with LLC property;
it can only obtain a
“charging order”
Except to the
extent set forth in
an LLC
Agreement, an
LLC has perpetual
existence
Except to the
extent set forth in
an LLC
Agreement, an
event that results
in the last
remaining member
ceasing to be a
member does not
result in dissolution
if a new member is
admitted pursuant
to the statute
LLP
Same
as GP
To reach us:
Scott E. Waxman
Direct dial: (302) 984-6114
[email protected]
Eric N. Feldman
Direct dial: (302) 984-6204
[email protected]
Nicholas I. Froio
Direct dial: (302) 984-6156
[email protected]
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Potter Anderson & Corroon LLP
1313 North Market Street
PO Box 951
Wilmington, DE 19899-0951
www.potteranderson.com
#852173