Chapter 3 - § 3.2 • FORMATION AND MANAGEMENT OF LIMITED LIABILITY COMPANIES
| Jurisdiction | Colorado |
§ 3.2.1—Formation of LLCs
Who is the Initial Member or Members?
The LLC Act requires that the articles of organization state that there is at least one member of the LLC.37 As discussed in § 3.1.1, "Statutory Filing Requirements — General," causing articles of organization to be delivered to the Colorado Secretary of State for filing constitutes "the affirmation or acknowledgment of each individual causing such delivery, under penalties of perjury, . . . that the individual in good faith believes the facts stated in the document are true."38 If the LLC in fact has no members at formation, then the formation requirements have not been satisfied, and the person causing the articles to be delivered for filing has made a misstatement that potentially exposes the person to penalties for perjury. These authors believe that in most cases there will be at least one person who has agreed to be a member of the LLC — probably the person who formed the LLC or directed the attorney to form the LLC. Moreover, although the definition of operating agreement suggests that that may be a chicken and egg problem with there being at least one member at formation, i.e., how can there be a member if there is no LLC, C.R.S. § 7-80-108(1)(c) provides some help by providing that "[a]n operating agreement may be entered into before, after, or at the time of filing of articles of organization and, whether entered into before, after, or at the time of such filing, may be made effective as of the formation of the limited liability company or as of the time or date provided in the operating agreement." Accordingly, these authors believe that, if at least one person has agreed to be a member of the LLC to be formed, that person has also adopted an operating agreement in which the person agrees to the formation of the LLC, to be a member, and to such other terms as the person has determined for the steps to be taken after formation of the LLC.39
Who Can Form an LLC?
Generally, any person (individual or entity)40 can form an LLC. The LLC Act requires that any individual forming an LLC be age 18 or older.41
Various Types of LLCs in Colorado
A Colorado LLC may be single-member or multi-member42 and may be established with or without a profit motive.43
As discussed in § 3.2.2, "Management of LLCs — Manager-Managed or Member-Managed?," a Colorado LLC may be member-managed or manager-managed. There is a third type of management available to a Colorado LLC: a manager-managed LLC without managers.44
Owners of LLCs
Much of the following discussion requires an understanding of the ownership structure of an LLC. Owners of the LLC can be:
• Members with an economic interest ("membership interest") in the LLC;
• Non-economic members; and
• Assignees.
The LLC Act defines a "member" as a "person[45 ] with an ownership interest in a limited liability company with the rights and obligations specified under this article."46 Although the LLC Act does not define "ownership interest," the LLC Act does define "membership interest" as "a member's share of the profits and losses of a limited liability company and the right to receive distributions of such company's assets."47
Members may make contributions to an LLC "in cash, property, or services rendered or a promissory note or other obligation to contribute cash or property or to perform services."48 The statute makes it clear that a person may be admitted to an LLC as a member and receive a membership interest without making a contribution or being obligated to make a contribution to the LLC.49 This arrangement may result in the member receiving a "profits interest" by which the member receives allocations of profits and losses from the business of the LLC, but does not initially have any interest in the capital (or value) of the LLC at the time of admission.50 In either case (the member making a contribution to the LLC or not making a contribution), the member would own a "membership interest" and be entitled to the rights of a member under the LLC Act and the LLC's operating agreement.
The LLC Act also provides that a member of the LLC may be a "non-economic member" — that is, a person may become a member of the LLC "without acquiring a membership interest"51 and without becoming obligated to make a contribution. Unless modified by the operating agreement, a non-economic member has all of the rights of a member, including the right to vote and the information rights in C.R.S. § 7-80-408, without, however, the right to any economic interest in the LLC. These provisions of C.R.S. § 7-80-501 also apply to single-member LLCs, thus opening the possibility that a single-member LLC may have one or more non-economic members.
The LLC Act also contemplates "assignees," but an LLC will have one or more assignees only if one or more of its members withdraws or transfers all or a part of a membership interest to a transferee who is not admitted as a member. As set forth in the LLC Act, "[u]nless the assignee or transferee is admitted as a member, the assignee or transferee shall only be entitled to receive the share of profits or other compensation by way of income and the return of contributions to which that member would otherwise be entitled and shall have no right to participate in the management of the business and activities of the limited liability company or to become a member."52 As a result (and unless contrary provisions are included in the operating agreement), among other limitations in the LLC Act, an assignee does not have the right to vote,53 bring a derivative proceeding,54 or inspect the records of the LLC.55 An operating agreement could allow assignees to vote or to inspect records,56 but presumably could not grant an assignee the right to bring a derivative proceeding.
Under the LLC Act (and unless modified by the operating agreement), a member may withdraw from the LLC.57 Following the member's withdrawal, the member will be treated as an assignee — with a right to receive the share of the profits or other compensation by way of income and the return of contributions but without the right to participate in the management of the business and affairs.58 If the withdrawal is in breach of the operating agreement, the withdrawing member may be liable to the LLC for damages.59
Can an LLC Exist Before Its Formation?
Simply put, the answer is "no." The LLC Act provides that an LLC is formed when its articles of organization are delivered to the Secretary of State for filing.60 The LLC Act goes on to say that "[a] limited liability company is formed when its articles of organization become effective" (unless there is a delayed effective date set forth in the articles).61 One should be able to say the same about a corporation under the Colorado Business Corporation Act (CBCA).62
This technical analysis is correct; however, C.R.S. § 38-34-105 provides a cure for a conveyance of real property to any entity that has yet to be formed. That section (amended in 201563 ) reads as follows:
(1) If a grantee described in a deed as an entity has not been formed at the time of the delivery of the deed to the grantee, the title to the real property described in the deed vests in the grantee when the entity is formed, and no other instrument of conveyance is required.
(2) As used in this section:
(a) "Entity" has the meaning specified in section 7-90-102 (20), C.R.S.
(b) "Formed" has the meaning specified in section 7-90-102 (29.5), C.R.S.
The statute does not address a number of issues:
• There is no time period stated in § 38-34-105 by which the entity must be formed. It could be minutes after the deed; it could be decades after the deed.
• There is no requirement that the entity formed be formed under Colorado law; it could be an entity formed in any state, and it does not even have to be qualified to do business in Colorado. Thus, before vesting the deed in any subsequently formed Colorado entity, one would arguably have to perform a national search for other entities of the same name.
• There is no contemplation of the status of title during the period before title vests in the entity after incorporation or formation. Does the grantor continue to hold title? Does the grantor hold title in trust for the non-existent entity? Is title in limbo?
• If real property is conveyed in the name of a non-existent entity, it apparently vests in the first entity formed in Colorado (or formed elsewhere that qualifies to do business in Colorado) that has that name.
While this statute does not necessarily recognize the existence of an entity before it is formed, it does create significant potential confusion when title is conveyed to a nonexistent entity.64 Given the ease of formation of an entity in Colorado for more than the past 20 years and the ease of determining whether a Colorado entity does in fact exist, this curative statute seems to be unnecessary, but it was sought by the real estate bar because the issue of title held by non-existent entities does seem to them to be a problem.
It should be noted that § 7-80-105 may impose liability on any person who acts in the name of an LLC before it is formed:
All persons who assume to act as a limited liability company without authority to do so and without good-faith belief that they have such authority shall be jointly and severally liable for all debts and liabilities incurred by such persons so acting.
The CBCA provides similarly in § 7-102-104. Even in the absence of statutory provisions like those cited from the LLC act and the CBCA, a person who acts on behalf of an unformed entity will be liable to the third party under agency law, and the entity once formed will be unable to ratify the contract.65 Although the entity once formed may adopt the contract, adoption does not relate back and does not release the person who acted on its behalf from liability on the contract unless the third party agrees to the...
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