Are the courts developing a unique theory of limited liability companies or simply borrowing from other forms?

• Author: Miller, Elizabeth S.

1. INTRODUCTION

   One would expect the answer to the question posed in the title to depend to a significant degree on the extent to which legislatures have developed a unique theory of limited liability companies (LLCs) or have simply borrowed from other forms. Commentators and courts often describe an LLC as a "hybrid" combining certain corporate and partnership features. This characterization invites the notion that in any given case, an LLC should be thought of either as "like a corporation" or "like a partnership." Viewed this way, an LLC may be unique in the manner it combines certain corporate and partnership features, but is perceived as having few, if any, features that are themselves unique or that, while inspired by the corporate or partnership form, play out in a manner other than they would in the corporate or partnership form. (1) If a provision in a state's LLC statute was obviously borrowed from the corporate or partnership context, then it should not be surprising to see courts relying on precedent from that context on the issue, and that is often the case. However, the case law provides glimpses of a unique theory of LLCs even where a concept, such as limited liability (a corporate concept) or the charging order (a partnership concept), has been borrowed from another form. If the issue is one that is not explicitly addressed within the parameters of the LLC statute, such as how an LLC or those associated with it are to be treated under another statutory or regulatory scheme, it also should come as no surprise when courts look at how other entities have been treated and whether and to what extent LLCs should be subject to similar treatment.

   Ultimately, the statutory and decisional law reflect a good deal of wholesale borrowing from the corporate and partnership contexts, the wisdom of which has been and will continue to be the subject of debate. To date, there appear to be more situations where courts dealing with LLCs have analogized to corporate precedent than partnership precedent, but one must be careful about the conclusions that are drawn from this state of the case law. Some issues, like the limited liability of a member or the direct versus derivative distinction in the LLC context, are prone to be litigated more frequently than others, and these features happen to be borrowed from the corporate context. In general, there simply is more case law dealing with the corporate context from which to draw, and courts tend to be somewhat more familiar with corporate law. Further, a court's reliance on case law dealing with the corporate context does not mean that the result in a particular case would not have been different in the partnership context. In fact, as partnership law has moved away from the aggregate theory and toward the entity theory (and as corporate law has adapted to some of the particular concerns arising in the closely held corporation context), the distinctions between partnerships and corporations have become less pronounced. Thus, applying corporate or partnership principles may lead to the same result in many cases, and the more appropriate question may be whether and to what extent the LLC context calls for distinct analysis or treatment.

   Some insight into how courts conceptualize LLCs is gleaned from cases in which the courts must determine how an LLC is treated under statutes (or, in some cases, private contracts or arrangements) that do not explicitly refer to LLCs. Statutes drafted prior to the advent of LLCs obviously were not drafted with LLCs in mind, and if the statute has not been amended to address LLCs, the issue may arise whether an LLC is included in some other term used in the statute, such as "person," "corporation," or "association." The courts have reached various conclusions in such cases. Although courts have readily accepted the analogy between an LLC and a corporation in many cases--even interpreting the word "corporation" in some instances to include an LLC--there are a number of notable contexts in which courts have recognized the unincorporated nature of an LLC and have refused to equate an LLC to a corporation. Part II discusses cases in which courts have had to determine whether or how a statute or doctrine applies to an LLC when the statute does not explicitly refer to LLCs.

   Part III examines judicial treatment of LLCs under the LLC statutes themselves. As noted above, the LLC form is often characterized as a "hybrid" entity because it combines certain corporate and partnership features. Inasmuch as LLC statutes borrowed heavily from the corporate and partnership contexts, it is no surprise that courts have looked to corporate and partnership case law when interpreting and applying LLC statutes. Analogizing to corporate or partnership law is sensible in many cases, and, when appropriate, facilitates more efficient and predictable results than attempting to develop LLC law "from scratch" so to speak. On the other hand, courts must take care not to assume that corporate or partnership precedent will resolve any question that arises in the LLC context. The very manner in which corporate and partnership principles are combined in the LLC context leads to some unique questions that may necessitate unique answers. Furthermore, to the extent that LLC statutes reflect variations from corporate and partnership approaches or themes, judicial analysis should acknowledge and address such variations and ensure that LLC law develops in a manner that takes such variations into account. Though the LLC case law spans less than two decades, it is already too voluminous for this article to comprehensively review and assess. Part III simply provides a glimpse of the judicial treatment of LLCs to date under LLC statutes by highlighting approaches and trends in a few select areas and illustrative cases.

2. CASES ANALYZING THE NATURE OF AN LLC UNDER STATUTES THAT DO NOT REFER TO LLCS AND DOCTRINES DEVELOPED OUTSIDE THE LLC CONTEXT

   1. Treatment of LLCs for Diversity Jurisdiction Purposes A substantial body of case law has developed in the context of the determination of the citizenship of an LLC for diversity jurisdiction purposes, and federal courts have overwhelmingly concluded that an LLC is not "incorporated" within the meaning of the federal diversity jurisdiction statute. Federal courts that have confronted and analyzed the issue have been virtually unanimous in concluding that an LLC's citizenship is not determined in the same manner as a corporation's citizenship for purposes of diversity jurisdiction, under which a corporation is deemed to be a citizen of its state of incorporation and the state where its principal place of business is located. (2) Rather, based on the approach to citizenship applied by the United States Supreme Court to a limited partnership in Carden v. Arkoma Associates, (3) federal courts have consistently held that an LLC has the citizenship of each of its members. (4) In Carden, the Court rejected the argument that a limited partnership should be considered a citizen of its jurisdiction of formation or, alternatively, that only the citizenship of its general partners should be considered. (5) The Court refused to deviate from the established precedent of considering the citizenship of every member of an unincorporated entity. (6) Acknowledging that its conclusion could "validly be characterized as technical, precedent-bound, and unresponsive to policy considerations raised by the changing realities of business organization," (7) the Court left to Congress the task of "accommodating our diversity jurisdiction to the changing realities of commercial organization." (8) The Court noted that Congress chose not to redefine how artificial entities other than corporations are treated under the diversity jurisdiction statute when it adopted the current dual-citizenship rule for corporations in 1958. (9) The Court recognized that the states would continue to create a wide assortment of artificial entities with different powers and characteristics but concluded that the manner in which the citizenship of these entities should be determined is a matter "more readily resolved by legislative prescription than by legal reasoning." (10) Thus, federal courts were essentially constrained by the United States Supreme Court to approach LLCs in this manner and to look to the citizenship of an LLC's members in determining citizenship for diversity purposes. Some federal courts have grown impatient with parties who fail to appreciate the well-established difference between an LLC and a corporation for purposes of establishing citizenship in a diversity case, and a party increasingly risks incurring the court's wrath and harsh treatment for this oversight. (11) Other courts are more tolerant as they point out the error in a party's assumption that an LLC is treated in the same manner as a corporation for purposes of diversity jurisdiction. (12) It does not appear that Congress is inclined to step in and alter the approach taken by courts to an LLC's citizenship in regular diversity jurisdiction cases. In 2005, Congress amended the diversity jurisdiction statute with respect to class actions and included in these amendments a dual-citizenship test for unincorporated associations in class action diversity cases; (13) Congress did not, however, act to address the issue outside of the class-action context.

   2. Treatment of LLC Interests Under Securities Laws

      The federal securities laws do not mention LLC interests in the provisions defining a "security." Therefore, whether an LLC membership interest constitutes a security depends upon whether the interest falls within any of the numerous categories or types of investments listed in the definition. The analysis employed in the case law is whether the membership interest in question is an "investment contract" as that term is used in the definition of a security. The cases dealing with the treatment of...