Print Article

Asset protection lawyers often hear such questions as "What documents should be included or created when forming a new LLC?"  or "Why is it necessary to do anything more than file a bare minimum, one-page Certificate of Formation?"

Clients asking such questions are usually motivated by a desire to keep things both simple and inexpensive. They may suspect that lawyers want to over-complicate simple projects with lengthy documents in order to collect higher fees. After all, in Merry Old England (from whence much of our law is derived), lawyers were actually paid by the word - this is true - and barristers of the day were therefore rewarded for creating long documents full of obscure verbiage.

Properly documenting an LLC has nothing to do with this dubious history. To understand why, it is necessary to discuss the doctrine of "piercing the corporate veil." The "veil" referred to here is, of course, the liability barrier that an LLC provides against creditors seeking to penetrate the company and seize the personal assets of its members. And it is established in the law (to varying degrees from state to state) that if an LLC does not have the characteristics and features of an independent, truly separate legal entity - including good documentation - then a judge may disregard the liability barrier and permit creditors to pursue the members personally and individually for company debts.

When involved in litigation relating to an LLC, one of the first things an astute attorney will do during the discovery process is ask to see the opposing party's "company book" including all relevant documentation.  If this documentation does not exist (or is inadequate) you can expect that a motion will be filed seeking to pierce the company's liability barrier. This can be a disastrous outcome for participants in an LLC who thought they were protected.

This article focuses on the documents necessary to form a Texas or Nevada Series LLC. A series LLC (as opposed to a traditional LLC) contains separate "series" or compartments for different assets and liabilities. The series LLC is now the preferred vehicle for real estate investors and others.

It is suggested that this article be read in conjunction with LLC's in Texas - Company Formation and LLC's in Texas - the Series LLC.  Both of these articles (along with many others on the subject of asset protection) can be found at www.LoneStarLandLaw.com.

It is not just the quantity of LLC documentation that matters but its quality and sophistication.  LLC documents should contain asset protection clauses and provisions from the very beginning of the process - and that means the Certificate of Formation.  This firm's COF is several pages long and includes reference to such matters as series specifications, notice of restrictions on sale or transfer or membership interests, and division of membership interests into Class A and Class B (Class B has few rights and is reserved for creditors).  Since the COF is a filed document and public record, creditors are put on notice from the outset that this particular company is the real thing. Going after the assets of its individual members will be nearly impossible. 

Core LLC documents are:

(1)  the Certificate of Formation (Texas) or Articles of Organization (Nevada);
(2)  the Company Agreement;
(3)  the Minutes of the First Meeting of Members ("organizational meeting");
(4)  signed and issued membership certificate(s);
(5)  signed consent by the registered agent;

Optional documents include:

(6)  warranty deed(s) conveying real property into the LLC;
(7)  a bill of sale conveying non-realty items or businesses into the LLC; and
(8) our management and consulting agreements which provide a format for capital transfers between the management company and the holding company (or visa versa), if the client is utilizing our recommended two-LLC structure.

All of the foregoing documents should be organized and contained in a company book. Our company book and its internal tabs are custom-designed by our printer to meet the needs of our investor clients.

This introduction would not be complete without addressing the subject of internet services and their highly simplistic documents. Beware. Use of an internet service to form an LLC should never be considered by any serious investor or business person. We consider their documents to be barely above the level of junk.

The Certificate of Formation supplies the essential information required by the Texas Business Organizations Code ("BOC") and the Secretary of State in order to establish a traditional or series LLC. It may also contain such additional information concerning the business and operations of the company as the initial members may wish to make public. It is suggested, however, that for anonymity and asset protection purposes the COF should include no more information than is prudent. The COF must be accompanied by the filing fee (we also add the optional fee for expedited handling).

Every company must have a registered agent. This person's name and physical address must be specified in the COF. The RA will receive official correspondence from the Secretary of State, the Comptroller, and from attorneys giving notices and making demands.  He or she is also the person who will be served with process by the constable if the company is sued.  This office is available to act as registered agent for an annual fee of $250.

The COF must also disclose the name and address of its initial manager(s). This is usually the client.  Note that this address may be a POB - in fact, we recommend a POB or office address rather than disclosing the client's home address. 

The third name that must be supplied in the COF is that of the organizer - and that is us.  The attorney signs the COF as an authorized representative of the company.

If the company is to be a series LLC then the BOC requires that the COF contain a "notice of limitation on series liability."  Our office goes into considerable detail on this, clearly stating that each series is independent and is not responsible for the debts and liabilities of other series.  

The Company Agreement governs the internal operation of the company. It should be designed to maximize asset protection and will be one of the first documents requested to be produced if the company is sued, since it not recorded with the Secretary of State or anywhere else. The Company Agreement should not be confused with the First Meeting of Members.  Although the content of these two documents may overlap somewhat, they are conceptually different and are designed to address separate items and issues.

Company Agreements are fairly lengthy and should be customized to fit the client's circumstances; however, all of this firm's Company Agreements contain certain key provisions, including but not limited to:

Series LLC. Designation of the company as a series LLC and a description of series characteristics, operations, membership, and management.

Membership percentage interests, voting rights, and management. A quorum is required for any legitimate meeting of members and consists of a majority of membership interests present in person or by written proxy. Most decisions are made by majority vote, but "Major Decisions" (e.g., the sale or encumbrance of company assets) require consent of members holding at least a two-thirds membership interest. Some decisions, including those involving dividend distributions, require a unanimous vote of members. 

Two classes of membership. These are "regular" members (Class A) and Class B members, who are defined to be any persons who acquire membership in the company by means of a court judgment, execution upon a judgment, assignment of a membership interest in satisfaction of a debt, or divorce. Class B members have very few rights in the company - basically the right to receive notices and be present at meetings.  They cannot vote.  This office divides membership in this way so that members of the company do not wind up in a disastrous "partnership" with other members' creditors and ex-spouses, since these persons are usually seeking to dissolve the company or sell off assets for cash.

Restrictions on Sale or Transfer of Membership Interests. Our Company Agreement states "No Member may assign, convey, sell, encumber or in any way alienate all or any part of that Member's Membership Interest without the prior written unanimous consent of all the other Members, which consent may be given or withheld, conditioned or delayed, as the remaining Members may determine in their sole discretion, without any requirement that such consent not be unreasonably withheld."  Including a provision of this kind is critical to the successful operation of a small company. Basically, each member has a right of first refusal to purchase the interest of every other member. If there are multiple members, then the membership interest to be sold will be divided pro rata among members choosing to exercise this right.

Dispute Resolution. The members agree to mediate unresolved disputes prior to resorting to litigation or the filing of a complaint with any government agency. If suit or a complaint is filed without having first submitted the dispute to mediation, the parties agree that proceedings will be put on hold pending completion of mediation.  

Also called the "organizational meeting," the minutes of the first meeting address a whole array of items pertaining to the company's start-up. Important elements include:

Persons Present. The initial paragraphs of the minutes recite the date and location of the meeting as well as persons present. The attorney who drafted the company's formation documents is often listed as present and being the one who prepares the minutes.

COF. The members approve the details of the Certificate of Formation and the various expenses incurred in forming the company.

Company Purpose. We prefer a general purpose statement.The general purpose of the company, as stated in the Certificate of Formation, is stated to be "any and all lawful purposes for which a limited liability company may be organized under the Texas Business Organizations Code." However, the minutes may go on to state that the company will focus its attention upon a particular business such as investing in real property.

Initial Members. The initial members, their respective initial contributions (whether in the form of capital or services rendered), and their respective percentage interests in the company are specified. Adding members later has the effect of reducing existing percentage interests pro rata.

Approval of Company Agreement. The Company Agreement is reviewed and approved.

Election of Managing Members. A managing member or co-managing members are designated with the operational authority to manage the day-to-day operations.

Official Seal. The company seal is affixed to the Minutes and approved.

Membership Certificates.The form and issuance of membership certificates are approved.

Organizational Expenses. Expenses incurred incident to forming and establishing the Company are approved and ratified. Reimbursement for company organizational expenses is approved.

Appointment of Registered Agent. The registered agent and registered address are recited and approved.

Assumed Names. These are recited and approved.

Series LLC Provisions. Provisions establishing the company as a series LLC are included.

Banking and Bookkeeping. This section addresses obtaining a taxpayer identification number, opening a company operating account, and check-writing authority.

Conclusion. The concluding paragraphs resolve that the company may commence business, state that the members waive notice of the meeting, and approve the minutes as transcribed.  All members sign.

In order to maintain the viability of the company as a separate legal entity that continues to provide a liability barrier for its members, the company should have at least one formal meeting per year - "formal" in the sense that it is reduced to writing and included in the company record book.  The basic elements of the annual meeting are review and ratification of the preceding year's actions by the company, its managing member(s), and officers (if any); specific approval of any major decisions; recognition of any unusual events or circumstances not in the company's ordinary course of business; and election of new manager(s) and officers.

It is also advisable to hold special meetings to approve any "major decision" as defined in the Company Agreement; approve the purchase or sale of real property; approve a loan to the company; or accept new members and realign the members' respective percentage interests.  Special meetings along these lines may be held anytime.

Consult a knowledgeable asset protection attorney when forming a Texas or Nevada LLC. The formation documents an LLC contain common elements that should be addressed in the case of every new company. However, enterprises vary - their purposes and members are different. The formation and organizational documents should be carefully drafted to reflect these differences. They should also provide tough protection from creditors and plaintiffs who are seeking to "pierce the corporate veil" and hold individual members liable for debts and actions of the company. Ongoing annual and special meetings should be held to preserve the independent legal character of the company. All relevant documents should be organized and contained in the company record book.

Information in this article is proved for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well.  This firm does not represent you unless and until it is retained and agrees in writing to do so.

Copyright © 2012 by David J. Willis.  All rights reserved worldwide.  David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at http://www.LoneStarLandLaw.com and www.TexasSeriesLLC.com.