Delaware LLC Act

by Joseph Scrofano

Limited liability companies, or LLCs, are business organizations that provide a lot of flexibility for the investors and managers who form them. LLCs share some characteristics with corporations, partnerships and sole proprietorship, and are therefore typically referred to as “hybrid business entities.” The Delaware LLC Act, found in Chapter 18 of the Delaware Code, sets out Delaware state law for how to form an LLC in the state, as well as the rights and responsibilities of the LLC owners, called "members."

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Formation

An LLC can be formed with one or more members. The members must file a Certificate of Formation with the Delaware secretary of state. This document includes the LLC's name and the address of the organization where it can receive service of process, or papers for a lawsuit and other important mail. Once the members file the Certificate of Formation, the LLC exists as a separate legal entity so long as the members follow the instructions set out in the Delaware LLC Act for the Certificate of Formation. Being a separate legal entity means that the LLC can sue and be sued separately from the individual members. Delaware law states that members should enter into an LLC agreement or operating agreement. This type of agreement typically sets out what the members’ ownership rights are and how they will operate the organization. This must be done at the time or after they file the Certificate of Formation.

Operations

LLC members can manage the business, where corporations typically have separation between owners, or shareholders, and managers, or directors. Therefore, LLC members can elect to operate the day-to-day activities of the LLC. However, LLC members could also elect to use a manager-managed model to operate the business. That means they could operate similarly to a corporation, act as shareholders, and have separate non-owner managers and directors. The members must state whether they intend to operate a member-managed or manager-managed LLC in their operating agreement. If they do not, Delaware law presumes the LLC to be member-managed.

Taxes

Another benefit to forming an LLC is its flexibility with taxes. Members can essentially elect how they wish the Internal Revenue Service to tax them. Sole proprietorship and partnerships, for instance, are taxed through the owners' and/or partners' individual income taxes -- the LLC itself is not subject to taxation. This form of taxation avoids what is often referred to as "double taxation" that corporations must pay. In a corporate business entity, the corporation pays taxes on profits, and the owners and shareholders pay a second tax on any other income they receive from the corporation. LLC members can avoid this by electing to be taxed as a sole proprietor or partnership.

Corporate Veil

The Delaware LLC Act limits the personal liability of LLC members the same way a corporation limits shareholder liability. Corporate shareholders are protected by a legal doctrine referred to as the “corporate veil,” meaning that shareholders cannot usually be held liable for the corporation's debts or negligent acts. LLC members have the same protections when they properly form a Delaware LLC. However, these protections are not unlimited. Delaware and other courts may “pierce the corporate veil” in certain situations where members act fraudulently or dishonestly.

Warning

It's a good idea to contact a qualified attorney licensed to practice in Delaware to find out how the facts of your particular situation apply to the Delaware LLC Act. This article should not be construed as legal advice, and is intended for educational purposes only.