LLC OPERATING AGREEMENTS: DRAFTING MANAGEMENT, DISTRIBUTION & TAX PROVISIONS, PART 1 & PART

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1 LLC OPERATING AGREEMENTS: DRAFTING MANAGEMENT, DISTRIBUTION & TAX PROVISIONS, PART 1 & PART 2 First Run Broadcast: June 13 & 14, :00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00a.m. P.T. (60 minutes each day) LLC operating agreements may be the most commonly document drafted or reviewed and negotiated by transactional counsel. The almost default choice of entity that LLCs have become make these agreements pervasive. But their virtual universality belies their complexity. The tax allocation and property distribution provisions alone where tax reality and cash reality may differ substantially require a firm grasp of tax law, the client s distribution plans, and financial accounting. Management provisions vary depending on whether the entity is member-managed or manager-managed, with fiduciary duties modifiable in a way they are not in other entities. These and other provisions make LLC operating agreements challenging to draft and negotiate. This program will provide you with a real world guide to drafting the most important provisions of LLC operating agreements. Day 1 June 13, 2017: Drafting the most important provisions of LLC operating agreements Planning for different types of capital contributions capital v. services, current contributions v. future capital calls Management provisions depending on whether the LLC is member-managed v. mangermanaged LLCs Fiduciary duties of members, modifications, and the LLC opportunity doctrine Restrictions on transfers of capital and profits interests Relationship between tax allocation and property distribution provisions, including IRC Section 704(b) accounting Day 2 June 14, 2017: Drafting allocation provisions for maximum tax benefit and to secure the safe harbor How payments to member (not distributions) are treated for financial v. tax purposes Drafting ordinary distributions, minimum tax distributions, waterfall distributions, liquidating distributions Rights of first refusal, rights of first offer, buy-sell provisions understanding the alphabet soup of exit alternatives Liquidations of the entity and sale of an individual member s interests Speakers: Leon Andrew Immerman is a partner in the Atlanta office of Alston & Bird, LLP, where he concentrates on federal income tax matters, including domestic and international tax planning and transactional work for joint ventures, partnerships, limited liability companies and corporations. He formerly served as chair of the Committee on Taxation of the ABA Business Law Section and as chair of the Partnership and LLC Committee of the State Bar of Georgia Business Law Section. He is also co-author of Georgia Limited Liability Company Forms and

2 Practice Manual (2d ed. 1999, and annual supplements). Mr. Immerman received his B.A., magna cum laude, from Carleton College, his M.A. from the University of Minnesota, and another M.A. and his Ph.D. from Princeton University, and his J.D. from Yale Law School. Lee Lyman is a shareholder in the Atlanta office of Carlton Fields Jorden Burt, LLP and has more than 20 years experience in corporate and real estate transactions. She provides corporate and transactional advice, with an emphasis on advising clients engaged in ongoing business transactions, including joint ventures, mergers and acquisitions, and business restructurings. She has extensive experience in LLC and partnership law, organization, structure, and operations. She has extensive experience structuring equity and debt financing for the acquisition, development and sale of real estate and in general corporate transactions. Ms. Lyman received her B.S. from Florida State University, her M.A. from the University of Pittsburg, her J.D. from Duke University School of Law.

3 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # Address LLC Operating Agreements: Drafting Management, Distribution & Tax Provisions, Part 1 Teleseminar June 13, :00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER June 6, 2017 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:

4 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # Address LLC Operating Agreements: Drafting Management, Distribution & Tax Provisions, Part 2 Teleseminar June 14, :00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER June 7, 2017 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:

5 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: June 13, 2017 Seminar Title: Location: Credits: Program Minutes: LLC Operating Agreements: Drafting Management, Distribution & Tax Provisions, Part 1 Teleseminar - LIVE 1.0 MCLE General Credit 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

6 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: June 14, 2017 Seminar Title: Location: Credits: Program Minutes: LLC Operating Agreements: Drafting Management, Distribution & Tax Provisions, Part 2 Teleseminar - LIVE 1.0 MCLE General Credit 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

7 DRAFTING LLC OPERATING AGREEMENTS: DEVELOPMENT COMPANY, LLC Lee Lyman Carlton Fields Jorden Burt Atlanta (404) Saba Ashraf Ballard Spahr LLP Philadelphia (215) L. Andrew Immerman Alston & Bird LLP Atlanta (404) June 13 & 14, 2017 ADMIN/ v3

8 DEVELOPMENT COMPANY, LLC LIMITED LIABILITY COMPANY AGREEMENT THIS LIMITED LIABILITY COMPANY AGREEMENT (the Agreement ) of DEVELOPMENT COMPANY, LLC (the Company ), effective the 11th day of October, 2011, is made and entered into by the Members of the Company. BACKGROUND ( Investor ) and ( Developer ) (collectively, the Initial Members ) have formed Delaware Company, LLC as a limited liability company under the Delaware Limited Liability Company Act, and desire to enter into this Agreement to govern the operations of the Company. The Members intend that the Company be classified as a partnership for federal and state income tax purposes NOW, THEREFORE, the Members on behalf of themselves agree as follows: 1.1 Formation. [Omitted] 1. THE COMPANY 1.2 Name; Place of Business; Registered Office and Agent. [Omitted] 1.3 Purpose. [Omitted] 1.4 Dissolution Events Causing Dissolution. The Company shall be dissolved and its affairs wound up only upon the earlier of the following to occur: Company; (a) (b) (c) The written agreement of all of the Members to dissolve the A decree of judicial dissolution; or When required by law. Notwithstanding the provisions of the Delaware Act, the Company shall not dissolve upon an event of disassociation with respect to the last remaining Member, but instead the legal successor to such Member shall automatically become a Member of the Company with all the rights appurtenant thereto in accordance with the Delaware Act. ADMIN/ v3

9 1.4.2 Liquidation of Property and Application of Proceeds. Upon the dissolution of the Company, the Managers (or, if none, a liquidator appointed by the Personal Representatives of the deceased Members) will wind up the Company's affairs in accordance with the Delaware Act, and will be authorized to take any and all actions contemplated by the Delaware Act as permissible, including, without limitation: criminal, or administrative; (a) prosecuting and defending suits, whether civil, (b) settling and closing the Company's business, causing the Accountants to prepare a final financial statement in accordance with Section 1.5.3, and making adjustments among Members with respect to distributions under Article 4 based upon such financial statement; (c) liquidating and reducing to cash the Property as promptly as is consistent with obtaining its fair value; Company's liabilities; and (d) discharging or making reasonable provision for the (e) distributing the proceeds of liquidation and any undisposed Property to the Members in accordance with [their positive Capital Account balances]1 [Section 4.1.1] Books, Records and Tax and Accounting Matters Availability. [Omitted] Tax and Accounting Decisions. Unless otherwise provided in Section or other provision of this Agreement, all decisions as to tax and accounting matters shall be made by the Managers; provided, however, that at the request of any Member, the Company shall make an election under Section 754 of the Code. Each of the Members shall supply to the Company the information necessary properly to give effect to any tax election made by the Company under this Section Reports. Within ninety (90) days after the end of each fiscal year, or such other times as determined by the Managers, the Managers shall cause to be delivered to all Members a profit and loss statement for, and a balance sheet as of the end of, such year or other period and the related notes, if any, together with any report thereon prepared and delivered by the Accountants. 1 For use with traditional ( layer cake ) allocations. See Section 4.2.1, Alternative 1. 2 For use with targeted (forced) allocations. See Section 4.2.1, Alternative 2. 2

10 1.5.4 Tax Returns. The Managers shall cause the Accountants to prepare all federal, state, municipal and other tax returns that the Company is required to file, and file with the appropriate taxing authorities all returns required to be filed by the Company in a manner required for the Company to be in compliance with any law governing the timely filing of such returns Taxable and Fiscal Year. The Company's taxable and fiscal years are the calendar year. 1.6 Amendment of Certificate of Formation [Omitted] 2. MEMBERS 2.1 Rights and Obligations of Members. 2.1 Limitation on Members' Liabilities. Each Member's liability shall be limited as set forth in this Agreement, the Delaware Act and other applicable law. 2.2 Priority and Return of Capital. Except as otherwise set forth in this Agreement: (i) no Member shall have the right to demand or receive property other than cash in return for a Capital Contribution or as a distribution pursuant to Article 4; and (ii) no Member shall have priority over any other Member, either as to the return of Capital Contributions or as to any distributions pursuant to Article Meetings. [Omitted] 2.3 Capital Contributions Member's Capital Contribution. Each Member's initial Capital Contribution is set forth on Exhibit B Additional Contributions. Subject to the approval of all Members, the Managers of the Company may require each Member to make additional Capital Contributions to the Company, on a pro rata basis, if the Managers determine that the Company needs additional capital. If a Member fails or is unable to meet a required capital call, the other Members may contribute their pro rata share of the defaulted contribution for the defaulting Member and, as determined by the Managers, the defaulting Member's interest will be diluted in favor of such contributing Member or Members. A Member's pro rata share of the defaulted contribution is determined by dividing the Member's required additional Capital Contribution by the total required additional Capital Contributions of all Members willing to make such a contribution for the defaulting Member Other Matters. 3

11 (a) Except as otherwise provided in this Agreement, no Member may demand or receive a return of Capital Contributions. No Member has the right to receive property other than cash except as provided in this Agreement. No Member is entitled to interest on any Capital Contribution. (b) The Managers have no personal liability for the repayment of any Capital Contribution of any Member Negative Capital Accounts. No Member is obligated to restore a negative balance in such Member's Capital Account Interest for Services. The Percentage Interest of any Member in excess of such Member's percentage of the Capital Contributions made by all Members shall be deemed to be a profits interest received in exchange for services rendered or to be rendered to or for the benefit of the Company. 2.4 Loans Loans to the Company. The Members may lend money to the Company as approved by the Managers. If a Member lends money to the Company pursuant to this Section 2.4.1, the amount of any such loan is not an increase in the Member's Capital Contribution or Percentage Interest, nor does it entitle the Member to any increase in the share of distributions of the Company, nor subject the Member to any greater proportion of the Losses that the Company may sustain. The amount of any such loan shall be a debt due from the Company to the Member, at such rates and on such terms as determined reasonably by the Managers, but in no event less than the Applicable Federal Rate Other Loans. If the Managers determine that funds are reasonably necessary for conducting the business of the Company, the Managers are authorized (but not obligated) to borrow the needed funds on the Company's behalf on commercially reasonable terms existing at the time of the borrowing, and all or any portion of the Company's assets may be pledged or conveyed as security for the indebtedness. 3.1 The Managers. 3. MANAGEMENT Management and Authority. The business and affairs of the Company shall be managed by its Managers. Except with respect to matters where the approval of the Members is expressly required pursuant to this Agreement, or by nonwaivable provisions of applicable law, the Managers have, to the full extent permitted by the Delaware Act, sole, exclusive, full and complete authority, power and discretion to manage and control the business, affairs and properties of the Company, to make all decisions regarding those matters and to perform any and all other acts or activities customary or incident to the management of the Company's business, including, without 4

12 limitation, the right and power to appoint individuals to serve as officers of the Company and to delegate authority to such officers Appointment, Number, Tenure and Qualifications. [Omitted] Quorum and Voting of Managers. [Omitted] Waiver of Notice. [Omitted] Action by Managers Without a Meeting. [Omitted] Tax Matters Person and Partnership Representative (a) The Tax Matters Person and Partnership Representative are each authorized and required to represent the Company, at the Company s expense, in connection with all examinations of the Company s affairs by taxing authorities, including administrative and judicial proceedings, and to expend Company funds for such professional services and costs associated therewith as the Tax Matters Person or Partnership Representative may reasonably determine. The Tax Matters Person and Partnership Representative shall each have sole authority to act on behalf of the Company in any such examinations and any resulting administrative or judicial proceedings, and shall have sole discretion to determine whether the Company, either on its own behalf or on behalf of the Members, will contest or continue to contest any determination or proposed determination by any taxing authority. (b) The Tax Matters Person or Partnership Representative shall promptly notify the Members of the commencement of any tax audit of the Company, receipt of a tax assessment, or receipt of a notice of final partnership administrative adjustment or final partnership adjustment, and shall otherwise keep the Members reasonably informed of the status of any tax audit or administrative or judicial proceeding. Without the consent of a Majority in Interest, the Tax Matters Person or Partnership Representative shall not extend the statute of limitations, file a request for administrative adjustment, file suit relating to any Company tax refund or deficiency, or enter into any settlement agreement relating to items of income, gain, loss or deduction of the Company with any taxing authority. (c) The Company shall not elect into the partnership audit procedures enacted under Section 1101 of the 2015 Act for any tax year beginning before January 1, 2018, and, to the extent permitted by law, the Partnership Representative on behalf of the Company shall elect out of such procedures pursuant to Code Section 6221(b) as amended by the 2015 Act, for tax years beginning on or after January 1, 2018, and each Member will cooperate in such election out. (d) For any year in which applicable law and regulations do not permit the Company to elect out of such procedures, then within forty-five (45) days of any notice of final partnership adjustment, the Company shall elect the alternative procedure under Code Section 6226 as amended by the 2015 Act, and each Member, 5

13 including each former Member, will cooperate in such election. The Partnership Representative shall furnish to the Internal Revenue Service and each Member, including each former Member, during the year or years to which a notice of final partnership adjustment relates, a statement of the Member s share of any adjustment set forth in the notice of final partnership adjustment. (e) Each Member agrees that such Member shall not treat any Company item inconsistently on such Member s federal, state, foreign, or other income tax return with the treatment of the item on the Company s return. Any deficiency for taxes imposed on any Member or former Member (including penalties, additions to tax or interest imposed with respect to such taxes, and any taxes imposed pursuant to Code Section 6226, as amended by the 2015 Act) shall be paid by such Member, and if paid by the Company will be recoverable from such Member. (f) The obligations of each Member or former Member under this Section shall survive the transfer or redemption by such Member of its membership interest, the termination of this Agreement, or the dissolution of the Company Liability of Members and Managers. [Omitted] Compensation. [Omitted] 3.2 Officers. [Omitted] 3.3 Appointment of Managers as Attorneys-In-Fact. [Omitted] 3.4 Indemnification of Members, Managers and Officers. [Omitted] 4. DISTRIBUTIONS AND ALLOCATIONS 4.1 Distributions Net Cash Flow. Except as otherwise provided in this Agreement, in the discretion of the Managers Net Cash Flow shall be distributed annually, or at such other times as determined by the Managers, to the Members in the following order and priority: (a) First, 100% to Investor until the cumulative distributions under this Section 4.1.1(a) equal Investor's initial Capital Contribution. (b) percent (80%) to Investor. Second, twenty percent (20%) to Developer and eighty 6

14 4.1.2 Minimum Tax Distribution. Except as otherwise provided in Section 1.4, notwithstanding Section the Company shall make distributions out of Net Cash Flow to the Members at such times and in such amounts as are reasonably estimated by the [Managers] [Members] to be at least sufficient to enable each Member to make timely payments of federal, state and local income taxes, including estimated taxes, attributable to such Member's Percentage Interests. Distributions under this Section shall be made twenty percent (20%) to Developer and eighty percent (80%) to Investor. Any amount distributed pursuant to this Section will be deemed to be an advance distribution of amounts otherwise distributable to the Members pursuant to Section 4.1.1(b) and will reduce the amounts that would subsequently otherwise be distributable to the Members pursuant to Section 4.1.1(b) in the order they would otherwise have been distributable Distribution Among Members. If any Percentage Interest is sold, assigned or transferred during any accounting period, all distributions on or before the date of such transfer will be made to the transferor, and all distributions after such date will be made to the transferee Amounts Withheld. All amounts withheld pursuant to the Code or any provision of any state or local tax law with respect to any payment or distribution to Members will be treated as amounts distributed to Members pursuant for all purposes of this Agreement In Kind Distributions. If any assets of the Company are distributed in kind, such assets will be distributed to Members entitled to such distribution as tenants-in-common in the same proportions as such Members would have been entitled to cash distributions Limitation Upon Distributions. No distribution shall be made to Members if prohibited by the Delaware Act. 4.2 Allocations. [Section 4.2.1, Alternative 1: Traditional ( Layer Cake ) Allocations] Profits and Losses. Except as otherwise provided in Section 4.2.2, any Profits or Losses of the Company for any Allocation Year shall be allocated among the Members in the following order and priority. 7

15 (a) Profits. (i) First, Profits shall be allocated one hundred percent (100%) to Investor in an amount equal to the excess, if any, of the cumulative Losses allocated to Investor pursuant to Section 4.2.1(b)(ii) for all prior Allocation Years over the cumulative Profits allocated pursuant to this Section 4.2.1(a)(i) for all prior Allocation Years. (ii) Second, after giving effect to the allocations made pursuant to Section 4.2.1(a)(i), Profits shall be allocated twenty percent (20%) to Developer and eighty percent (80%) to Investor. (b) Losses. (i) First, Losses shall be allocated twenty percent (20%) to Developer and eighty percent (80%) to Investor in an amount equal to the excess, if any, of the cumulative Profits allocated pursuant to 4.2.1(a)(ii) for all prior Allocation Years over the cumulative Losses allocated pursuant to this Section 4.2.1(b)(i) for all prior Allocation Years. (ii) Second, after giving effect to the allocations made pursuant to Section 4.2.1(b)(i), Losses shall be allocated one hundred percent (100%) to Investor. Notwithstanding the other provisions of this Section 4.2.1(b), if the amount of Loss that would otherwise be allocated to a Member in any Allocation Year would cause or increase a Member's Adjusted Capital Account Deficit as of the last day of such Allocation Year, then a proportionate part of such Loss equal to such excess shall be allocated to the other Member to the extent such allocation can be made without violating the provisions of this sentence with respect to such other Member. [Section 4.2.1, Alternative 2: Targeted (Forced) Allocations.] Profits and Losses. Except as otherwise provided in Section 4.2.2, any Profits or Losses (and, to the extent necessary, individual items of income, gain, loss or deduction) of the Company for any fiscal year or other period shall be allocated among the Members in such manner that, as of the end of such period, the Capital Account of each Member, immediately after giving effect to such allocations, is, as nearly as possible, equal to: (a) the amount that would be distributed to such Member under this Agreement, determined as if the Company (i) were dissolved and terminated at the end of such period, (ii) its affairs were wound up and each asset on hand at the end of such period were sold for cash equal to its Gross Asset Value, (iii) all liabilities of the Company were satisfied (limited with respect to each nonrecourse liability to the fair 8

16 market value of the assets securing such liability); and (iv) the net assets of the Company were distributed to the Members in accordance with Section 4.2; less (b) such Member s share of Membership Minimum Gain and such Member s Member Nonrecourse Debt Minimum Gain, computed immediately prior to the hypothetical sale of assets described in Section 4.2.1(a) Regulatory Allocations. (a) Qualified Income Offset. If a Member unexpectedly receives in any Allocation Year any adjustment, allocation or distribution described in Regulations Sections (b)(2)(ii)(d)(4), (5), or (6), and if a Member has an Adjusted Capital Account Deficit as of the last day of such Allocation Year (determined as if this Section 4.2.2(a) were not in this Agreement), then all items of income and gain of the Company (consisting of a pro rata portion of each item of Company income and gain, including gross income) for such Allocation Year (and, if necessary, for subsequent Allocation Years) shall be allocated to the Member in the amount and in the manner necessary to eliminate such Adjusted Capital Account Deficit as quickly as possible. (b) Gross Income Allocation. If a Member has a deficit Capital Account as of the last day of any Allocation Year (determined as if Section 4.2.2(a) and this Section 4.2.2(b) were not in this Agreement) in excess of the sum of the amount such Member is obligated to restore pursuant to any provision of this Agreement and the amount such Member is deemed to be obligated to restore pursuant to Regulations Sections (g)(1) and (i)(5), then all items of income and gain of the Company (consisting of a pro rata portion of each item of Company income and gain, including gross income) for such Allocation Year (and, if necessary, for subsequent Allocation Years) shall be allocated to the Member in the amount of such excess as quickly as possible. (c) Minimum Gain Chargeback. Except as otherwise provided in Section (f) of the Treasury Regulations, notwithstanding any other provision of this Article V, if there is a net decrease in Membership Minimum Gain during any Allocation Year, each Holder shall be specially allocated items of Company income and gain for such Allocation Year (and, if necessary, subsequent Allocation Years) in an amount equal to such Holder s share of the net decrease in Membership Minimum Gain, determined in accordance with Treasury Regulations Section (g). Allocations pursuant to the previous sentence shall be made in proportion to the respective amounts required to be allocated to each Holder pursuant thereto. The items to be so allocated shall be determined in accordance with Sections (f)(6) and (j)(2) of the Treasury Regulations. This Section 4.4.2(c) is intended to comply with the minimum gain chargeback requirement in Section (f) of the Treasury Regulations and shall be interpreted consistently therewith. (d) Member Minimum Gain Chargeback. Except as otherwise provided in Section (i)(4) of the Treasury Regulations, notwithstanding any other 9

17 provision of this Article V, if there is a net decrease in Member Nonrecourse Debt Minimum Gain attributable to a Member Nonrecourse Debt during any Allocation Year, each Holder who has a share of the Member Nonrecourse Debt Minimum Gain attributable to such Member Nonrecourse Debt, determined in accordance with Section (i)(5) of the Treasury Regulations, shall be specially allocated items of Company income and gain for such Allocation Year (and, if necessary, subsequent Allocation Years) in an amount equal to such Holder s share of the net decrease in Member Nonrecourse Debt Minimum Gain, determined in accordance with Treasury Regulations Section (i)(4). Allocations pursuant to the previous sentence shall be made in proportion to the respective amounts required to be allocated to each Holder pursuant thereto. The items to be so allocated shall be determined in accordance with Sections (i)(4) and (j)(2) of the Treasury Regulations. This Section 4.4.2(d) is intended to comply with the minimum gain chargeback requirement in Section (i)(4) of the Treasury Regulations and shall be interpreted consistently therewith. (e) Nonrecourse Deductions and Member Nonrecourse Deductions. Nonrecourse Deductions for any Allocation Year shall be allocated twenty percent (20%) to Developer and eighty percent (80%) to Investor. Any Member Nonrecourse Deductions for any Allocation Year shall be specially allocated to the Member who bears the economic risk of loss with respect to the Nonrecourse Debt to which such Member Nonrecourse Deductions are attributable in accordance with Regulations Section (i)(1). (f) Section 754 Adjustments. To the extent an adjustment to the tax basis of any Company asset pursuant to Code Section 734(b) or Code Section 743(b) is required to be taken into account, pursuant to Treasury Regulations Section (b)(2)(iv)(m)(2) or Treasury Regulations Section (b)(2)(iv)(m)(4) in determining Capital Accounts as the result of a distribution to a Holder in complete liquidation of such Holder s interest in the Company, the amount of such adjustment to Capital Accounts shall be treated as an item of gain (if the adjustment increases the tax basis of the asset) or loss (if the adjustment decreases such tax basis) and such gain or loss shall be specially allocated to Holders in accordance with their interests in the Company in the event Treasury Regulations Section (b)(2)(iv)(m)(2) applies, or to the Holder to whom such distribution is made in the event Treasury Regulations Section (b)(2)(iv)(m)(4) applies. (e) Regulatory Allocations. The allocations set forth in Sections 4.2.2(a) through 4.2.2(f) and Section (the Regulatory Allocations ) are intended to comply with certain requirements of Sections (b) and of the Regulations. Notwithstanding any other provision of this Article 4 other than the Regulatory Allocations, the Regulatory Allocations shall be taken into account in allocating Profits, Losses and items of Company income, gain, loss and deduction to the Members so that, to the extent possible, the net amount of such allocations of Profits, Losses and other items and the Regulatory Allocations to each Member shall be equal to the net amount that would have been allocated to each such Member if the Regulatory Allocations had not occurred. 10

18 4.2.3 Other Allocation Rules. (a) Allocations of Individual Items. Except as otherwise provided in this Agreement, all items of Company income, gain, loss, deduction for federal and state income tax purposes, and any other allocations not otherwise provided for, shall be divided among the Members in the same proportions as they share Profits or Losses, as the case may be, for the Allocation Year. (b) Allocation Within Period. For purposes of determining the Profits, Losses, or any other items allocable to any period, Profits, Losses, and any such other items shall be determined on a daily, monthly, or other basis, as determined by the Managers using any permissible method under Section 706 of the Code and the Regulations thereunder. (c) Allocable Cash Basis Item. Any allocable cash basis item of the Company (as defined in Section 706(d) of the Code) for any Allocation Year that is required to be allocated to the Members in the manner provided in Section 706(d) of the Code must be allocated to the Members in the manner so required. (d) Allocation of Insurance Premiums and Proceeds. Notwithstanding any other provision to the contrary in this Agreement, no portion of the premiums paid or proceeds received with respect to any life and/or disability insurance maintained by the Company in the case of a Member s death or disability shall be allocated to such Member. (e) Transfer of Percentage Interests. If one or more Percentage Interests are transferred during any Allocation Year of the Company, the Company income or loss attributable to such Percentage Interests for such Allocation Year shall be allocated between the transferor and the transferee in any manner permitted by law as they shall agree; provided, however, that if the Company does not receive, within 120 days of the transfer, written notice stating the manner in which such parties have agreed to allocate such Company income or loss, then the Company may allocate income or loss between the parties based on the percentage of the Allocation Year each party was, according to the books and records of the Company, the owner of record of the interests transferred Loss Limitation. Losses allocated pursuant to Section shall not exceed the maximum amount of Losses that can be allocated without causing any Member to have an Adjusted Capital Account Deficit at the end of any Allocation Year. In the event some but not all of the Members would have Adjusted Capital Account Deficits as a consequence of an allocation of Losses pursuant to Section hereof, the limitation set forth in this Section shall be applied on a Member by Member basis and Losses not allocable to any Member as a result of such limitation shall be allocated to the other Members in accordance with the positive balances in such Member's Capital 11

19 Accounts so as to allocate the maximum permissible Losses to each Member under Section (b)(2)(ii)(d) of the Regulations Power of Managers to Vary Allocations of Profits and Losses. It is the intent of the Members that each Member's allocable share of Profits and Losses shall be determined and allocated in accordance with the provisions of this Section 4.2 to the fullest extent permitted by Section 704(b) of the Code, or its statutory successor. However, if the Company is advised that the allocations provided in this Section 4.2 will not be respected for Federal income tax purposes, the Managers shall amend the allocation provisions of this Agreement in the manner and to the extent in the best interest and consistent with the economic sharing of the Members, but in no event shall such reallocation be greater than the minimum reallocation necessary so that the allocation in this Section 4.2 will be respected for Federal income tax purposes Tax Allocations. In accordance with Section 704(c) of the Code and the Regulations thereunder and with Section (b)(2)(iv)(f)(4) and (b)(4)(i) of the Regulations, income, gain, loss and deduction with respect to any property contributed to the capital of the Company or property revalued on the Company's books and in the Capital Accounts shall, solely for tax purposes, be allocated among the Members so as to take account, under the [SPECIFY METHOD] as defined by Section of the Regulations, of any variation between the adjusted basis of such property to the Company for federal income tax purposes and its Gross Asset Value. 5. TRANSFERS OF MEMBERSHIP INTERESTS 5.1 Transfer of Interests Restriction on Transfers. Except as otherwise permitted by this Agreement, no Member may Transfer all or any portion of such Member's Membership Interest Permitted Transfers. (a) A Member may Transfer all or part of his Membership Interest with the advance written consent of a Majority in Interest of the Members. (b) A Member may Transfer all or part of his Membership Interest to a Member of the Company at any time upon notice to the Company. (c) If a Member receives a bona fide offer from a third party for such third party to acquire any part of his Membership Interest owned by him, the transferring Member must first offer the Membership Interest proposed to be transferred to the Company and the non-transferring Members in accordance with the following provisions: 12

20 (i) The transferring Member shall give notice of his intent to Transfer ("Notice of Transfer") contemporaneously to the Company and the non-transferring Members. The Notice of Transfer must describe the offer and the terms and conditions upon which the transferring Member proposes to Transfer the Membership Interest. The Company may elect to purchase all or any part of the Membership Interest by giving notice ("Notice of Company Purchase") to the transferring Member and the non-transferring Members, within thirty (30) days of its receipt of the Notice of Transfer. The Notice of Company Purchase must indicate the portion of the Membership Interest the Company intends to acquire. (ii) If the Company does not elect to acquire all of the transferring Member's Membership Interest, or only elects to acquire a portion of the transferring Member's Membership Interest, the non-transferring Members may elect to acquire the portion of the Membership Interest the Company is not acquiring by giving notice to the Company and the transferring Member within forty-five (45) days after receipt of the Notice of Transfer. The non-transferring Members' purchases will be on a pro rata basis unless a Member agrees with another Member to purchase some or all of that Member's pro rata portion. (iii) If the Company and the non-transferring Members do not elect to purchase all of the Membership Interest proposed to be transferred within sixty (60) days of receipt of the Notice of Transfer, then the transferring Owner is free to Transfer his Membership Interest to the third party acquirer on the terms and conditions originally proposed. If the transferring Member proposes to Transfer his Membership Interest on other terms, or if more than ninety (90) days have elapsed since the date of his first Notice of Transfer, then he will be required to reoffer his Membership Interest to the Company and the non-transferring Members in accordance with this Section (iv) Any closing of the purchases contemplated by this Section shall take place within seventy-five (75) days after the date of the Notice of Transfer in the, metropolitan area at a date, time and place of the Company's choosing if it is purchasing any portion of the Membership Interest. If not, the purchasing Members shall select the date, time and place of closing. (v) For an offer to be considered bona fide (A) the third party extending the offer must be a creditworthy person who is not a relative, spouse or relative of a spouse of the transferring Member, or any employee, director, officer, shareholder, partner or member of an entity of which the transferring Member is himself an employee, director, officer, shareholder, partner or member, or an entity of which the transferring Member is himself an employee, director, officer, shareholder, partner or member, and (B) the offer must be accompanied by a cash payment of earnest money to the transferring Member in an amount equal to not less than twenty percent (20%) of the proposed purchase price for the Membership Interest to be transferred. (d) A Member may Transfer all or any part of his Membership Interest, outright or in trust, to or for the benefit of himself, his spouse, or any of his lineal descendants (including any person adopted according to law at any time), but only 13

21 if the proposed transferee executes and delivers to the Company appropriate documentation providing that he and the Membership Interest transferred to him shall be bound by this Agreement [Omitted] [Omitted] Admission of Interest Holders as Members. Subject to the other provisions of this Section 5.1, a transferee of a Membership Interest may be admitted to the Company as a substituted Member only upon satisfaction of the following conditions: (a) The Membership Interest with respect to which the transferee is being admitted was acquired by means of a Permitted Transfer as set forth in Section 5.1.2; (b) The transferee becomes a party to this Agreement as a Member and executes such documents and instruments as the Managers deem necessary or appropriate to confirm such transferee as a Member and such transferee's agreement to be bound by the terms and conditions of this Agreement; (c) The transferee pays or reimburses the Company for all reasonable legal, filing, and publication costs that the Company incurs in connection with the admission of the transferee as a Member with respect to the transferred Membership Interests; (d) If the transferee is not a sui juris human being, the transferee provides the Company with evidence satisfactory to counsel for the Company of the authority of the transferee to become a Member and to be bound by the terms and conditions of this Agreement; and (e) A Majority in Interest of the Members consent to the admission of the transferee as a new Member. 5.2 Additional Members. After the date of this Agreement any Person may become a Member only as a Permitted Transferee of a Percentage Interest or any portion thereof, subject to the terms and conditions of this Agreement, or by admission with the consent of a Majority in Interest. No new Member shall be entitled to any retroactive allocation of losses, income or expense deductions incurred by the Company. The Managers may, at their option, at the time a Member is admitted, close the Company books (as though the Company's tax year had ended) or make pro rata allocations of loss, income and expense deductions to a new Member for that portion of the Company's tax year in which a Member was admitted in accordance with the provisions of Section 706(d) of the Code. 14

22 5.3 Withdrawal/Redemption Rights Withdrawal. [Omitted] Mandatory Purchase Upon Death. In the event of the death of a Member (other than in the event all Members die within a ninety (90) day period), the Company must purchase the Membership Interest that was held by the deceased Member and the Personal Representative of the deceased Member must sell such Member's Membership Interest to the Company. The proceeds of the life insurance policies, if any, purchased by the Company pursuant to Section below shall be applied to the purchase price of the deceased Member's Membership Interest. The purchase price for the deceased Member's Membership Interest shall be its Fair Market Value Nonpermitted Transfer. In the event of a Transfer or an attempted Transfer of a Membership Interest that is not a Permitted Transfer, the Company has the option, but not the obligation, to purchase the Membership Interest that is the subject of the nonpermitted Transfer or attempted Transfer. The purchase price for such Membership Interest shall be its Fair Market Value Payment of Purchase Price. In the event of the death of a Member, the purchase price for the deceased Member's Membership Interest will be paid in one lump sum from the Company upon (a) the tenth (10th) day after the proceeds of the insurance policy insuring the life of the deceased Member have been received by the Company if the Company purchased a life insurance policy for such Member, or (b) within ninety (90) days after the date of the Member's death if the Company did not purchase a life insurance policy for the Member. In the event of a nonpermitted Transfer or attempted Transfer, the purchase price will be paid in equal quarterly installments (including principal and interest) over a five (5) year period (unless a shorter period is agreed to by all the Managers). In no event, however, will the sum of the quarterly payments be in excess of percent ( %) of the Company's Net Income for such quarter after considering mandatory distributions and any other redemption payments the Company is obligated to make, or any Reserve created therefore (the " % Limitation"). In the event the % Limitation is triggered, the applicable payment period shall be extended by the shortest period possible without violating the % Limitation Interest. In all cases where the purchase price is not paid in one lump sum, interest will accrue on the unpaid balance of the purchase price for the period outstanding at the Applicable Federal Rate in effect on the date of the event giving rise to the purchase of the Membership Interest Life Insurance. The Company may purchase a life insurance policy on the life of some or all of the Members. The amount of the proceeds of each policy shall be sufficient to cover the obligation of the Company to acquire a deceased Member's Membership Interest. The Company will pay the premiums on the policies that it owns. 15

23 5.4 Buy-Sell Option Manner of Offer. Any Member (the "Offeror") at any time may offer to the other Members (the "Offerees") both to sell his Membership Interest or to buy all of the Offerees' Membership Interests. Such offer must be in writing and must contain the following: 5.4; (a) A statement of intention to make an offer under this Article (b) A statement of the Offeror's determination of the value of each percentage of Membership Interest subject to the offer, which must be identical for each Membership Interest; (c) A statement that a condition to any purchase pursuant to the offer shall be the absolute and unconditional indemnity by the purchaser of the seller against any loss, claim or damage that the seller may suffer arising out of any guarantee by the seller of any debt of the Company for borrowed money; (d) A statement that the purchase price for the Membership Interests subject to the offer shall be payable in cash at closing; and (e) A statement that such offer is both an offer to sell all the Membership Interests owned by the Offeror and an offer to purchase all the Membership Interests owned by the Offeree Term of Offer. The Offeror's offer shall be irrevocable for fortyfive (45) days (the "Option Period"), and the Offerees may, on or before the expiration of the Option Period, accept either the offer to sell or the offer to buy Manner of Acceptance. (a) Both Offerees Elect to Accept the Offer to Buy. If, during the Option Period, both Offerees elect to accept the Offeror's offer to buy, the Offeror must buy, and each Offeree must sell to the Offeror, all of the Membership Interest owned by such selling Offerees. (b) Both Offerees Elect to Accept the Offer to Sell. If, during the Option Period, both Offerees elect to accept the Offeror's offer to sell, the Offeror must sell all of his Membership Interest, and each Offeree must buy from the Offeror the Offeree's pro rata share of the Offeror's Membership Interest. An Offeree's pro rata share shall be determined by multiplying the Offeror's Membership Interest by the fraction, the numerator of which is such Offeree's Membership Interest and the denominator of which is all of the Membership Interests of the Offerees. 16

24 (c) Only One Offeree Elects to Accept the Offer to Sell. If, during the Option Period, either, but not both, of the Offerees accepts the Offeror's offer to sell (either because, during the Option Period, one Offeree accepts the Offeror's offer to buy or because one Offeree fails to accept either the Offeror's offer to buy or the Offeror's offer to sell), the Offeror must sell all of his Membership Interest to the Offeree accepting the offer to sell, and the Offeror's offer to buy shall become null and void. The Offeree accepting the Offeror's offer to sell, must buy all of the Offeror's Membership Interest and must immediately offer (the "Second Offer") to buy all of the Membership Interest owned by the other Offeree who did not accept the original Offeror's offer to sell (the "Second Offeree"). The Second Offer shall be on the same terms as the original Offeror's offer. If the Second Offeree fails to accept the Second Offer within ten (10) days, the Second Offer shall expire, at which time the maker of the Second Offer shall have the right, exercisable on or before the fifteenth (15th) day after the expiration of such ten (10) day period, to buy all of the Membership Interest of the Second Offeree, and if such right is exercised, the Second Offeree shall be required to sell, in accordance with the terms of the Second Offer and the provisions of this Section 5.4. (d) Only One Offeree Elects To Accept The Offer To Buy. If, during the Option Period, one of the Offerees accepts the Offeror's offer to buy and the other Offeree fails to accept either the Offeror's offer to buy or offer to sell, then the Offeror shall buy, and the selling Offeree shall sell to the Offeror, all of the selling Offeree's Membership Interest. The Offeror shall then have the right, exercisable on or before the tenth (10th) day after the expiration of the initial Option Period, to buy all of the Membership Interest of the non-responding Offeree, and if the Offeror exercises such right, the non-responding Offeree must sell to the Offeror all of his Membership Interest in accordance with the terms of the offer and the provisions of this Section 5.4. (e) Both Offerees Fail To Accept Either Offer. If, during the Option Period, neither Offeree accepts either of the Offeror's offers to sell or to buy, the Offeror shall have the right, exercisable on or before the tenth (10th) day after the expiration of the Option Period, to buy all of the Membership Interests of both the nonresponding Offerees (but not less than all of such interests), and if the Offeror exercises such right, the non-responding Offerees shall be required to sell their Membership Interest to the Offeror, in accordance with the terms of the offer and the provisions of this Section Closing. The Closing of any purchase or sale pursuant to this Section 5.4 shall be held at the time and place and on the date specified by written notice by the buyer(s) to the seller(s) (the "Buy-Sell Closing Date"), which date shall be within sixty (60) days after the end of the Option Period. In the discretion of the Managers, all undistributed Net Income as of the Buy-Sell Closing Date, if any, shall be distributed to the Members in accordance with the applicable provisions of Article 4 within thirty (30) days after the Buy-Sell Closing Date. The specified purchase price shall be paid by the buyer(s) in immediately available funds at the Buy-Sell Closing Date, and the seller(s) shall execute, seal, and deliver for and on their behalf, all documents that may be 17

25 necessary or appropriate, in the reasonable opinion of counsel to the buyer(s), to effect such sale free and clear of all liens and encumbrances Specific Performance. The Members acknowledge and agree that monetary damages to compensate a Member for any breach of this Section 5.4 would be inadequate. Accordingly, this Section 5.4 shall be enforceable by action of specific performance and other appropriate equitable relief. 5.5 Additional Transfer Restrictions Preserve Partnership Tax Status. No Member shall be permitted to transfer any portion of its interest in the Company or take any other action that, in the judgment of the Managers, would materially increase the risk that the Company would be treated as a publicly traded partnership within the meaning of Section 7704 of the Code or to be classified as a corporation within the meaning of Section 7701(a) of the Code Technical Tax Terminations. No Member shall be permitted to transfer all or any portion of its interest in the Company or to take any other action that would result in a termination of the Company within the meaning of Section 708(b)(1)(B) of the Code, without the approval of the Managers Transfers that Trigger Tax Withholding. Unless arrangements concerning withholding are approved by the Managers (if such withholding is required of the Company), no Member shall be permitted to transfer all or any portion of its interest in the Company to any Person, unless such Person is a United States Person as defined in Section 7701(a)(30) of the Code and is not subject to withholding of any federal tax ERISA Limitations. No Member shall be permitted to transfer all or any portion of its Company interest if such transfer will cause the assets of the Company to be deemed plan assets under ERISA or the Code, or result in any prohibited transaction under ERISA or the Code. 6. NONCOMPETITION AND CONFIDENTIALITY 6.1 Noncompete. Each Member agrees that he will not, so long as he is either a Member, a Manager or an employee of the Company and for a period of ( ) year thereafter, be retained by, render consulting or advisory services to, or be a proprietor, director, member, manager, partner or shareholder of any Person (other than a publicly traded entity of which such Member owns two percent (2%) or less of the equity interests) that competes directly with the Company or any successor or subsidiary of the Company in the business of [ ] in the areas where the Company currently markets or plans to market its products and services, or interfere, disrupt or attempt to disrupt any past, present or prospective relationship, contractual or otherwise, between the Company and any of its customers or clients or other Persons with whom it deals and with whom such Member had dealings during the last twelve (12) months before his or her departure. 18

26 6.2 Nonsolicitation of Customers. Each Member agrees that he will not, so long as he is either a Member, a Manager or an employee of the Company and for a period of two (2) years thereafter, directly or indirectly, on behalf of himself or of anyone other than the Company, solicit or attempt to solicit for the purpose of conducting the business of the Company, any customer or actively sought potential customer of the Company with whom such Member had active dealings during the last twelve (12) months before his or her departure, or disrupt or attempt to disrupt any past, present or prospective relationship, contractual or otherwise, between the Company and any of its customers or clients or other Persons with whom it deals and with whom such Member had dealings during the last twelve (12) months before his or her departure. 6.3 Nonsolicitation of Employees. Each Member agrees that he will not, so long as he is either a Member, a Manager or an employee of the Company and for a period of two (2) years thereafter, indirectly or directly, solicit or recruit for employment or induce or encourage to leave employment with the Company, on his own behalf or on behalf of any other person or entity other than the Company or any affiliate of the company, any person with whom such Member worked during such Member s affiliation with the Company and who performed services for Company clients or worked on Company products or projects while employed by the Company. 6.4 Confidentiality. Each Member agrees that he must not, directly or indirectly, during the time he is either a Member, Manager or an employee of the Company, and for ( ) years thereafter, divulge to any Person, or use for his own benefit, any Confidential Information of the Company, or at any time divulge to any Person, or use for his own benefit, any Trade Secrets of the Company 6.5 Severability. Although the restrictions contained in this Article 6 are considered by the parties hereto to be fair and reasonable, it is recognized that restrictions of the nature contained in this Article 6 may fail for technical reasons and accordingly it is hereby agreed that if any of such restrictions are adjudged to be void or unenforceable for whatever reason, but would be valid if part of the wording thereof were deleted, or the period thereof reduced or the area dealt with thereby reduced in scope, the restrictions contained in this Article 6 shall apply, at the election of the Company, with such modifications as may be necessary to make them valid, effective and enforceable in the particular jurisdiction in which such restrictions are adjudged to be void or unenforceable. 6.6 Injunctive Relief. If a violation of any covenant contained in this Article 6 occurs or is threatened, each Member agrees and acknowledges that such violation or threatened violation will cause irreparable injury to the Company, that the remedy at law for any such violation or threatened violation will be inadequate and that the Company is entitled to temporary and permanent injunctive relief without the necessity of proving actual damages. 19

27 7. MISCELLANEOUS 7.1 Notices. [Omitted] 7.2 Severability. [Omitted] 7.3 Captions. [Omitted] 7.4 Person and Gender. [Omitted] 7.5 Benefits and Burdens. [Omitted] 7.6 Applicable Law. [Omitted] 7.7 Entire Agreement. [Omitted] 7.8 Agreement in Counterparts. [Omitted] 7.9 Amendment. [Omitted] 7.10 Further Assurances. [Omitted] IN WITNESS WHEREOF, the parties hereto have entered into this Agreement as of the date first above written. MEMBERS: Investor: Developer: 20

28 EXHIBIT A As used in this Agreement, the following terms shall have the following meanings: Accountants means any firm of independent certified public accountants engaged for the Company. Adjusted Capital Account Deficit means, with respect to any Member, the deficit balance, if any, in such Member's Capital Account as of the end of the relevant Allocation Year, after giving effect to the following adjustments: (a) Such Capital Account shall be increased to reflect the amounts, if any, which such Member is obligated to restore to the Company or is treated as or deemed to be obligated to restore pursuant to Regulations Sections (g)(1) and (i)(5); and (b) Such Capital Account shall be reduced to reflect any items described in Regulations Sections (b)(2)(ii)(d)(4), (5) and (6). The foregoing definition of Adjusted Capital Account Deficit is intended to comply with the provisions of Regulations Section (b)(2)(ii)(d) and shall be interpreted consistently therewith. be amended. Agreement means this Limited Liability Company Agreement, as it may Allocation Year means: (i) the period commencing on the date of this Agreement and ending on December 31, 2004, (ii) any subsequent twelve (12) month period commencing on January 1 and ending on December 31, or (iii) any portion of the period described in clauses (i) or (ii) for which the Company is required to allocate Profits, Losses, and other items of Company income, gain, loss, or deduction pursuant to this Agreement. Applicable Federal Rate means, depending upon the initial payment period as described in Section of this Agreement, the annual federal short term rate of interest, mid term rate of interest, or long term rate of interest, as appropriate, described in Section 1274(d) of the Code. "Appraised Value" means the value determined by a majority of a board of three appraisers, where the Personal Representative of a deceased Member or Member disputing the Fair Market Value appoints one appraiser and the other Members appoint one appraiser and the two appointed appraisers appoint the third appraiser. Capital Account means with respect to any Member, the Capital Account maintained for such Member in accordance with the following provisions: 21

29 (a) To each Member's Capital Account there shall be credited such Member's Capital Contributions, such Member's distributive share of Profits and any items in the nature of income or gain that are allocated pursuant to Section 4.2 hereof, and the amount of any Company liabilities assumed by such Member or that are secured by any Property distributed to such Member; (b) To each Member's Capital Account there shall be debited the amount of cash and the Gross Asset Value of any Property distributed to such Member pursuant to any provision of this Agreement, such Member's distributive share of Losses and any items in the nature of expenses or losses that are allocated pursuant to Section 4.2 hereof, and the amount of any liabilities of such Member assumed by the Company or that are secured by any property contributed by such Member to the Company; (c) Subject to the provisions of this Agreement, in the event any interest in the Company is transferred in accordance with the terms of this Agreement, the transferee shall succeed to the Capital Account of the transferor to the extent it relates to the transferred interest; and (d) In determining the amount of any liability for purposes of clauses (a) and (b) of this definition, there shall be taken into account Section 752(c) of the Code and any other applicable provisions of the Code and Regulations. The foregoing provisions and the other provisions of this Agreement relating to the maintenance of Capital Accounts are intended to comply with Regulations Section (b), and shall be interpreted and applied in a manner consistent with such Regulations. The Managers may modify the definition of Capital Accounts contained in this Agreement to the extent the Managers reasonably determine that such modification is necessary to comply with such Regulations, provided that such modification is not likely to have a material effect on the amounts distributable to a Member hereunder upon the dissolution of the Company in accordance with Section 1.4. Capital Contributions means with respect to any Member, the amount of money and the initial Gross Asset Value of any property (other than money) contributed to the Company with respect to the Percentage Interest held by such Member. amended. Code means the United States Internal Revenue Code of 1986, as Company means Development Company, LLC, a limited liability company organized under the laws of the State of Delaware. Delaware Act or Act means the Delaware Limited Liability Company Act, as amended. Depreciation shall mean, for each Allocation Year, an amount equal to the depreciation, amortization or other cost recovery deduction allowable for federal 22

30 income tax purposes with respect to an asset for such year or other period, except that if the Gross Asset Value of an asset differs from its adjusted basis for federal income tax purposes at the beginning of such year or other period, Depreciation shall be an amount which bears the same ratio to such beginning Gross Asset Value as the federal income tax depreciation, amortization or other cost recovery deduction for such year or other period bears to such beginning adjusted tax basis; provided, however, that if the federal income tax depreciation, amortization or other cost recovery deduction for such year is zero, Depreciation shall be determined with reference to such beginning Gross Asset Value using any reasonable method selected by the Managers. Disbursements means, with respect to the Company for any period, all costs and expenses paid or incurred during such period by the Company. Economic Interest means a Member's or Economic Interest Owner's share of the Company's Profits, Losses and distributions pursuant to this Agreement and the Delaware Act, but shall not include any right to information, to an accounting of the affairs of the Company, to inspect the books or records of the Company, to receive notice of any meetings of Members, or to vote on, consent to or otherwise participate in any decision of the Members. Economic Interest Owner means the owner of an Economic Interest who is not a Member. Fair Market Value means the value of the Company determined each year within sixty (60) days of the end of the prior fiscal year by agreement of the Managers [or Members] multiplied by the appropriate Member s relative percentage Membership Interest in the Company [or a percentage determined by dividing number of Units owned by the appropriate Member by the total number of Units outstanding]. [Fair Market Value may also be determined by reference to a specific formula i.e., book value, book value multiplied by an appropriate multiplier, a function of EBITDA, etc.] If the Member or Person whose Membership Interest is being redeemed objects to the Fair Market Value, then Fair Market Value shall be the Appraised Value. Fair Market Value shall be determined without taking into account the value of any insurance proceeds received or to be received with respect to a Member s death or Permanent Disability. Gross Asset Value means, with respect to any asset, the asset's adjusted basis for federal income tax purposes, except as follows: (a) The initial Gross Asset Value of any asset contributed by a Member to the Company shall be the fair market value of such asset, as determined by the contributing Member and the Company; (b) The Gross Asset Values of each item of Property shall be adjusted to equal its gross fair market value, as determined by the Managers, as of the following times: (i) the acquisition of an additional interest in the Company by any new or existing Member either in exchange for more than a de minimis Capital Contribution or in connection with the grant of more than a de minimis interest in the Company as 23

31 consideration for the provision of services to or for the benefit of the Company; (ii) the distribution by the Company to a Member of more than a de minimis amount of Property; and (iii) the liquidation of the Company within the meaning of Regulations Section (b)(2)(ii)(g); provided, however, that if Gross Asset Values are adjusted as provided herein the Member's Capital Accounts shall be restated in accordance with Regulations Section (b)(2)(iv)(f) and that adjustments pursuant to clauses (i) and (ii) above shall be made only if the Managers reasonably determine that such adjustments are necessary or appropriate to reflect the relative economic interests of the Members in the Company; (c) The Gross Asset Value of any Property distributed to any Member shall be its fair market value, as determined by the Member and the Company, on the date of distribution; and (d) The Gross Asset Values of Property shall be increased (or decreased) to reflect any adjustments to the adjusted basis of such Property pursuant to Section 734(b) of the Code or Section 743(b) of the Code but only to the extent that such adjustments are taken into account in determining Capital Accounts pursuant to Regulations Section (b)(2)(iv)(m); provided, however, that Gross Asset Values shall not be adjusted pursuant to this clause (d) of this definition to the extent the Managers determine that an adjustment pursuant to clause (b) of this definition is necessary or appropriate in connection with a transaction that would otherwise result in an adjustment pursuant to clause (d) of this definition. If the Gross Asset Value of an asset has been determined or adjusted pursuant to clauses (a), (b) or (d) of this definition, such Gross Asset Value shall thereafter be adjusted by the Depreciation taken into account with respect to such asset for purposes of computing Profits and Losses. Gross Receipts means, with respect to the Company, for any period, all revenues, income, earnings, or cash flow of any kind or description received during such period by or on behalf of the Company. Losses has the meaning set forth herein under Profits or Losses. Majority in Interest means Members owning more than fifty percent (50%) of the outstanding Percentage Interests. Agreement. Managers means the Persons described in Section of this Member Nonrecourse Debt has the same meaning as the term partner nonrecourse debt in Section (b)(4) of the Treasury Regulations. Member Nonrecourse Debt Minimum Gain has the same meaning as the term partner nonrecourse debt minimum gain in Treasury Regulation Section (i)(2). 24

32 Member Nonrecourse Deductions has the same meaning as the term partner nonrecourse deductions in Regulations Sections (i)(1) and (i)(2). Members means collectively, each of the parties who signs a counterpart of this Agreement as a Member, and each of the parties who may hereafter become Members. Member means any of the Members. Membership Minimum Gain has the same meaning as the term partnership minimum gain in Sections (b)(2) and (d) of the Treasury Regulations. Net Cash Flow means, for any period, Gross Receipts for such period minus Disbursements for such period, adjusted for additions to or reductions in Reserves. Nonrecourse Deductions has the meaning set forth in Regulations Sections (b)(1) and (c). Nonrecourse Debt means a nonrecourse liability as set forth in Regulations Section (b)(3). Partnership Representative for any tax year beginning on or after January 1, 2018, means Developer, or any other person appointed by a Majority in Interest from time to time as the partnership representative within the meaning of that term in Section 6223(a) of the Code as amended by the 2015 Act, subject to replacement by a Majority in Interest at any time as permitted by law. Percentage Interest initially means, with respect to any Member, the percentage interest set forth opposite such Member's name on Exhibit B attached hereto. To the extent that Members Percentage Interests change, such changes will be reflected in the Company s books and records without the requirement of amending this Agreement. Permitted Transfer means a transfer of a Percentage Interest as described in Section Person means any individual, partnership, corporation, trust, unincorporated association, joint venture, limited liability company or other entity or any government, governmental agency or political subdivision. Personal Representative means the Person acting in a representative capacity as the executor or administrator of a Member's estate or the duly appointed guardian of the property of a Member. Profits or Losses means, for each Allocation Year, an amount equal to the Company's taxable income or loss for such Allocation Year, determined in 25

33 accordance with Section 703(a) of the Code (for this purpose, all items of income, gain, loss or deduction required to be stated separately pursuant to Section 703(a)(1) of the Code shall be included in taxable income or loss), with the following adjustments: (a) Any income of the Company that is exempt from federal income tax and not otherwise taken into account in computing Profits or Losses pursuant to this definition shall be added to such taxable income or loss; (b) Any expenditures of the Company described in Section 705(a)(2)(B) of the Code or treated as Section 705(a)(2)(B) of the Code expenditures pursuant to Regulations Section (b)(2)(iv)(i), and not otherwise taken into account in computing Profits or Losses pursuant to this definition, shall be subtracted from such taxable income or loss; (c) In the event the Gross Asset Value of any Company asset is adjusted pursuant to clauses (b) or (c) of that definition, the amount of such adjustment shall be taken into account as gain or loss from the disposition of such asset for purposes of computing Profits or Losses; (d) Gain or loss resulting from any disposition of Property with respect to which gain or loss is recognized for federal income tax purposes shall be computed by reference to the Gross Asset Value of the Property disposed of, notwithstanding that the adjusted tax basis of such Property differs from its Gross Asset Value; (e) In lieu of the depreciation, amortization, and other cost recovery deductions taken into account in computing such taxable income or loss, there shall be taken into account Depreciation for such Allocation Year, computed in accordance with the definition of Depreciation herein; and (f) Notwithstanding any other provision of this definition, any items which that are allocated pursuant to Section hereof shall not be taken into account in computing Profits or Losses. Project means the real property described on Exhibit C attached hereto and incorporated by reference herein. Property means all assets owned by the Company and forming a part of or in any way related to or used in connection with the ownership, operation and management of the business of the Company, including, without limitation, all real and personal property. Regulations means the Income Tax Regulations, including Temporary Regulations, promulgated under the Code, as such Regulations may be amended (including corresponding provisions of succeeding regulations). 26

34 Reserves means, with respect to any period, the amount deemed necessary or appropriate by the Managers for (a) funding reserves for contingent liabilities, working capital, repairs, replacements, renewals, (b) paying taxes, insurance, debt service, or other costs or expenses incident to the ownership or operation of the Company, and (c) any other purposes deemed necessary or appropriate by the Managers to meet the current or anticipated future needs of the Company. Tax Matters Person for any tax year beginning before January 1, 2018, means Developer, or any other Member appointed by a Majority in Interest from time to time as the tax matters partner within the meaning of that term in Section 6223(a) of the Code as amended by the 2015 Act, subject to replacement by a Majority in Interest at any time as permitted by law Act means the Bipartisan Budget Act of 2015, Pub. L

35 EXHIBIT B DEVELOPMENT COMPANY, LLC LIMITED LIABILITY COMPANY AGREEMENT Members Initial Capital Contribution Percentage Interest Investor: Developer: $2,000.00* 80% $ % *Gross Asset Value of the Project. ADMIN/ v3

36 EXHIBIT C Legal Description of the Project ADMIN/ v3

37 Drafting LLC Operating Agreements Lee Lyman Carlton Fields Jorden Burt Saba Ashraf Ballard Spahr LLP # v1 L. Andrew Immerman Alston & Bird LLP June 13 & 14, 2017

38 "DEVELOPMENT COMPANY, LLC" Development Company, LLC Limited Liability Company Agreement June 13, 2017 This presentation discusses the LLC Operating Agreement of "Development Company, LLC," a Delaware LLC (with occasional references to "Corporate Company, LLC"). This is a fairly typical but simple LLC Agreement. This Agreement reflects a very common pattern, traditionally found in limited partnerships: the LLC brings together capital ("Investor") and services ("Developer"). Assumes the LLC is taxed as a partnership. 2

39 "DEVELOPMENT COMPANY, LLC" Sample Provision We ve provided a separate abridged form of an Operating Agreement or Limited Liability Company Agreement (as it is referred to in Delaware). Blue boxes on slides show selected provisions from the Operating Agreement. 3

40 THE BASICS An Operating Agreement or Limited Liability Agreement is a contract and governed largely by principles of contract law. Basic components: What goes in (contributions). How it runs (allocations; governance; restrictions; exit strategies). What comes out (distributions). How it ends (sales; liquidation). 4

41 CONTRIBUTIONS Section 2.3 Capital Contributions Member's Capital Contribution. Each Member's initial Capital Contribution is set forth on Exhibit B. The Operating Agreement will generally recite: The initial contributions of each party. Obligations if any to make future contributions. Consequences of failing to meet future contribution obligations. 5

42 DOCUMENTING THE CONTRIBUTION Member's Capital Contribution. Each Member's initial Capital Contribution is set forth on Exhibit B. Exhibit B shows: $2,000 capital contribution by Investor. $0 capital contribution by Developer. Some advisors recommend that Developer put in at least some capital. In any case, services are not capital. 6

43 "CAPITAL CONTRIBUTION" Capital Contributions include cash and the fair market value of property contributed. Sometimes there will be a separate "Contribution Agreement," with representations and warranties as in a sale. "Capital Contributions" means, with respect to any Member, the amount of money and the initial Gross Asset Value of any property (other than money) contributed to the Company with respect to the Percentage Interest held by such Member. 7

44 DOCUMENTING THE CONTRIBUTION EXHIBIT B DEVELOPMENT COMPANY, LLC LIMITED LIABILITY COMPANY OPERATING AGREEMENT Members' Names and Addresses Initial Capital Contribution Percentage Interest Investor: Developer: $2, % $ % 8

45 TAX FOLLOWS BOOK With some exceptions, the Regulations say: Tax income follows from "book" income. Once you know what allocations are made on the "books" of the LLC, you generally know what taxable income each Member of the LLC has. 9

46 HOW MANY BOOKS DO YOU NEED? An LLC may have to keep three or more kinds of books: Tax. Financial reporting (GAAP, IFRS or other). "704(b)" (defined by Regulations under Section 704(b) of the Code). Most LLC agreements require the LLC to keep 704(b) books. 10

47 704(b) BOOKS VS. TAX BOOKS 704(b) books are not really tax books. For the most part, the allocation provisions in LLC agreements that tax advisors typically want to see are technically 704(b) "book" allocations and not tax allocations. 704(b) books start from taxable income, but make significant adjustments. 704(b) books represent, in effect, the IRS's version of the real economics of the deal. 11

48 704(b) BOOKS VS. TAX BOOKS The theory is that the real economics should determine the tax consequences. For example, if you will be entitled to a distribution of profits, you should be taxable when those profits are earned. In many situations you cannot figure out the tax consequences without first thinking about the 704(b) books. When tax can't follow book, there are special "704(c)" rules for reconciling the two. 12

49 CONNECTING THE PIECES The 704(b) Regulations link together the principal tax and economic provisions of the LLC agreement: 1. Contributions. 2. Allocations. 3. Distributions. 4. Capital Accounts. Economic terms and tax terms are interrelated. There are other tax-related provisions but these four concepts are fundamental and are the ones we focus on. In a sense, the Capital Accounts summarize the other three concepts. Capital Accounts are essential to LLC agreements and partnership tax. 13

50 CONNECTING THE PIECES In the text of this Agreement, the most crucial tax-related sections are: Article 4 (Distributions and Allocations). Section 1.4.2(e) (Liquidating Distributions). Section 2.3 (Capital Contributions). However, the text relies heavily on Exhibit A ("Definitions"). Some of the most important and surprising provisions are in the definitions rather than the text. Do not neglect the definitions, especially not the definition of "Capital Account" and the other terms used in maintaining the Capital Account. 14

51 CONTRIBUTIONS + ALLOCATIONS = DISTRIBUTIONS This formula is not a secret but: It is not made explicit in LLC agreements. It is only occasionally made explicit in discussions about drafting or understanding LLC agreements. It tends to get buried under the details (especially details about debt-financed deductions or distributions). However, this Agreement and most others are designed to satisfy the formula over the lifetime of the LLC. 15

52 LIFETIME PERSPECTIVE In partnership tax, focus on the entire lifetime of the partnership. In particular, always ask: What would happen on a complete liquidation at "book value"? Nowadays many LLCs are intended to last indefinitely, just like corporations, but partnership tax was not designed with indefinite life in mind. 16

53 FORMATION AND INITIAL CONTRIBUTIONS Investor owns two parcels of raw land: WHITEACRE BLACKACRE Fair Market Value: $1,000 $1,000 Basis: $1,000 0 Investor contributes the land to Development Company LLC. Developer agrees to develop the land and receive a share of the proceeds from any increase in value. The business deal is that Investor gets back the first $2,000 of cash flow. Any proceeds above the first $2,000 are divided 80% to Investor and 20% to Developer. 17

54 OPENING BALANCE SHEET Assets Liabilities and Capital Cash $ 0.00 Debt $ 0.00 Land Capital Whiteacre $1, Investor $2, Blackacre 1, Developer 0.00 Total Assets $2, Total Liabilities and Capital $2, Investor's capital account is $2,000. Developer's capital account is zero. 18

55 LIQUIDATING DISTRIBUTION Assets Liabilities and Capital Cash $0.00 Debt $0.00 Land Capital Whiteacre $0.00 Investor $0.00 Blackacre 0.00 Developer 0.00 Total Assets $0.00 Total Liabilities and Capital $0.00 A liquidating sale and distribution to Investor at book value brings all capital accounts to zero. 19

56 HOW DOES THE LLC KEEP TRACK OF THE FORMULA? The Capital Account (with some adjustments) is like a snapshot of the amount, at any given time, that the Members would receive on a liquidation at "book value." Contributions + Allocations - Distributions Capital Account Allocations may be positive (income or gain) or negative (deduction or loss). This presentation deals mostly with positive allocations. 20

57 CAPITAL ACCOUNTS: COMMON MISCONCEPTIONS The Capital Account is not simply Contributions less Distributions. Allocations of Profits and Losses must be shown in the Capital Account. Some LLC Agreements define a concept such as "Unreturned Capital" consisting of: Capital Contributions, less Certain Distributions (those Distributions treated as return of capital rather than as a share of profit). Do not assume that Capital Account corresponds to Unreturned Capital. 21

58 CAPITAL ACCOUNTS: COMMON MISCONCEPTIONS Using terms like LLC "Units" or "Shares" does not necessarily make Capital Accounts less crucial. LLCs are very different from corporations, even if corporate terminology is used. The Capital Account does not include debt. Capital Account reflects an equity interest. However, the basis of a Member in the LLC will include the Member's share of the LLC's debt almost (but not exactly) as if the Member incurred the debt himself. 22

59 CAPITAL ACCOUNTS Capital Accounts should equal zero after the LLC liquidates: Contributions + Allocations Distributions = Capital Account = 0 23

60 "CAPITAL ACCOUNT": CREDITS Credit Capital Account With Contributions and Profit Allocations (a) To each Member's Capital Account there shall be credited such Member's Capital Contributions, such Member's distributive share of Profits and any items in the nature of income or gain that are allocated pursuant to Section 4.2 hereof, and the amount of any Company liabilities assumed by such Member or that are secured by any Property distributed to such Member; 24

61 "CAPITAL ACCOUNT": DEBITS Debit Capital Account for Distributions and Loss Allocations (b) To each Member's Capital Account there shall be debited the amount of cash and the Gross Asset Value of any Property distributed to such Member pursuant to any provision of this Agreement, such Member's distributive share of Losses and any items in the nature of expenses or losses are allocated pursuant to Section 4.2 hereof, and the amount of any liabilities of such Member assumed by the Company or that are secured by any property contributed by such Member to the Company; 25

62 "CAPITAL ACCOUNT": LIABILITIES If the Member assumes liabilities of the Company, the Member is treated as making a capital contribution. If the Company assumes liabilities of the Member, the Member is treated as receiving a distribution. (d) In determining the amount of any liability for purposes of clauses (a) and (b) of this definition, there shall be taken into account Section 752(c) of the Code and any other applicable provisions of the Code and Regulations. 26

63 "CAPITAL ACCOUNT": LIABILITIES Capital Accounts are affected by liabilities that the Member assumes or that the LLC assumes from the Member. Capital Accounts are not affected by the Member's "share" of the Company's liabilities, even though the Member's "share" of liabilities is included in the Member's basis. In many instances, if the Member's tax basis is higher than the Member's Capital Account, the reason is that the tax basis but not Capital Account includes a share of the Company's 27 liabilities.

64 "CAPITAL ACCOUNT": COMPLYING WITH REGULATIONS This Agreement says that the definition of "Capital Accounts" is intended to comply with certain provisions in the Regulations. Some LLC agreements define Capital Accounts by simply incorporating the Regulations by reference omitting all the details. The foregoing provisions and the other provisions of this Agreement relating to the maintenance of Capital Accounts are intended to comply with Regulations Section (b), and shall be interpreted and applied in a manner consistent with such Regulations. 28

65 "CAPITAL ACCOUNT": COMPLYING WITH REGULATIONS LLC agreements sometimes give managers authority to modify Capital Account computations to comply with the Regulations, although it is hard to know what these provisions really mean. The Managers may modify the definition of Capital Accounts contained in this Agreement to the extent the Managers reasonably determine that such modification is necessary to comply with such Regulations, provided that such modification is not likely to have a material effect on the amounts distributable to a Member hereunder upon the dissolution of the Company in accordance with Section

66 "CAPITAL ACCOUNT": TRANSFERS Transferee Succeeds to Capital Account of Transferor (c) Subject to the provisions of this Agreement, in the event any interest in the Company is transferred in accordance with the terms of this Agreement, the transferee shall succeed to the Capital Account of the transferor to the extent it relates to the transferred interest. 30

67 "GROSS ASSET VALUE" The value of property reflected in Capital Accounts is often defined, as in this Agreement, as "Gross Asset Value." Crucial substantive features of the Capital Accounts are built into this definition. "Gross Asset Value" means, with respect to any asset, the asset's adjusted basis for federal income tax purposes, except as follows: 31

68 "GROSS ASSET VALUE" Focus on who gets to make the decision about what the Gross Asset Value of an asset is, especially after the initial contribution. Initial Gross Asset Value is usually a mutual decision between the Company and the contributor. (a) The initial Gross Asset Value of any asset contributed by a Member to the Company shall be the fair market value of such asset, as determined by the contributing Member and the Company; 32

69 "BOOKING UP" Booking up Capital Accounts means reflecting new fair market values for the LLC's assets, and adjusting Capital Accounts accordingly. The Managers may be delegated the authority to decide on new values, but other procedures for determining new values are possible. (b) The Gross Asset Values of each item of Property shall be adjusted to equal its gross fair market value, as determined by the Managers, as of the following times: 33

70 "BOOKING UP" Gross Asset Value of all existing property is typically "booked up" when an additional interest is issued to a new or existing Member (other than de minimis interests). (i) the acquisition of an additional interest in the Company by any new or existing Member in exchange for more than a de minimis Capital Contribution or in connection with the grant of more than a de minimis interest in the Company as consideration for the provision of services to or for the benefit of the Company; 34

71 "BOOKING UP" Example: Suppose that the LLC needs extra cash and New Investor agrees to contribute $2,000. If the net assets of the LLC at the time have increased in value to $4,000 (rather than the $2,000 original book value), New Investor's contribution will represent $2,000 out of the total $6,000 value. New Investor should be credited with owning only 1/3 of the capital -- not ½. 35

72 "BOOKING UP" The $2,000 increase in value that accrued before the new investment should be credited to the Capital Accounts of Investor and Developer, as if the assets had been sold. This increase in Capital Accounts is not taxable to Investor and Developer, but creates built-in gain that can eventually come back to haunt them almost as if Investor and Developer had contributed appreciated property to a new partnership with New Investor. 36

73 "BOOKING UP" Gross Asset Value also may be booked up on a distribution of property (whether or not in liquidation). (ii) the distribution by the Company to a Member of more than a de minimis amount of Property; and (iii) the liquidation of the Company within the meaning of Regulations Section (b)(2)(ii)(g); 37

74 "BOOKING UP" In this agreement and many others a book-up on liquidation is mandatory. Book-ups on other events may or may not be needed. adjustments pursuant to clauses (i) and (ii) above shall be made only if the Managers reasonably determine that such adjustments are necessary or appropriate to reflect the relative economic interests of the Members in the Company; 38

75 WHAT IS DEVELOPER'S INTEREST Capital: $0.00 Profits: 20% IN THE LLC? Developer contributes no capital and initially has a zero Capital Account. However, she receives a 20% interest in profits. Exhibit B shows that Developer has a 20% "Percentage Interest," which reflects her share of profits. However, her initial Capital Account is zero. It is misleading to define her interest as a single number. How many "units" does Developer have? The question is meaningless. This LLC Agreement does not use the term "units. The state LLC act does not use the term units. 39

76 PROFITS INTEREST FOR SERVICES Section explains that Developer received a profits interest for services -- which generally is nontaxable to her Interest for Services. The Percentage Interest of any Member in excess of such Member's percentage of the Capital Contributions made by all Members shall be deemed to be a profits interest received in exchange for services rendered or to be rendered to or for the benefit of the Company. 40

77 PROFITS INTEREST FOR SERVICES Some LLC agreements recite that the Members received their interests solely for capital, but that is not true here. We noted under the definition of "Gross Asset Value" that this Agreement permits booking up Capital Accounts on the issuance of a profits interest. The regulations now expressly authorize booking up on issuing a profits interest, but at one time did not. 41

78 FUTURE CONTRIBUTIONS Section provides for the possibility of later capital contributions. An LLC agreement will often require unanimous approval of Members before additional capital can be required, but some LLC agreements do not. 42

79 FUTURE CONTRIBUTIONS Section permits vague penalties for default on making a required capital contribution. It is somewhat unlikely this penalty provision would have to be used here, since a Member here is not required to contribute capital unless the Member agrees to it. In deals where future capital contributions may be required without unanimous consent, the penalty for default may be more important. 43

80 MANAGEMENT/GOVERNANCE Under most states law, LLCs are either member managed or manager managed. By default, the basic roles, duties and responsibilities of each are defined by state statutes, but can be and usually are -- modified by the written operating agreement. 44

81 MANAGER MANAGED Articles of Organization and/or Operating Agreement stipulate whether the Company is manager managed. Development Company, LLC is managermanaged: Manager(s) have full authority to manage the Company. Member rights to governance and voting must be expressly reserved. Some LLCs require the Managers to be Members; many do not. Often the Member providing the services (Developer in our case) would be the Manager. 45

82 MEMBER CONSENT? Major decisions in a manager managed LLC nevertheless often require the consent of the Member(s): Operating Budget or Business Plan. Significant Capital Expenditures. New Indebtedness, Financing or Refinancings. Business Combinations. Sale of any portion of Company Property. Change in Business. Dissolution. 46

83 VOTING Beware of the state statutory default rules! Georgia Per capita voting default rule One member = one vote Delaware Default rule voting based on capital contributions More contributions = more voting power Always make voting provisions (percentages or units or other) clear in your operating agreement 47

84 GOVERNANCE VARIATIONS Some LLCs ape corporate governance, and provide for a Board and Officers. This is strictly a matter of choice the LLC act in Delaware and most other states doesn t provide for Boards or Officers, but doesn t prohibit them either. Governance patterns are almost unlimited. 48

85 FIDUCIARY DUTIES Fiduciary duties may be defined in state statutes, but should be addressed in the Operating Agreement regardless. May be based on common law principles, as in Delaware. Typically fiduciary duties in the LLC context may be reduced or even eliminated. In Delaware fiduciary duties can be completely eliminated (but not the contractual covenant of good faith and fair dealing). Effect of fiduciary standards can be to place restrictions on activities of both Managers and Members. 49

86 RESTRICTIONS ON MEMBERS Other Restrictive Covenants: Non-competition provisions. Non-solicitation provisions. Confidentiality. 50

87 RESTRICTIONS ON TRANSFER Restriction on Transfers. Except as otherwise permitted by this Agreement, no Member may Transfer all or any portion of such Member's Membership Interest. Most LLC Agreements will restrict the ability of Members to freely transfer their interests. Transfer restrictions are usually enforceable, but questions about enforceability do arise. 51

88 PERMITTED TRANSFERS Certain kinds transfers may be permitted: After obtaining specified consent. Transfers to family members, or for estate planning purposes. Transfers to affiliated entities. Transfers that have been subject to a right of first refusal or similar mechanism. 52

89 TRANSFER RESTRICTIONS Transfer restrictions are mostly imposed for business reasons, just like restrictions on transferring shares in closely-held C corporation. However, some transfer restrictions are tax-related. In this Agreement, the tax-related restrictions are gathered in Section 5.5 ("Additional Transfer Restrictions"). For example, transfers that would make Development Company, LLC a publicly traded partnership" are prohibited, because (with some exceptions) publicly traded partnerships are treated as corporations for 53 tax purposes. Code Section 7704.

90 TRANSFER RESTRICTIONS The rules on publicly traded partnerships are complicated, but an LLC is safe if it always has fewer than 100 partners, and is not required to register any interests under the Securities Act of " Preserve Partnership Tax Status. No Member shall be permitted to transfer any portion of its interest in the Company or take any other action that, in the judgment of the Managers, would materially increase the risk that the Company would be treated as a 'publicly traded partnership' within the meaning of Code Section " 54

91 PROHIBITED TRANSFERS Some transfers are specifically limited: No technical tax terminations. No transfers that would trigger withholding. No transfers that violate ERISA limitations. 55

92 WHAT GETS DISTRIBUTED? Answer: "Net Cash Flow" Net Cash Flow is defined by reference to defined in terms such as "Operating Expense," "Reserves," and "Gross Revenues." In this Agreement, the overall effect of these elaborate cross-referring definitions is that Net Cash Flow means whatever the Managers decide to distribute. Members sometimes want tighter controls over distributions. 56

93 "NET CASH FLOW" Different LLC agreements use different terms for what gets distributed, including: "Net Profits." "Net Income." "Distributable Income." The exact term doesn't matter, but the phrase "Net Cash Flow" is less misleading. Profits and income do not get distributed. Cash (and sometimes property) gets distributed. 57

94 DISTRIBUTIONS Beware of the state statutory default rules! Georgia Per capita distribution default rule Distributions shared equally among Members Delaware Default rule distributions based on agreed value of capital contributions More contributions = more distributions Always make distribution waterfalls clear in your operating agreement 58

95 DOCUMENTING THE DISTRIBUTIONS Section 4.1.1(a) says that Investor first receives a cumulative distribution equal to the initial amount of capital he contributed. So he receives the first $2,000 of distributions. Section 4.1.1(b) says that after Investor receives this first $2,000 of distributions, distributions are made 20% to Developer and 80% to Investor. 59

96 DOCUMENTING THE DISTRIBUTIONS (a) First, 100% to Investor until the cumulative distributions under this Section 4.1.1(a) equal Investor's initial Capital Contribution. (b) Second, twenty percent (20%) to Developer and eighty percent (80%) to Investor. Note that distributions are not made strictly in accordance with Percentage Interests. There is nothing unusual or anomalous about this. 60

97 YEAR TWO: SALE OF WHITEACRE Assume Whiteacre was sold in Year 2 for $2,000, and there are no other income and expense items, leaving $2,000 Net Cash Flow. Without a minimum tax distribution to Developer, the full $2,000 could be distributed to Investor. 61

98 MINIMUM TAX DISTRIBUTION? As we will see when we discuss allocations, Developer will have $200 of taxable income even if she gets no distribution. A minimum tax distribution provision may say, notwithstanding Investor's preferential distribution, the Company should distribute enough so that the Members can pay their tax. This provision is intended to help the Members Developer in particular cope with "phantom income." 62

99 MINIMUM TAX DISTRIBUTION? Minimum Tax Distribution. Except as otherwise provided in Section 1.4, notwithstanding Section the Company shall make distributions out of Net Cash Flow to the Members at such times and in such amounts as are reasonably estimated by the [Managers] [Members] to be at least sufficient to enable each Member to make timely payments of federal, state and local income taxes, including estimated taxes, attributable to such Member's Percentage Interests. 63

100 MINIMUM TAX DISTRIBUTION? Section only requires the tax distribution to be a reasonable estimate of the amount needed to pay taxes. The estimate may be less than is actually needed. Section only requires the tax distribution to be made out of "Net Cash Flow." For example, the Company does not need to borrow money to make a tax distribution. No matter what the LLC agreement says, there is always some risk that a Member will have phantom income. 64

101 MINIMUM TAX DISTRIBUTION? "Distributions under this Section shall be made twenty percent (20%) to Developer and eighty percent (80%) to Investor. Any amount distributed pursuant to this Section will be deemed to be an advance distribution of amounts otherwise distributable to the Members pursuant to Section 4.1.1(b) and will reduce the amounts that would subsequently otherwise be distributable to the Members pursuant to Section 4.1.1(b) in the order they would otherwise have been distributable." 65

102 MINIMUM TAX DISTRIBUTION? This Agreement says that tax distributions are made 20/80. For example, if Developer needs $20 to pay her taxes, Investor must get $80 -- even if he does not need it to pay his taxes. An LLC agreement need not require tax distributions to be made in the same proportion as profits are shared. However, many agreements do. 66

103 "PAYMENTS" TO THE MEMBERS Practitioners sometimes distinguish "distributions" from "payments." "Payments" are often set forth outside the LLC agreement, including: "Guaranteed payments" for capital or services. Payment of sales price for property sold to the LLC. 67

104 "PAYMENTS" TO THE MEMBERS However, some "payments" are provided for in vague terms by this Agreement, e.g., Section (interest on loans) and (compensation to Managers) Loans to the Company. The Members may lend money to the Company as approved by the Managers Compensation. Compensation of the Managers will be fixed from time to time by an affirmative vote of a Majority in Interest. 68

105 WHAT IS ALLOCATED? Answer: "Profits" (and "Losses" and other "items"). You can use other terms, but be clear that allocations are accounting entries and not real money. "Net Cash Flow" gets distributed, not allocated. 69

106 "PROFITS" AND "LOSSES" The definition of "Profits" and "Losses" like the definition of "Gross Asset Value" -- starts from taxable income, and then makes adjustments. "Profits" or "Losses" means, for each Allocation Year, an amount equal to the Company's taxable income or loss for such Allocation Year, determined in accordance with Section 703(a) of the Code (for this purpose, all items of income, gain, loss or deduction required to be stated separately pursuant to Section 703(a)(1) of the Code shall be included in taxable income or loss), with the following adjustments: 70

107 "PROFITS" AND "LOSSES" The adjustments bring taxable income and loss into line with "book" income and loss. However, these are the "704(b)" books the books kept under the 704(b) Regulations and not tax books or financial accounting books. (a) Any income of the Company that is exempt from federal income tax and not otherwise taken into account in computing Profits or Losses pursuant to this definition shall be added to such taxable income or loss; 71

108 "PROFITS" AND "LOSSES" Items that must be specially allocated under Section (the "Regulatory Allocations") are allocated before the allocations of Profits and Losses (under Section 4.2.1). (f) Notwithstanding any other provision of this definition, any items that are allocated pursuant to Section hereof shall not be taken into account in computing Profits or Losses. Separating out "Regulatory Allocations" means that losses attributable to nonrecourse debt are not included in "Losses." 72

109 LAYER-CAKE ALLOCATIONS The general rule for allocating Profits appears here as the second level of allocations in the first version of Section 4.2.1(a). (The first level of allocations "charges back" previous Losses.) (ii) Second, after giving effect to the allocations made pursuant to Section 4.2.1(a)(i), Profits shall be allocated twenty percent (20%) to Developer and eighty percent (80%) to Investor. 73

110 "TARGETED" ALLOCATIONS Many LLC agreements nowadays omit detailed allocation provisions, in favor of "targeted" allocations such as the alternative version of Section The targeted capital account provision says: Allocate so that Capital Accounts (with certain adjustments) equal the amounts the Members would receive in a liquidating distribution. 74

111 "TARGETED" ALLOCATIONS Instead of following the detailed allocation instructions specified in the LLC agreement (which are sometimes ignored anyway) the LLC's accountants each year have to figure out how to make allocations. This is sometimes called the "forced" allocation approach: allocations are "forced" to correspond to Capital Accounts. 75

112 YEAR THREE: SALE OF BLACKACRE Assume in Year 3 the Company sells Blackacre for $2,000. The Company distributes the proceeds to Investor and Developer in liquidation of the Company. 76

113 YEAR THREE: SALE OF BLACKACRE Assume Investor received the first $2,000 of proceeds in Year Two. The business deal is that all subsequent distributions are made 80/20. So the $2,000 proceeds in Year 3 go: $1,600 to Investor. $400 to Developer. 77

114 LIQUIDATING DISTRIBUTIONS Liquidating distributions are commonly drafted in one of two ways: In accordance with positive Capital Accounts. In accordance with specific distribution provisions. Liquidating in accordance with Capital Accounts may mean that your tax allocations are safer. Liquidating in accordance with distribution provisions may mean that your business deal is safer. 78

115 LIQUIDATING DISTRIBUTIONS Liquidation provisions generally begin by authorizing the Managers to take the steps required by law Liquidation of Property and Application of Proceeds. Upon the dissolution of the Company, the Managers (or, if none, a liquidator appointed by the Personal Representatives of the deceased Members) will wind up the Company's affairs in accordance with the Delaware Act, and will be authorized to take any and all actions contemplated by the Delaware Act as permissible, including, without limitation: 79

116 LIQUIDATING DISTRIBUTIONS The crucial provision on liquidation relates to the distribution of any "residual" (after creditors have been paid off). The residual will be distributed either in accordance with Capital Accounts, or in accordance with a distribution scheme spelled out in the LLC agreement. (e) distributing the proceeds of liquidation and any undisposed Property to the Members in accordance with [their positive Capital Account balances] [Section 4.1.1]. 80

117 LIQUIDATING DISTRIBUTIONS In our example, liquidating in accordance with Capital Accounts or in accordance with Section is exactly the same as it is intended to be and it should be. Especially in complicated deals, parties worry that the Capital Accounts may not work out as anticipated. The drafting trend in recent years is for LLC agreements to say that liquidation will be in accordance with the fixed distribution provision rather than in accordance with Capital Accounts. 81

118 OUR EXAMPLE: YEAR 2 Assume Whiteacre was sold in Year 2. Whiteacre had a tax basis and value of $1,000 when Investor contributed it, so there was $1,000 of income to allocate. The $1,000 income is allocated: $800 to Investor. $200 to Developer. Developer is allocated $200 of income even though she receives no cash (assume no "tax distribution"). 82

119 YEAR THREE: SALE OF BLACKACRE Assume in Year 3 the Company sells Blackacre for $2,000. What is the income of the Company, and how should it be allocated? The book income of the Company is $1,000. Blackacre was booked into the Company at $1,000, and is sold for $2,000, so there is $1,000 of book income. This income of the Company should be allocated 80/20 in Year Three. 83

120 OVER THE LIFE OF THE LLC: CONTRIBUTIONS + ALLOCATIONS = DISTRIBUTIONS The formula works out just right. INVESTOR Year Contributions Allocations Distributions One: $2, Two: 0 $800 $2,000 Three: 0 $800 $1,600 Life of LLC: $2,000 + $1,600 = $3,600 DEVELOPER Year Contributions Allocations Distributions One: Two: 0 $200 0 Three: 0 $200 $400 Life of LLC: 0 + $400 = $400 84

121 HOW DOES LLC ACHIEVE THESE RESULTS? Answer: Allocate all Profits 80% to Investor and 20% to Developer (assuming no chargebacks). Distribute the first $2,000 to Investor; all subsequent distributions 80/20. 85

122 THE "SAFE HARBOR" The 704(b) Regulations on "substantial economic effect" include two "safe harbors" for allocations. Allocations that fit in a safe harbor are safe from IRS challenges. One safe harbor requires the Members to have an unlimited obligations to restore negative Capital Accounts, which nowadays is almost unheard of. The other safe harbor requires, among other things, layer-cake allocations and liquidation by capital accounts. The rules we have been discussing deal with whether an allocation has "economic effect." There are other rules dealing with whether the economic effect is "substantial," but substantiality is a less mechanical test, and is not reflected as directly in the LLC agreement. 86

123 YEAR THREE: SALE OF BLACKACRE Suppose in Year 3 the Company sells Blackacre for $2,000. The "book value" of Blackacre was $1,000, so the Company has $1,000 of book income. The tax basis of Blackacre was zero, so the Company has $2,000 of tax income. 87

124 RECONCILING BOOK AND TAX INCOME Investor wound up getting total cash distributions of $3,600 from the Company. Investor's initial tax basis in the property contributed to the Company was $1,000. Thus he should have $2,600 of taxable income, and not $1,600. Allocating the extra $1,000 entirely to Investor is fair. 88

125 RECONCILING BOOK AND TAX INCOME Investor is allocated a total $1,800 of taxable income (not "Profits") under "704(c)" in Year Three, consisting of: the entire $1,000 of built-in gain, plus 80% of the $1,000 of gain that arose after the property was contributed to the Company. 89

126 HOW TO RECONCILE TAX AND BOOK There are different "704(c)" methods and they can have wildly different consequences. A Member contributing appreciated property may find out that under some methods gain is recognized long before the LLC sells the property. A Member contributing cash may find out that under some methods depreciation deductions are less than if the Member had bought an equivalent amount property outside the LLC. 90

127 HOW TO RECONCILE TAX AND BOOK Vague instructions to reconcile tax and book may work out in simple cases, but in many situations there are alternative methods, and the choice of method is anything but neutral, innocuous tax boilerplate. Choice of "704(c)" method should be carefully considered and negotiated when a Member is contributing appreciated property especially depreciable property. 91

128 SUMMARY OF BOOK/TAX RECONCILIATION INVESTOR: Year Book Tax One: $ 2,000 Contribution $ 1,000 Contribution Two: Allocation Allocation - 2,000 Distribution - 2,000 Distribution $ 800 Book Basis $ 0 Tax Basis* * Since there cannot be negative basis, the distribution of $200 in excess of basis is taxable to Investor. This LLC has no debt, but LLC debt allocated to investor could have increased the Investor's basis and facilitated a $200 nontaxable distribution. 92

129 SUMMARY OF BOOK/TAX RECONCILIATION INVESTOR: Year Book Tax Three: $ 800 Book Basis $ 0 Tax Basis Allocation + 1,800 Allocation $1,600 Book Basis $ 1,800 Tax Basis - 1,600 Distribution - 1,600 Distribution $ 0 Final Book Basis $ 200 Final Tax Basis* * $200 tax basis after the liquidating distribution gives Investor a $200 loss, possibly offsetting $200 of the $1,800 income allocation. 93

130 HOW TO RECONCILE TAX AND BOOK (Section 4.2.6) Tax Allocations. In accordance with Section 704(c) of the Code and the Regulations thereunder and with Section (b)(2)(iv)(f)(4) and (b)(4)(i) of the Regulations, income, gain, loss and deduction with respect to any property contributed to the capital of the Company or property revalued on the Company's books and in the Capital Accounts shall, solely for tax purposes, be allocated among the Members so as to take account, under the [SPECIFY METHOD] as defined by Section of the Regulations, of any variation between the adjusted basis of such property to the Company for federal income tax purposes and its Gross Asset Value. 94

131 THE "REGULATORY ALLOCATIONS" IMPLEMENT THE SECRET FORMULA The secret formula says that over the life of the Company: Contributions + Allocations = Distributions However, certain situations present special challenges when attempting to comply with the secret formula. 95

132 "ADJUSTED CAPITAL ACCOUNT DEFICIT" The special situations tend to involve actual or potential negative (i.e., deficit) Capital Accounts. For example, the secret formula may be violated if a Member receives a distribution in excess of his Capital Account, and is not required to restore the negative balance in the Capital Account. If the Member is not required (and is not deemed to be required) to restore the deficit, the Member has an "Adjusted Capital Account Deficit." 96

133 PURCHASE RIGHTS AND OBLIGATIONS Most LLC Agreements will provide mechanisms to address changes in ownership either by voluntary transactions or through forced repurchases or other types of transfers. Mechanisms can also help break deadlocks or ensure cooperation in certain transactions. Members will want to provide for "take out" mechanisms or other exit strategies. 97

134 ROFRs AND ROFOs Right of First Refusal Triggered by third party offer Right to purchase Price usually set by third party Right of First Offer Triggered by Member s intent to sell Right to receive first offer Price determined by Member or valuation formula 98

135 BUY-SELL May be useful for breaking deadlocks. Are only practical when there are very few members. An offer to sell, or purchase, for the same price. Offeree, not offeror, controls the direction of sale. Rarely consummated. 99

136 TAG ALONGS & DRAG ALONGS; CO-SALE RIGHTS Tag Along Benefits Minority Owners Allows Minority Owners to opt to participate in transaction on a pro rata basis Both Minority and Majority Owners generally participate on the same terms Drag Along Benefits Majority Owners Requires Minority Owners to participate in a change of control transaction Both Minority and Majority Owners generally participate on the same terms 100

137 OTHER PURCHASE RIGHTS AND OBLIGATIONS Possible triggering events: Death of a Member. Disability of a Member. Departure of Employee-Member. Non-permitted transfer. Right or obligation of Company or other Members to purchase interest. Price may vary depending on reason for repurchase. 101

138 VALUATION Book value Original Cost Formula based on EBIDTA Agreed Value Appraised Value "Appraised Value" means the value determined by a majority of a board of three appraisers, where the Personal Representative of a deceased Member or Member disputing the Fair Market Value appoints one appraiser and the other Members appoint one appraiser and the two appointed appraisers appoint the third appraiser. 102

139 FUNDING In the event of the death of a Member, the purchase price for the deceased Member's Membership Interest will be paid in one lump sum from the Company upon (a) the tenth (10th) day after the proceeds of the insurance policy insuring the life of the deceased Member have been received by the Company if the Company purchased a life insurance policy for such Member, or (b) within ninety (90) days after the date of the Member's death if the Company did not purchase a life insurance policy for the Member. In the event of a nonpermitted Transfer or attempted Transfer, the purchase price will be paid in equal quarterly installments (including principal and interest) over a five (5) year period (unless a shorter period is agreed to by all the Managers). Possibilities: All Cash. Promissory Note. Installment Payments. 103

140 FUNDING Cash Flow Limitations In no event, however, will the sum of the quarterly payments be in excess of percent ( %) of the Company's Net Income for such quarter after considering mandatory distributions and any other redemption payments the Company is obligated to make, or any Reserve created therefore (the " % Limitation"). In the event the % Limitation is triggered, the applicable payment period shall be extended by the shortest period possible without violating the % Limitation. 104

141 SALES OF LLC INTERESTS By default, the sale of an LLC (or partnership) interest creates an assignee not a Member. What does it take to become a Member? Some possibilities: Consent of other Members (or Managers). Joinder to the Operating Agreement. A Permitted Transfer. Payment of expenses. Compliance with securities laws. 105

142 ALLOCATIONS WHEN MEMBERSHIP INTERESTS CHANGE This Agreement has provisions explaining how to make allocations in case interests change. The tax rules permit two general methods: Close the Company's books when interests change. Allocate pro rata (e.g., a 50% interest held 30 days is allocated 30/365 of 50% of the year's Profits and Losses). 106

143 ALLOCATIONS WHEN MEMBERSHIP INTERESTS CHANGE This Agreement lets the transferee and transferor choose the allocation method they want. (e) Transfer of Percentage Interests. If one or more Percentage Interests are transferred during any fiscal year of the Company, the Company income or loss attributable to such Percentage Interests for such fiscal year shall be allocated between the transferor and the transferee in any manner permitted by law as they shall agree

144 ALLOCATIONS WHEN MEMBERSHIP INTERESTS CHANGE If the Company issues interests to a new Member, the Managers under this Agreement choose the allocation method (but in practice the method is often negotiated). The Managers may, at their option, at the time a Member is admitted, close the Company books (as though the Company's tax year had ended) or make pro rata allocations of loss, income and expense deductions to a new Member for that portion of the Company's tax year in which a Member was admitted in accordance with the provisions of Section 706(d) of the Code. 108

145 THE END: DISSOLUTION AND LIQUIDATION Dissolution: Commences process of liquidation. Liquidation: Winding up and disposition of the assets and liabilities of the legal entity. 109

146 DISSOLUTION Possible Triggering Events: Agreement of Members: Majority. Supermajority. Unanimous. Sale of substantially all assets Judicial dissolution No remaining Members End of specified term. 110

147 EVENTS OF DISSOCIATION Possibilities: Withdrawal. Resignation or removal. Death. Incompetency. Bankruptcy. Transfer of complete Membership Interest. 111

148 IF THE LAST MEMBER STANDING FALLS? Notwithstanding the provisions of the Delaware Act, the Company shall not dissolve upon an event of disassociation with respect to the last remaining Member, but instead the legal successor to such Member shall automatically become a Member of the Company with all the rights appurtenant thereto in accordance with the Delaware Act. What happens if the last Member ceases to be a Member of the LLC? In some states the LLC automatically terminates (or dissolves). An LLC can be continued or re-constituted. Or Operating Agreement can provide for an automatic continuation. 112

149 LIQUIDATION Although liquidation occurs at the end of the LLC s life it was almost the first thing that the tax advisor focused on when the LLC was formed. If the Company liquidates: It books up Capital Accounts to fair market value (see the definition of "Gross Asset Value"). It pays off or provides for liabilities. It sells assets and distributes the proceeds (or distributes assets in kind). 113

150 LOSS ON LIQUIDATION What if the amount available to distribute is less than the aggregate Capital Accounts as they existed before liquidation? The LLC obviously cannot distribute more than it has. The LLC has, by definition, experienced a loss. The loss will be allocated among the Members and reduce their Capital Accounts. This loss is a 704(b) book loss. The loss may or may not be a tax loss; it may even be a tax gain. Example: Suppose Blackacre is sold for $500. It had zero basis when contributed, but $1,000 book value. The LLC has a book loss (sale for less than book value) but a tax gain (sale for more than basis). The tax gain will be allocated to Investor. See discussion above on reconciling "tax" and "book." 114

151 PARTNERSHIP AUDITS In late 2015, Congress totally revamped the rules on partnership audits. The workings of the new provisions remain something of a mystery, but they are scheduled to go into effect for tax periods beginning in 2018 anyway LLC agreements today are being drafted to take the new provisions into account to the extent possible. The most radical change wrought by the new rules is that, with some important exceptions, the LLC itself will be liable when the IRS makes adjustments on audit. Up until now, the LLC never had liability for federal income tax on its income; all liability was on the Members. 115

152 PARTNERSHIP AUDITS The consensus among advisors is that the new rules are badly flawed (at best). Many LLCs will be eligible to elect out of the new rules entirely. It is likely that most LLCs that have the option to elect out will exercise that option. If the LLC elects out, the IRS will have to audit the Members individually; there will be no centralized audit of the entity. For LLCs that cannot or choose not to elect out entirely, the new rules institute the role of Partnership Representative. 116

153 DEFAULT RULE: CODE SECTION 6225 Tax is assessed and collected at the LLC level on the imputed underpayment amount. Imputed underpayment amount is computed using the highest rates under the Code. Penalties, interest, statute of limitations all determined at the LLC level. LLCs will be permitted to reduce the imputed underpayment amount based on showing the IRS the tax status of the Members. Capital gains for individuals. Non-UBTI for tax-exempt entities. Dividend-received deduction for corporations. 117

154 DEFAULT RULE: CODE SECTION 6225 The imputed underpayment amount can also be reduced to the extent that a Member files amended returns and pay the applicable tax. Generally no requirement that all Members file amended returns in order for the LLC to get the benefit of this rule. However, if the adjustment reallocates items among Members, then all Members must file amended returns. IRS must approve any modification of the imputed underpayment amount. 118

155 ELECTION OUT: CODE SECTION 6221(b) Many LLCs will be eligible to elect out of the LLClevel determination. 100 or fewer K-1s. All Members are: Individuals C corps Foreign entities that would be C corps if they were domestic S corps (each K-1 of the S corp counts towards the 100 total permitted) Estates of deceased Members. It is unknown to what extent tiered LLCs (LLCs that have partnerships or other LLCs as Members) will be allowed to elect out. Development Company, LLC should qualify to elect 119 out.

156 PARTNERSHIP REPRESENTATIVE Unless the LLC can and does elect out, it acts through a partnership representative. Much more powerful than the tax matters partner (or tax matters person ) was under the previous rules. Need not be a Member (unlike the tax matters partner ). Only qualification: must have a substantial presence in the US. If the LLC does not select a partnership representative, the IRS can choose any person (Member or not) to be the representative. It is unknown how the IRS will go about choosing a partnership representative. It is essential for the LLC to choose its own partnership representative, preferably in the Operating Agreement. 120

157 PARTNERSHIP REPRESENTATIVE Broad authority by statute to bind the LLC and the Members. Authority includes not just agreeing to extend the statute of limitations or filing a Tax Court petition but also agreeing to adjustments. LLC Operating Agreements generally should put limits on what the partnership representative can do without approval of Members or Managers. IRS need not respect those limits, but presumably they would be valid under state law. IRS not required to notify Members of proceedings -- not even majority Members. Members have no right by law to participate in proceedings. 121

158 PUSH-OUT ELECTION: CODE SECTION 6226 The push-out election is an alternative to LLClevel liability. Adjustment taken into account by the Member. LLC notifies Member of adjustment. The Member does not amend past returns; it pays tax in the year that the LLC furnished the notice. The new audit procedures, including the role of the partnership representative, still apply under the push-out election. Penalties are still determined at the LLC level (Code Section 6221) even though the Member must pay them. 122

159 PUSH-OUT ELECTION: CODE SECTION 6226 The push-out election is not the same as having the Member file amended returns. The Member computes the tax and interest that would have been due if the original K-1 had reflected the adjustment. The Member reports and pays the amount with its current year s tax return. The Member-level statute of limitations is irrelevant; the only statute of limitations is the one on the LLC. The Member pays even if it has sold the LLC in the interim. 123

160 TAX MATTERS PARTNER/PERSON The Tax Matters Person of the Company must be Developer or Investor. If Developer is the only Manager, then the Developer is eligible. However, if neither Developer nor Investor is a Manager, then either Developer or Investor may be the Tax Matters Person. Tax Matters Person for any tax year beginning before January 1, 2018, means Developer, or any other Member appointed by a Majority in Interest from time to time as the tax matters partner within the meaning of that term in Section 6223(a) of the Code as amended by the 2015 Act, subject to replacement by a Majority in Interest at any time as permitted by law. 124

161 PARTNERSHIP REPRESENTATIVE For tax years starting in 2018, the Tax Matters Person is out and the Partnership Representative is in. Partnership Representative need not be a Member (or partner ). Partnership Representative for any tax year beginning on or after January 1, 2018, means Developer, or any other person appointed by a Majority in Interest from time to time as the partnership representative within the meaning of that term in Section 6223(a) of the Code as amended by the 2015 Act, subject to replacement by a Majority in Interest at any time as permitted by law. 125

162 AUTHORITY TO REPRESENT THE COMPANY The Members should be especially cautious in deciding on the Partnership Representative, and should attempt as best they can to put reasonable restraints on its power. "The Tax Matters Person and Partnership Representative are each authorized and required to represent the Company, at the Company s expense, in connection with all examinations of the Company s affairs by taxing authorities, including administrative and judicial proceedings, and to expend Company funds for such professional services and costs associated therewith as the Tax Matters Person or Partnership Representative may reasonably determine

163 "BOOKS, RECORDS AND TAX AND ACCOUNTING MATTERS" Lots of tax decisions are made for the LLC by the Internal Revenue Code. There is limited choice about: Tax year. Accounting method. Some Operating Agreements spell out tax year and/or accounting method, even if there is no choice, just so that everyone understands what tax year and accounting method are expected. 127

164 TAXABLE YEAR An LLC generally must use the same taxable year as a majority of its Members. Code Section 706(b). This Operating Agreement spells out that the Company will use the calendar year, but this Company could not have chosen any other year. "1.5.5 Taxable and Fiscal Year. The Company's taxable and fiscal years are the calendar year." 128