Why LLCs are Now the Entity of Choice in Pennsylvania Webinar Noon-1 p.m. June 1, 2016

Transcription

1 Why LLCs are Now the Entity of Choice in Pennsylvania Webinar Noon-1 p.m. June 1, 2016 Wendi Kotzen, Partner Ballard Spahr, Philadelphia William H. Clark Jr., Partner Drinker, Biddle and Reath, Philadelphia Saba Ashraf, Partner Ballard Spahr, Philadelphia

2 A Brief Review of Entity Law Basics Relating to Choice of Entity William H. Clark, Jr. Drinker Biddle & Reath LLP One Logan Square Philadelphia, PA (215)

3 always: reduce taxes general approach on choice of entity limit the liability of the owners and usually: protect the people in charge while: implementing the governance arrangement desired by the owners

4 liability of owners corporation shareholders protected general partnership partners jointly and severally liable LLP PA partial shield DE full shield limited partnership general partners liable LLLP full or partial shield for general partners limited liability company members protected business trust beneficial owners protected good bad mixed good good

5 protection of those in charge exoneration authorized by statute for corporations (and indirectly for some limited liability companies) available by contract for other types of entities indemnification authorized by statute for corporations, limited partnerships, and limited liability companies available by contract for other types of entities advancement of expenses authorized by statute for corporations, limited partnerships, and limited liability companies available by contract for other types of entities variation of duties available in Delaware, but currently not in Pennsylvania

6 governance arrangements there are three basic governance paradigms: 1. corporation board with overall responsibility and officers 2. general partnership all owners actively participate in management 3. limited partnership one or more managers locked into position the three paradigms largely may be replicated in any type of entity organized under Pennsylvania law this is true even for corporations because of the validation of freedom of contract in 15 Pa.C.S. 1306(a)(8)(ii) and (b)

7 ENTITY COMPARISON CHART By Wendi L. Kotzen Saba Ashraf Ballard Spahr LLP William H. Clark, Jr. Drinker, Biddle & Reath May 2016

8 TAX C CORP S CORP LIMITED PARTNERSHIP LIMITED LIABILITY PARTNERSHIP GENERAL PARTNERSHIP LIMITED LIABILITY COMPANY BUSINESS TRUST ORGANIZE TAX FREE GENERALLY YES GENERALLY YES GENERALLY YES GENERALLY YES GENERALLY YES GENERALLY YES GENERALLY YES TAX FREE CONTRIBUTION OF PROPERTY AFTER FORMATION TAX ON DEBT IN EXCESS OF BASIS OF CONTRIBUTED PROP GENERALLY NO GENERALLY NO YES YES YES YES YES YES YES POSSIBLY POSSIBLY POSSIBLY POSSIBLY POSSIBLY CAN HAVE CORPORATE OWNER YES NO (EXEMPT ORG CORPORATE OWNERS WILL NOT CAUSE LOSS OF S STATUS) YES YES YES YES YES NEED TWO OWNERS NO NO YES YES YES NO, BUT IF ONE OWNER, WILL BE DISREGARDED FOR FIT AND PA INCOME TAX PURPOSES NO, BUT IF ONE OWNER, WILL BE DISREGARDED FOR FIT AND PA INCOME TAX PURPOSES MAXIMUM NUMBER OF OWNERS NO 100 NO NO NO NO NO This chart assumes that each entity that is not a state law corporation does not elect to be treated as a corporation and is not publicly traded. 7

9 TAX C CORP S CORP LIMITED PARTNERSHIP PASS THROUGH FED LIMITED LIABILITY PARTNERSHIP GENERAL PARTNERSHIP LIMITED LIABILITY COMPANY NO YES YES YES YES YES YES BUSINESS TRUST PASS THROUGH PA INC TAX NO YES, EXCEPT INCOME SUBJECT TO FIT (e.g., BUILT-IN GAINS) - SUBJECT TO CNIT REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL SHAREHOLDERS FOR TAX YEARS BEGINNING AFTER 12/31/2014, S CORPS WITH 11 OR MORE SHAREHOLDERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE SHAREHOLDERS ACTUAL TAX LIABILITY YES PARTNERSHIP REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL PARTNERS AND CNIT FROM CORPORATE PARTNERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR PARTNERS TAX UPON FAILURE TO WITHHOLD FOR TAX YEARS BEGINNING AFTER 12/31/2014, PARTNERSHIPS WITH ENTITY PARTNERS OR WITH 11 OR MORE PARTNERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE PARTNERS ACTUAL TAX LIABILITY YES PARTNERSHIP REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL PARTNERS AND CNIT FROM CORPORATE PARTNERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR PARTNERS TAX UPON FAILURE TO WITHHOLD FOR TAX YEARS BEGINNING AFTER 12/31/2014, PARTNERSHIPS WITH ENTITY PARTNERS OR WITH 11 OR MORE PARTNERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE PARTNERS ACTUAL TAX LIABILITY YES PARTNERSHIP REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL PARTNERS AND CNIT FROM CORPORATE PARTNERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR PARTNERS TAX UPON FAILURE TO WITHHOLD FOR TAX YEARS BEGINNING AFTER 12/31/2014, PARTNERSHIPS WITH ENTITY PARTNERS OR WITH 11 OR MORE PARTNERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE PARTNERS ACTUAL TAX LIABILITY YES REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL OWNERS AND CNIT FROM CORPORATE MEMBERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR MEMBERS TAX UPON FAILURE TO WITHHOLD FOR TAX YEARS BEGINNING AFTER 12/31/2014, LLCS WITH ENTITY MEMBERS OR WITH 11 OR MORE MEMBERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE MEMBERS ACTUAL TAX LIABILITY YES REQUIRED TO WITHHOLD PIT FROM NON-RESIDENT INDIVIDUAL OWNERS AND CNIT FROM CORPORATE MEMBERS THAT DO NOT FILE IN PA; CAN BE LIABLE FOR MEMBERS TAX UPON FAILURE TO WITHHOLD FOR TAX YEARS BEGINNING AFTER 12/31/2014, LLCS WITH ENTITY MEMBERS OR WITH 11 OR MORE MEMBERS THAT UNDERREPORT INCOME BY $1 MILLION OR MORE ARE LIABLE FOR TAX WITHOUT REGARD TO THE MEMBERS ACTUAL TAX LIABILITY 8

10 TAX C CORP S CORP LIMITED PARTNERSHIP ELECTION REQUIRED FOR FEDERAL, PA NO YES PA FOLLOWS FEDERAL (UNLESS ELECTION TO OPT OUT) LIMITED LIABILITY PARTNERSHIP GENERAL PARTNERSHIP LIMITED LIABILITY COMPANY NO NO NO NO NO BUSINESS TRUST PA CAPITAL STOCK TAX PHASED OUT EFFECTIVE 1/1/16 OWNER GETS BASIS FOR ENTITY S DEBT CALENDAR OR BUSINESS YEAR REQUIRED CAN HAVE SUBSIDIARIES CAN BE DISREGARDED FOR FIT PURPOSES N/A N/A N/A N/A N/A N/A N/A NO NO YES YES YES YES YES NO YES YES YES YES, WITH CERTAIN EXCEPTIONS YES YES YES YES YES YES YES NO NO YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED YES YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED YES YES IF DIRECTLY OR INDIRECTLY WHOLLY OWNED CITY OF PHILADELPHIA TAXES (GENERALLY NO PASS- THROUGH ENTITIES) BUSINESS INCOME AND RECEIPTS TAX (FORMERLY BUSINESS PRIVILEGE TAX) BUSINESS INCOME AND RECEIPTS TAX QSSS NOT TREATED AS SEPARATE ENTITY BUT S CORP. PARENT AND QSSS TREATED AS ONE ENTITY AND SUBJECT TO BPT. BUSINESS INCOME AND RECEIPTS TAX NET PROFITS TAX BUSINESS INCOME AND RECEIPTS TAX NET PROFITS TAX BUSINESS INCOME AND RECEIPTS TAX NET PROFITS TAX FOLLOWS FIT BUSINESS INCOME AND RECEIPTS TAX (IF DRE, THEN OWNER SUBJECT TO BIRT AND - IF APPLICABLE - NPT) BUSINESS INCOME AND RECEIPTS TAX NET PROFITS TAX 9

11 TAX C CORP S CORP LIMITED LIMITED LIABILITY GENERAL LIMITED LIABILITY PARTNERSHIP PARTNERSHIP PARTNERSHIP COMPANY BUSINESS TRUST SUBJECT TO AT NO, UNLESS YES YES YES YES YES YES RISK RULES CLOSELY HELD SUBJECT TO PASSIVE ACTIVITY LOSS RULES NO, UNLESS CLOSELY HELD YES YES YES YES YES YES ACCRUAL METHOD REQUIRED EMPLOYMENT TAX/ SELF- EMPLOYMENT TAX YES, UNLESS QPSC OR GR NOT ON DIVIDENDS NO, UNLESS IT HAS INVENTORY ISSUES EXIST FOR OE YES IF C CORP PARTNER OR TAX SHELTER, UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY GUARANTEED PAYMENTS FOR SERVICE YOU RENDERED THE PARTNERSHIP ARE NET EARNINGS FOR SELF- EMPLOYMENT TAX. YES IF C CORP PARTNER OR TAX SHELTER, UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY GUARANTEED PAYMENTS FOR SERVICE YOU RENDERED THE PARTNERSHIP ARE NET EARNINGS FOR SELF- EMPLOYMENT TAX. YES IF C CORP PARTNER OR TAX SHELTER, UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY GENERAL PARTNER'S EARNINGS FROM SELF- EMPLOYMENT INCLUDE DISTRIBUTIVE SHARE OF INCOME OR LOSS AND GUARANTEED PAYMENTS FOR SERVICES RENDERED. LIMITED PARTNERS ONLY INLUCLUDE GUARANTEED PAYMENTS. YES IF C CORP MEMBER OR TAX SHELTER UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY GUARANTEED PAYMENTS FOR SERVICE YOU RENDERED THE PARTNERSHIP ARE NET EARNINGS FOR SELF- EMPLOYMENT TAX. YES IF C CORP MEMBER OR TAX SHELTER UNLESS GR AND UNLESS IT CHECKS THE BOX, OR IT HAS INVENTORY YES ON ALLOCABLE SHARE OF INCOME IF MEMBER HAS PERSONAL LIABILITY FOR DEBT OR CLAIMS VS. ENTITY, AUTHORITY TO CONTRACT ON BEHALF OF THE BUSINESS TRUST OR PARTICIPATES IN THE BUSINESS TRUST S TRADE OR BUSINESS FOR MORE THAN 500 HOURS DURING THE BUSINESS TRUST S TAX YEAR; IF MEMBER IS SERVICE MEMBER 10

12 3.8% NET INVESTMENT INCOME TAX TAX C CORP S CORP DOUBLE TAX ON SALE OF ASSETS CAN RECEIVE STOCK TAX FREE IN A MERGER ENTITY ASSET BASIS STEP UP ON TRANSFER BY OWNER BY SALE OR DEATH MAY BE IMPOSED ON GAIN FROM SALES OF STOCK AND DIVIDENDS EARNED BY INDIVIDUAL SHAREHOLDERS YES MAY BE IMPOSED ON GAIN FROM SALES OF STOCK AND OTHER INCOME EARNED BY INDIVIDUAL SHAREHOLDERS IF OWNERSHIP IS A PASSIVE ACTIVITY NO, UNLESS TAX ON BUILT IN GAIN LIMITED LIMITED LIABILITY GENERAL LIMITED LIABILITY PARTNERSHIP PARTNERSHIP PARTNERSHIP COMPANY BUSINESS TRUST MAY BE IMPOSED MAY BE MAY BE MAY BE MAY BE IMPOSED ON GAIN FROM IMPOSED ON IMPOSED ON IMPOSED ON ON GAIN FROM SALES OF GAIN FROM GAIN FROM GAIN FROM SALES OF PARTNERSHIP SALES OF SALES OF SALES OF INTERESTS AND INTERESTS AND PARTNERSHIP PARTNERSHIP MEMBERSHIP OTHER INCOME OTHER INCOME INTERESTS AND INTERESTS AND INTERESTS AND EARNED BY EARNED BY OTHER INCOME OTHER INCOME OTHER INCOME INDIVIDUAL IF INDIVIDUAL EARNED BY EARNED BY EARNED BY OWNERSHIP IS A PARTNERS IF INDIVIDUAL INDIVIDUAL INDIVIDUAL PASSIVE ACTIVITY OWNERSHIP IS A PARTNERS IF PARTNERS IF MEMBERS IF PASSIVE ACTIVITY OWNERSHIP IS A OWNERSHIP IS A OWNERSHIP IS A PASSIVE PASSIVE PASSIVE ACTIVITY ACTIVITY ACTIVITY NO NO NO NO NO YES YES NO NO NO NO NO NO NO YES WITH 754 ELECTION YES WITH 754 ELECTION YES WITH 754 ELECTION YES WITH 754 ELECTION YES WITH 754 ELECTION QPSC = QUALIFIED PERSONAL SERVICE CORP. GR = GROSS RECEIPTS UNDER $10,000,000 OE = OWNER EMPLOYEE QSSS = QUALIFIED SUBCHAPTER S SUBSIDIARY 11

13 BUSINESS C CORP S CORP LIMITED PARTNERSHIP LIMITED LIABILITY YES YES YES FOR LIMITED FOR OWNERS PARTNERS LIMITED LIABILITY PARTNERSHIP DEPENDS ON STATE STATUTE. DELAWARE OFFERS FULL SHIELD. PENNSYLVANIA PARTNERS ARE NOT LIABLE FOR MISCONDUCT OF OTHER PARTNERS BUT ARE LIABLE FOR OBLIGATIONS OF THE COMPANY. GENERAL LIMITED LIABILITY BUSINESS TRUST PARTNERSHIP COMPANY NO YES YES LIMITED LIABILITY OF DIRECTORS/ MANAGERS/ OFFICERS IMPACT OF DEATH OF AN OWNER ON THE BUSINESS (PARTNERSHIP / LLC AGREEMENTS MAY PROVIDE OTHERWISE) TRANSFERABILITY OF INTERESTS IN ENTITY ARE ANNUAL ELECTIONS OF DIRECTORS, MANAGERS, AND OFFICERS REQUIRED YES YES NO, FOR GENERAL PARTNER NONE NONE STATUTORY DISSOLUTION IF GENERAL PARTNER DIES OTHERWISE, NONE YES YES, BUT RESTRICTIONS DESIRABLE YES, BUT OFTEN RESTRICTED SOME FOR GENERAL PARTNER STATUTORY DISSOLUTION IF GENERAL PARTNER DIES OTHERWISE, NONE YES, BUT OFTEN RESTRICTED NO STATUTORY DISSOLUTION YES, BUT OFTEN RESTRICTED DEPENDS ON STATUTE DEPENDS ON STATUTE, MOST ARE THE SAME AS FOR A LIMITED PARTNERSHIP YES, BUT OFTEN RESTRICTED YES YES NO NO NO NO NO DEPENDS ON STATUTE NONE YES, BUT OFTEN RESTRICTED 12

14 FEDERAL AND PENNSYLVANIA INCOME TAX CONSEQUENCES OF STATE ENTITY CONVERSIONS LP TO LLC AND LLC TO LP LP TO LLC GENERALLY A CONVERSION FROM AN LP TO AN LLC WILL NOT BE TAXABLE TO THE LIMITED PARTNERS. LIMITED PARTNERS WILL HAVE A TAX BASIS FOR THEIR MEMBERSHIP INTERESTS EQUAL TO THEIR BASIS FOR THEIR PARTNERSHIP INTERESTS, PLUS THEIR SHARE OF THE LLC S RECOURSE DEBT. THE GENERAL PARTNER S BASIS FOR ITS MEMBERSHIP INTEREST WILL DECREASE BY THE OTHER MEMBER S SHARE OF THE LLC S RECOURSE DEBT. THE GENERAL PARTNER COULD RECOGNIZE GAIN IF THERE IS A DECREASE IN ITS SHARE OF LIABILITIES AND THE DECREASE EXCEEDS THE PARTNER'S BASIS FOR ITS PARTNERSHIP INTEREST. THE LLC'S BASIS FOR ITS ASSETS WILL BE THE SAME AS THE BASIS THE LP HAD FOR THE ASSETS PLUS ANY GAIN RECOGNIZED BY THE PARTNERS. THE PENNSYLVANIA TAX CONSEQUENCES SHOULD BE THE SAME AS THE FEDERAL TAX CONSEQUENCES. LLC TO LP WILL BE VERY RARE GENERALLY CONVERSION FROM AN LLC TO AN LP WILL NOT BE TAXABLE TO THE LLC MEMBERS. THE LIMITED PARTNERS WILL HAVE A BASIS FOR THEIR LIMITED PARTNERSHIP INTERESTS EQUAL TO THEIR BASIS FOR THEIR MEMBERSHIP INTERESTS LESS THEIR SHARE OF THE LP S RECOURSE DEBT. THE GENERAL PARTNER WILL HAVE A BASIS FOR ITS GENERAL PARTNERSHIP INTEREST EQUAL TO ITS BASIS FOR ITS MEMBERSHIP INTEREST PLUS THE OTHER MEMBER S SHARE OF THE RECOURSE DEBT. THE LP'S BASIS FOR ITS ASSETS WILL BE THE SAME AS THE BASIS THE LLC HAD FOR THE ASSETS PLUS ANY GAIN RECOGNIZED BY THE MEMBERS. THE PENNSYLVANIA TAX CONSEQUENCES SHOULD BE THE SAME AS THE FEDERAL TAX CONSEQUENCES. CORPORATION TO LLC AND LLC TO CORPORATION CORPORATION TO LLC WILL BE VERY RARE THERE WILL BE DOUBLE TAX. THE CORPORATION IS TREATED AS IF IT SOLD ITS ASSETS FOR THEIR FAIR MARKET VALUE. GAIN OR LOSS IS RECOGNIZED BY THE CORPORATION IN THE AMOUNT OF THE DIFFERENCE BETWEEN THE FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS. ALSO THE SHAREHOLDERS ARE TAXED ON THE EXCESS OF THE FAIR MARKET VALUE OF THE ASSETS OVER THEIR TAX BASIS FOR THEIR SHARES. THE MEMBERS WILL HAVE A FAIR MARKET VALUE BASIS FOR THEIR MEMBERSHIP INTERESTS. THE LLC WILL HAVE A FAIR MARKET VALUE BASIS FOR ITS ASSETS. FOR S-CORPS, THE GAIN OR LOSS RECOGNIZED BY THE CORPORATION ON THE DIFFERENCE BETWEEN THE FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS WILL BE PASSED THROUGH TO THE S-CORP SHAREHOLDERS. LLC TO CORPORATION THE CONVERSION WILL BE TAX-FREE UNLESS THE LLC S ASSETS ARE ENCUMBERED BY DEBT THAT EXCEEDS THEIR BASIS. THE CORPORATION S TAX BASIS FOR THE ASSETS WILL BE THE BASIS THAT THE LLC HAD FOR THOSE ASSETS PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS BASIS FOR THEIR STOCK WILL BE THEIR BASIS FOR THEIR MEMBERSHIP INTERESTS LESS THEIR SHARE OF THE LLC S DEBT PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS WILL RECOGNIZE GAIN TO THE EXTENT THAT THEIR SHARE OF THE LLC S DEBT EXCEEDS THEIR BASIS FOR THEIR MEMBERSHIP INTEREST. 13

15 CORPORATION TO LP AND LP TO CORPORATION CORPORATION TO LP WILL BE VERY RARE THERE WILL BE DOUBLE TAX. THE CORPORATION IS TREATED AS IF IT SOLD ITS ASSETS FOR THEIR FAIR MARKET VALUE. GAIN OR LOSS IS RECOGNIZED BY THE CORPORATION IN THE AMOUNT OF THE DIFFERENCE BETWEEN FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS. ALSO THE SHAREHOLDERS ARE TAXED ON THE EXCESS OF THE FAIR MARKET VALUE OF THE ASSETS OVER THEIR TAX BASIS FOR THEIR SHARES. THE PARTNERS WILL HAVE A FAIR MARKET VALUE BASIS FOR THEIR PARTNERSHIP INTERESTS PLUS THEIR SHARE OF THE PARTNERSHIP S NON RECOURSE DEBT. THE PARTNERSHIP WILL HAVE A BASIS FOR ITS ASSETS EQUAL TO THE FAIR MARKET VALUE OF THE ASSETS FOR S-CORPS, THE GAIN OR LOSS RECOGNIZED BY THE CORPORATION ON THE DIFFERENCE BETWEEN THE FAIR MARKET VALUE OF THE ASSETS AND THEIR TAX BASIS WILL BE PASSED THROUGH TO THE S-CORP SHAREHOLDERS. LP TO CORPORATION THE CONVERSION WILL BE TAX-FREE UNLESS THE PARTNERSHIP S ASSETS ARE ENCUMBERED BY DEBT THAT EXCEEDS THEIR BASIS. THE PARTNERSHIP S TAX BASIS FOR THE ASSETS WILL BE THE BASIS THAT THE PARTNERSHIP HAD FOR THOSE ASSETS PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS BASIS FOR THEIR STOCK WILL BE THEIR BASIS FOR THEIR PARTNERSHIP INTERESTS LESS THEIR SHARE OF THE PARTNERSHIP S DEBT PLUS ANY GAIN RECOGNIZED. THE SHAREHOLDERS WILL RECOGNIZE GAIN TO THE EXTENT THAT THEIR SHARE OF THE PARTNERSHIP S DEBT EXCEEDS THEIR BASIS FOR THEIR PARTNERSHIP INTEREST. 14

16 15 Conversion of Entities under Pennsylvania Law William H. Clark, Jr. Drinker Biddle & Reath LLP One Logan Square Philadelphia, PA (215)

17 16 Since July 1, 2015, Pennsylvania has authorized the conversion of entities from one form to another. The conversion provisions are found in 15 Pa.C.S. Subch. 3E and are part of a complete set of inter-entity transaction provisions. The provisions of 15 Pa.C.S. Ch. 3 apply to transactions involving only Pennsylvania entities and also those involving an entity organized under the law of a foreign jurisdiction that permits inter-entity transactions. 16

18 17 conversion (I) (single state) L.P. A (PA) LLC A (PA)

19 18 conversion (II) (multi-state) L.P. A (DE) LLC A (PA)

20 19 The only trick to using the new provisions is learning a new vocabulary: governor interest interest holder organic law organic rules private organic rules public organic record entity v. association 19

21 20 Governor: a person by or under whose authority the powers of an association are exercised and under whose direction the activities and affairs of the association are managed pursuant to the organic law and organic rules of the association. For example: director of a business corporation manager of a manager-managed LLC member of a member-managed LLC 20

22 21 Interest: a share in a corporation for profit, a membership or share in a corporation not-for-profit, a governance interest, or a distributional interest. For example: share in a business corporation membership interest in an LLC Interest holder: a direct or record holder of an interest. For example: shareholder of a business corporation member of an LLC 21

23 22 Organic law: the law of the jurisdiction of formation of an association governing its internal affairs. For example: the Business Corporation Law of 1988 the Limited Liability Company Law of 1994 Organic rules: the public organic record and private organic rules of an association. For example: articles and bylaws of a business corporation certificate of formation and operating agreement of an LLC 22

24 Private organic rules: the rules that govern the internal affairs of an association, are binding on all its interest holders and are not part of its public organic record, if any. For example bylaws of a business corporation operating agreement of an LLC 23 Public organic record: the document the public filing of which by the department or a similar agency in another jurisdiction is required to form an association. For example: articles of a business corporation certificate of formation of an LLC 23

25 entity v. association 24 An entity is a domestic or foreign organization of a type whose organic law is found in Title 15. In contrast, association is a broader term that includes any type of private organization, whether domestic or foreign. A banking institution is an association but not an entity. association entity

26 25 The definitions just discussed are found in 15 Pa.C.S Thus, they apply to all of Title 15 and all of the Pennsylvania business entity laws. Definitions applicable just to Chapter 3 relating to fundamental transactions appear in 15 Pa.C.S These definitions are mostly unremarkable and simply facilitate the wording of Chapter 3. Three definitions are worth noting and will be discussed later: interest holder liability protected agreement protected governance agreement 25

27 26 procedures generally The statutory provisions for conversions parallel the provisions for other types of transactions under Ch. 3: authorization of the transaction preparation of a plan approval of the plan by the governors and interest holders amendment or abandonment of the plan filing and effectiveness effect of the transaction Substantive approval requirements under current law continue unchanged. These are collected in a separate Subchapter 3B and organized by type of entity. 26

28 27 Note that the general rule in Pennsylvania is that approval of a fundamental transaction requires the affirmative vote of a majority of the votes cast (which excludes abstentions) at a meeting at which a quorum is present. This is in marked contrast to Delaware where approval requires the affirmative vote of a majority of the outstanding interests. 27

29 28 dissenters rights Dissenters rights are available for shareholders on a conversion. Statutory dissenters rights are not available for interest holders in entities that are not business corporations. Contractual dissenter rights are available for interest holders in entities that are not business corporations. See 15 Pa.C.S

30 29 special treatment 15 Pa.C.S. 329 permits a plan to classify interest holders into groups on a basis other than the class or series of interest that they hold and provide mandatory treatment for members of the group. This special treatment will be respected if either: 1. the interest holders receiving special treatment have either: a class vote, or dissenters rights 2. a court of competent jurisdiction finds that the special treatment was undertaken in good faith, after reasonable deliberation and was in the best interest of the association.

31 30 protected agreements The concept of a protected agreement or protected governance agreement provides transitional protection. These concepts are defined in 15 Pa.C.S. 312 as follows: Protected agreement. Either of the following: (1) A record evidencing indebtedness and any related agreement in effect on July 1, (2) A protected governance agreement. Protected governance agreement. Either of the following: (1) The organic rules of a domestic entity or foreign association in effect on July 1, (2) An agreement that is binding on any of the governors or interest holders of a domestic entity or foreign association on July 1, 2015.

32 31 If such an agreement deals with a merger, the agreement is deemed to apply to a conversion. The notion is that, if people contracted for special rules or protections in the event of a merger at a time when conversions were not authorized, they are deemed to have wanted the same special arrangements for a conversion. Underlying the concept is a recognition that a conversion could previously have been accomplished by using a merger.

33 32 interest holder liability Interest holder liability is defined in 15 Pa.C.S. 312 and is personal liability for either: a liability of an association as a result of being an interest holder; or an obligation to contribute to the association imposed by the organic rules. A transaction must be approved by any person that will have interest holder liability following the transaction. 32

34 33 A B A B General Partnership Corporation General Partnership Corporation A B A B General Partnership Corporation 33

35 Thank you for attending Questions? ballardspahr.com drinkerbiddle.com