Legislature(1997 - 1998)
04/30/1997 04:53 PM House L&C
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HOUSE LABOR AND COMMERCE STANDING COMMITTEE
WORK SESSION ON HB 266
April 30, 1997
4:53 p.m.
MEMBERS PRESENT
Representative Norman Rokeberg, Chairman
Representative John Cowdery
Representative Joe Ryan
MEMBERS ABSENT
Representative Bill Hudson
Representative Jerry Sanders
Representative Tom Brice
Representative Gene Kubina
COMMITTEE CALENDAR
HOUSE BILL NO. 266
"An Act relating to limited liability companies and limited
partnerships; and providing for an effective date."
- HEARD AND HELD
(* First public hearing)
PREVIOUS ACTION
BILL: HB 266
SHORT TITLE: LIMITED LIABILITY COMPANIES
SPONSOR(S): REPRESENTATIVE(S) RYAN, Therriault
JRN-DATE JRN-PG ACTION
04/30/97 1408 (H) READ THE FIRST TIME - REFERRAL(S)
04/30/97 1408 (H) LABOR & COMMERCE
04/30/97 (H) L&C AT 3:30 PM CAPITOL 17
WITNESS REGISTER
JERRY WEAVER
Alaska Bankers Association
301 West Northern Lights Boulevard
Anchorage, Alaska 99503
Telephone: (907) 265-2920
POSITION STATEMENT: Testified the Alaska Bankers Association
didn't currently have an opinion on HB 266.
MIKE STONE, Certified Public Accountant
601 West Fifth Avenue, Suite 700
Anchorage, Alaska 99501
Telephone: (907) 265-1211
POSITION STATEMENT: Testified on HB 266.
RICH HOMPESCH, Attorney
119 North Cushman
Fairbanks, Alaska 99701
Telephone: (907) 452-1700
POSITION STATEMENT: Testified on HB 266.
DICK THWAITES
500 "L" Street, Suite 301
Anchorage, Alaska 99501
Telephone: (907) 277-7595
POSITION STATEMENT: Testified on HB 266.
ACTION NARRATIVE
TAPE 97-54, SIDE A
Number 001
CHAIRMAN NORMAN ROKEBERG called the House Labor and Commerce work
session on HB 266 to order at 4:53 p.m. Members present were
Representatives Rokeberg, Cowdery and Ryan.
HB 266 - LIMITED LIABILITY COMPANIES
Number 040
CHAIRMAN ROKEBERG asked Representative Ryan, sponsor of HB 266, "An
Act relating to limited liability companies (LLC) and limited
partnerships; and providing for an effective date," to present his
sponsor statement.
REPRESENTATIVE JOE RYAN said, "House Bill 266 hopes to take care of
an opportunity that was offered the first of this year. The IRS
(Internal Revenue Service), unlimited liability companies and
limited partnerships had a rather long complicated set of
regulations to try to make sure these people were not using them to
escape corporation taxes. And they had a number of tests. If you
hit any two of the tests, you're considered, for practical
purposes, tax (indisc.) a corporation. And this got very difficult
to administer and there were a few of attorneys who could
understand it, and so a model law was written as -- well uniform
law and this is what's been used. It's been very cumbersome and
expensive. And I think two years ago we introduced this limited
liability company into Alaska. Well the first of this year the IRS
repealed those regulations. Now all you have to do is to make
application to check the box as an entry classification and you are
-- have done. And we feel that, myself sponsoring this
legislation, I feel that we are in an opportunity to remain at the
cutting edge of businesses to attract limited liability companies
and limited partnerships could be formed in Alaska. With the
Internet, today, it makes things a lot easier. And we're cleaning
up the statutes and making them easier and more simple -- will
allow people to use this vehicle in Alaska in which will eventually
bring more business to Alaska."
REPRESENTATIVE RYAN said he feels that by passing the bill, we have
an opportunity to remain at the cutting edge of businesses to
attract limited liability companies and limited partnerships to be
formed in Alaska. He said this would clean up statutes and make
them more simple. It will allow people to use this vehicle in
Alaska which will eventually bring more business to Alaska. He
noted there are some witnesses on-line who are much more aware of
the technical aspects then he is.
Number 209
JERRY WEAVER, Alaska Bankers Association, was on-line in Anchorage.
He said because the committee isn't going to vote on the bill, he
has no comments at this time.
CHAIRMAN ROKEBERG asked Mr. Weaver if the Alaska Bankers
Association has an opinion on the bill.
MR. WEAVER indicated they didn't at this time. He noted they have
only had about an hour to review the bill.
CHAIRMAN ROKEBERG said he would try to get an expedited hearing for
the bill. He said it would be brought up again on Friday or at the
call of the chair.
Number 278
MIKE STONE, Certified Public Accountant, testified via
teleconference from Anchorage. He noted he is representing
himself. Mr. Stone said he will speak to the benefits of passing
legislation that would simplify state law given the fact that the
IRS did greatly simplify their approach on classification of
entities. As Representative Ryan has said many of the tests that
were required to be in state law so that we could be assured that
these entities would be treated as partnerships for income tax
purposes only really are no longer needed because of the IRS'
change in position. It literally is a situation where you can
check the box and determine whether you want to be active in
partnerships or corporations. He said any simplification of the
law that would make it easier to work with and fall in line with
the "check the box" regulation issued by the IRS would be
beneficial.
CHAIRMAN ROKEBERG said he remembers what is called a "safe harbor
rule." He asked Mr. Stone if that is germane to HB 266.
MR. STONE said, "There really were not a safe harbor per se. It
was more that we had to be sure that we didn't have continuity of
life or we didn't have -- to tell you the truth I can't remember
what the four items are off the top of my head, but it was a matter
of having to draft, very carefully (indisc.) that you would fail at
least two of these tests so you wouldn't be thrown in to be taxed
like a corporation even though you are actually organized as a
partnership entity. So it was a matter of careful drafting to
avoid the tax treatment of being taxed by the corporations."
MR. STONE explained there were some rulings that were put out by
the IRS that kind of (indisc.) safe harbors saying that, "Well
look, if you're gonna have a limited partnership and the general
partner is a corporation, then we will respect that corporation as
the general partner so long as it has X dollars of equity." Mr.
Stone said they were very concerned that a limited partnership
would be set up where nobody had liability because the corporation
was judgement proof because it had no assets. He said with the IRS
backing off from this whole area, those types of concerns really
aren't present anymore.
Number 585
CHAIRMAN ROKEBERG said he isn't sure why some of the changes are
being made in existing statutes when we are trying to speak to IRS
regulations. He said one that troubles him is that both in the LLC
portion and the limited partnership portion of the bill it requires
a unanimous or 100 percent vote of the members to amend or change
their operating agreements unless there is another method
stipulated in their operating agreement. For example, the LLCs
went from two-thirds to all members. He questioned how that would
affect the tax situation.
MR. STONE said if you have a one member LLC, you could no longer
have a two-thirds vote. He noted that particular provision is a
default provision, but an operating agreement can state something
other than "all" and that will be respected as the law indicates.
CHAIRMAN ROKEBERG said it seems to him that there is a prohibition
on withdraws and there could be some difficulties that may come
about. He said, "For example, if you had a limited partnership
which, because of the nature of its asset base, was accruing
continual losses and also at the same time with an (indisc.)
depreciation schedule, the capital account was going further in the
negative and the prospects for a turnaround of that particular
partnership were -- if there is an ability to elect to withdraw by
a limited partner - at a point in time it may be prudent for the
limited partner to be able to withdraw unilaterally and cut his
further losses if he made a judgement. And then I'm concerned
where in this bill that there is restrictions on the ability to
withdraw under this. I mean is there -- are we gonna to be doing
something here that would effect that or would in fact that be a
circumstance sometimes the fact pattern that I described
hypothetically."
MR. STONE referred to the situation Representative Rokeberg
described and said he has seen that happen in the past. The income
tax law has changed somewhat in terms of looking at the at-risk
provisions for real estate that kind of lends itself to where you
would no longer get to take those losses. He said many limited
partners wanted the ability to be rid of these limited
partnerships. He said he could not speak to how the provisions in
the bill would affect that. He said Chairman Rokeberg's
hypothetical example certainly has occurred.
Number 897
CHAIRMAN ROKEBERG said, "Right, okay, because it is on page 10 in
Section 17, specifically on that point and I brought it up to you
because it would be typically some advise a CPA may give to a
client if he did an analysis of the investment situation and may
have recommended to a client that that would be a prudent course of
action. Have you ever been in that situation where you've
recommended that?"
MR. STONE said it's been more of a situation where he has run the
numbers for his client which indicated that if they were tired of
dealing with it, the pain would not be too great to get out of it.
Number 937
CHAIRMAN ROKEBERG said, "And they usually then -- would their basis
be at the time they withdrew and that would be provided for either
under the state statutes that applied to that particular - that
organization and/or the written agreement?"
MR. STONE said, "I'm sorry, I didn't understand your question."
CHAIRMAN ROKEBERG responded, "I'm not sure I did either. Let me
restate it. So at the point of withdraw be -- depend on the laws
of the state of the limited partnership at the time, where that was
a domicile say it was a delawarn (ph.) under the partnership or it
could be stipulated in the written agreement I take."
MR. STONE said what he did was his client, the limited partner,
requested of the general partner that he basically relinquish his
limited partnership interest. The general partner acknowledged and
agreed to that. So that is what happened. Mr. Stone said this
would contemplate that the partnership agreement would more than
likely allow for the same type of process.
Number 1041
RICH HOMPESCH, Attorney, was next to testify via teleconference
from Fairbanks. He said he would address Section 3 and Section 17
of the bill. The first thing he would like to bring up is the
applicability provision in Section 24. He said these changes in
the law wouldn't apply to any existing partnership or LLC unless
the entity filed an amendment with the Department of Commerce and
Economic Development stating that this law will apply. He said if
Chairman Rokeberg is asking about any existing partnerships or LLC,
then the answer is that nothing has changed. Those laws would
still apply to those existing entities.
MR. HOMPESCH referred to page 2, Section 3, and said it states that
unless another level of consent is required in the operating
agreement of the company, then the written consent of all members
is required. He said HB 266 does not prohibit members of a LLC
from deciding that 51 percent, two-thirds or any other number of
members are required to amend the articles of organization, for
example. The bill provides that unless the operating agreement
otherwise provides, everyone must agree. He said if you have a 10
percent interest in an entity, it is only fair that terms of your
agreement do not vary just because two-thirds of the members are
voting in favor of it.
Number 1183
CHAIRMAN ROKEBERG asked if that is a policy judgement or does that
reflect the new IRS code.
MR. HOMPESCH said it does have a very significant impact in the IRS
code. He said the question under Chapter 14 of the IRS code is,
"What is the value of an interest in a limited liability company or
a limited partnership?" What the IRS has done is said for the
purposes evaluation, we're going to disregard the terms of the
agreement and we're going to look at their state law. Mr. Hompesch
said if their state law says that upon two-thirds of a vote of the
members, you can change anything in your agreement, then what
happens is, for instance on liquidation, the IRS would say if the
decedent who owned 80 percent interest in the entity, the IRS would
say that decedent could then completely liquidate the company and
get the money for the estate. If an estate can be paying 100
percent for its interest in a LLC when a person dies, that person's
interest in the LLC will be worth far more than if that entity
continued and perhaps (indisc.) liquidated in 20 years.
Number 1299
CHAIRMAN ROKEBERG asked Mr. Hompesch to explain the distinctions
between what an LLC is and a limited partnership.
MR. HOMPESCH said they are very similar. The big difference is in
a LLC, although the company is taxed in most instances like a
partnership, all of the members have limited liability. He said,
"By contrast a limited partnership, though again in most instances
is taxed as a partnership, at least one member had unlimited and
that member is the general partner."
Number 1365
CHAIRMAN ROKEBERG said in a limited partnership you have to have
more than one member, but according to the bill before the
committee a LLC could be established with one member.
MR. HOMPESCH said, "Regulation section 301.77013(A) changed the
rules and provides that a sole proprietor could become a limited
liability company and still be taxed as the sole proprietor. So
that was a direct result of a change in the internal revenue code
or the IRS' position."
CHAIRMAN ROKEBERG questioned when that happened.
MR. HOMPESCH said he believes it part of the "check the box"
regulations. He indicated he believes it is a new change. It has
a significant impact on Alaskan businesses for this reason. Under
existing law, if a person comes to him and says he/she would like
to incorporate and have limited liability, but they would be sole
shareholder of the entity....
CHAIRMAN ROKEBERG interrupted and said normally he would recommend
a "Sub S" if that was appropriate, historically.
MR. HOMPESCH said the disadvantage with a Sub S corporation is that
if a Sub S corporation distributes assets that have appreciated in
value, upon the distribution there is a taxable event. The sole
shareholder would have to pay a capital gains tax on any
appreciation of the assets. However, if we allow a one member LLC
in Alaska, the LLC would taxed as sole proprietorship and most of
the time the distribution of an asset from a one member LLC would
not be a taxable event.
Number 1597
CHAIRMAN ROKEBERG indicated he is very excited as he is a sole
proprietor of a business. He asked Mr. Hompesch if he is
suggesting that with the passage of HB 266, a sole proprietorship
could be turned into an LLC and gain the benefits in terms of
liability. He asked, "Under a LLC, is the corporate vale that you
get in a "C" type corp., in terms of the case law and what's been
built up, how does that compare LLC to a "C" corp. for example?"
MR. HOMPESCH explained there are few cases involving LLCs. He said
he believes most attorneys would agree that the case law involving
corporations is a analogous to limited liability companies so
probably the courts would adopt that case law when dealing with the
same issuance in a LLC. At this point, he believes it is still an
open question.
Number 1643
CHAIRMAN ROKEBERG said, "But the primary benefit though is, for
example, you go to a lender and arrange for financing and under an
LLC, if in fact the lender is willing to grant you that, that they
would have only a recourse to the asset rather to an individual
unless there was a requirement by a lender of a personal guarantee.
Is that correct?"
MR. HOMPESCH said that is correct. He noted in his experience, the
lender always asks for a personal guarantee.
Number 1683
CHAIRMAN ROKEBERG asked what other benefits would accrue under a
LLC to a sole proprietor besides the debt and the protection of
their own personal portfolio.
MR. HOMPESCH said that is all the benefits he can think of.
CHAIRMAN ROKEBERG said, "But then if there was a third party cause
of action like there is an action in tort, those are the types of
things that would protect the assets of the - say it was called a
single LLC."
MR. HOMPESCH said not necessarily. If the sole member of the LLC
was negligent, that person is always going to be liable for their
own negligence. This bill does not change that. However, if an
employee of the LLC was negligent, but the member was not then the
member's personal assets, outside of the LLC, would not be at risk.
Number 1751
CHAIRMAN ROKEBERG said, "Mr. Stone, did you cover the two-thirds
and the unanimous there sufficiently for the folks here in
committee? Because I notice in Section 21 also, you're adding a
whole new provision. What's the current law in terms of a change
of the partnership agreement for a limited partnership because
you've added a new section here that it has to be by unanimous
consent on page 12, Section 21?"
MR. HOMPESCH responded, "I believe this is the law, but the IRS
apparently at times, has argued otherwise. So this will clarify
what we think the law is which is all members of partnership
agreements have to agree if the agreement is changed."
Number 1831
CHAIRMAN ROKEBERG referred to page 3, Section 6 and said a foreign
limited company has been added. He asked if that is defined
anywhere else in existing statute.
MR. HOMPESCH said it is in the definition section of law. This
change was suggested by Bob Manley who worked on the original
Limited Liability Act and he mentioned that some of the attorneys
felt that this should have been clarified in the original act
because the definition of a limited liability company does not
include a foreign limited liability company. It was understood
that this provision was to apply to both. He said Section 6 is not
a change that has come about because of a change in the IRS
regulations.
Number 1900
REPRESENTATIVE RYAN said that we are still talking about using the
term "foreign" as a foreign country and/or foreign state.
MR. HOMPESCH said that is correct. He noted the reference that Mr.
Manley mentioned is in the definition section of 10.50.990. He
said, "Sub 9 in existing law says a limited liability company or
domestic limited liability company means an organization organized
under this chapter that is...."
TAPE 97-54, SIDE B
Number 001
MR. HOMPESCH continued, "I think it was intended that, as to
foreign limited liability companies, there would also be limited
liability to third parties. So this is a change that just
clarifies that."
CHAIRMAN ROKEBERG referred to page 3, Section 7, and asked why
language was removed starting on line 23 through 29. He said he
isn't sure he fully understands the intention.
MR. HOMPESCH explained it is his understanding that when the
limited liability company was adopted, there was included a special
election under AS 10.15.085(A). He said as he understands, the
purpose of this election was to make sure that an Alaska limited
liability company would not have one of the four corporate
characteristics which is continuity of life. Now that corporate
characteristic is really irrelevant, so it was deleted. He said it
has been suggested to him by an attorney, David Shaftel, who was
involved with the original act, that it would be appropriate to
make this deletion. He noted every reference to the old election
has been deleted and this is one of them.
Number 101
REPRESENTATIVE RYAN explained under the old continuity of the life,
people had artificially set up a corporation that somehow would
terminate so that there couldn't be continuity of the life and they
would quality as a double taxation basis. Now since we no longer
need to meet that requirement, this is just striping that excess
verbiage out of the document so people don't have to go through
these artificial barriers to meet a tax requirement.
CHAIRMAN ROKEBERG asked what would occur if there was a failure of
the partners within a limited liability company and they wanted to
dissolve it and reorganize it.
Number 130
MR. HOMPESCH said as long all have agreed to dissolve then it would
be dissolved or the court could order it.
CHAIRMAN ROKEBERG said what if one person wants to get out.
MR. HOMPESCH explained, "If your agreement said that if one member
wanted to get out, that that one member could get out, then what
you see in Section 7 wouldn't be a problem because Section 7, under
10.50.400 (1) says that you could have a dissolution at any time
(indisc.) specified in the operating agreement. So if the
operating agreement said if one person wants to dissolve the
entity, then the entity dissolves and that's what would happen.
Elsewhere, we talk about with withdraw. If the agreement provides
that one member may withdraw at any time then of course that
provision in the agreement controls over the statute."
Number 187
CHAIRMAN ROKEBERG said as a matter of customary practice, would an
interest in a LLC be marketable similar to a limited partnership
interest.
REPRESENTATIVE RYAN said he would imagine it would depend on how
they do it.
DICK THWAITES, testifying via teleconference from Anchorage, said
he believes there might be some securities difference because the
limited partnership would have some additional requirements there
because you're relying on the general partner and other management.
In the LLC, you have more universal management like a partnership
and you aren't subject to the same strict rules.
CHAIRMAN ROKEBERG asked how long LLCs have been available in
American law.
MR. THWAITES responded since 1976, and in Alaska since 1995. He
said Alaska was actually approached first in 1974, but chose not to
adopt it. Wyoming adopted it in 1976, and was the first state.
Number 280
CHAIRMAN ROKEBERG said, "Let's move on to Section 8 where the
standard for dissolution by court is not reasonably practical to
continue operation has been changed to impossible. It seems like
we're raising to about the highest standards you can get here. I'm
not sure I understand why that was done."
MR. HOMPESCH said he isn't sure which states have this language,
but the issue is one of valuation by the IRS. If a court can
liquidate an (indisc.) LLC and an estate can be paid in cash for
its interest, then the more easily the court can do this, the
higher the value of the interest in the LLC, and more estate taxes
would have to be paid. The members of an LLC in an operating
agreement can agree that they will allow the court to dissolve them
whenever the court wants to. That would certainly would be
enforceable. However, if the members of a LLC do not want the
court to dissolve it very easily, in order for that provision to be
enforceable, it has to appear in state law.
CHAIRMAN ROKEBERG said this would make it more difficult for a
dissolution to take effect by court order.
MR. HOMPESCH said that is correct. For state tax purposes, it
would cause interest in the LLC to be worth less than federal/state
tax purposes.
CHAIRMAN ROKEBERG asked if that is because the asset base isn't
being broken up.
MR. HOMPESCH indicated that is correct. It is harder to break it
up.
CHAIRMAN ROKEBERG said he has several other questions regarding the
bill and would contact him directly.
ADJOURNMENT
CHAIRMAN ROKEBERG adjourned the House Labor and Commerce work
session on HB 266 at 5:40 p.m.
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