Legislature(1993 - 1994)
03/23/1994 01:15 PM JUD
* first hearing in first committee of referral
= bill was previously heard/scheduled
= bill was previously heard/scheduled
HB 420 - LIMITED LIABILITY COMPANIES Number 332 CHAIRMAN PORTER: "The next bill for consideration is HB 420. We are in teleconference for this bill, and we have, initially, the bill sponsor, Rep. Therriault. Welcome, Rep. Therriault. Please tell us about your bill." Number 353 REP. GENE THERRIAULT, SPONSOR OF HB 420, said, "I do have a sponsor statement that I'd like to read into the record, and then on teleconference we have a number of people that have worked extensively on drafting the language of the bill and can talk to the specific legal questions that you might have. For the record, my name is Gene Therriault, I am a State Representative to House District 33. "HB 420 proposes a new hybrid form of business structure called a limited liability company that combines the tax advantages of a partnership and the liability safeguards of a corporation. Although a combination of these two business structures is currently allowed in statute through formation of an S corporation, this structure has limitations that are avoided by LLCs. For example, S corporations do not allow ownership by certain types of shareholders. "Under current law, corporate earnings are subject to double taxation through the payment of corporate taxes and personal taxes after distribution of dividends. LLCs avoid this double taxation by allowing earnings to flow through to individual owners in the same manner partnership income is handled. Although businesses can be organized through an S corporation to avoid double taxation and encompass some of the advantages of partnerships, they do not enjoy all the advantages of partnerships when it comes to allocating income and deductions. "One of the greatest advantages is, as the name implies, the limited liability offered by the LLC structure. With LLCs, as with regular corporations, only the company's assets and not the owner's personal assets, are at risk in business- related lawsuits. In partnerships, so-called limited partners enjoy such protection, but general partners don't. And limited partners face restrictions on how active they can be in the business. LLCs are designed to protect all members while imposing no limits on their involvement in operation of the business. "Thirty-four states now permit limited liability companies, and passage in most of the remaining states is expected. Wyoming passed the first LLC act in 1977. Other states slowly followed suit until 1988, when the Internal Revenue Service issued Rev. Rul. 88-76, which classified a Wyoming LLC as a partnership for federal tax purposes, even though none of the members or managers were personally liable for any debts of the company. Following the ruling, formation of LLCs burgeoned, with two states adopting LLC acts in 1990, four in 1991, 10 in 1992 and more than 20 states introducing measures in 1993. "LLCs have tended to be family businesses, professional service firms, venture capital companies, real estate businesses and start-ups. I believe the LLC will provide these business owners with an efficient and flexible investment vehicle that allows both limited liability and federal income tax treatment as a partnership. I introduced the bill, which is based on a prototype American Bar Association draft, with the intention of generating discussion on this topic." Rep. Therriault added to this prepared statement: "Since that time, I did introduce a sponsor substitute which adopted a lot of work that was done by a subcommittee of the Alaska Bar Association. I believe some of the people that are on teleconference to be available to make comments and answer questions were involved in that re-drafting which basically took the American Bar Association draft and kind of Alaskanized it. With that, Mr. Chairman, I am available to answer any questions or we can go right to the teleconference." Number 418 REP. GAIL PHILLIPS: "Rep. Therriault, would you please tell me who was on that subcommittee? What groups were represented on the subcommittee?" REP. THERRIAULT: "I think it was a subcommittee of the Alaska Bar Association." Number 427 REP. JIM NORDLUND: "Gene, I think this is a good bill, actually. I considered introducing it myself, although--I understood--what I was looking into was limited liability partnership instead of limited liability company, and I'm just wondering - maybe you, or maybe somebody who is going to testify here could explain, if there is a difference." Number 446 REP. THERRIAULT: "I believe there is a working group in the Commerce Department, somewhere in the Administration that is working on limited liability partnerships. It's a different animal yet than this, but might be another business structure that people would have to choose from. My wife is an attorney up in Fairbanks and she has told me that she has had a number of clients come to her and have said, `We understand there is a new form of business. Is it available in the state of Alaska?' So, when people go to form businesses they have a number of options of what the business structure can be. It can be a full partnership or a sole proprietorship, limited partnership, a number of things. This would just add one more option for them to consider when forming the business structure." REP. NORDLUND: "Maybe somebody who was going to testify could explain. I just wanted to know the difference between the two." CHAIRMAN PORTER: "That was one of the questions I was going to ask, myself, so we'll hope to be edified by the testimony." REP. DAVIDSON: "Rep. Therriault, I can certainly understand the need for favorable tax treatment at the federal level. My question is, why is this limited liability company necessary? For example, would it allow for less responsible actions by companies that do not now have that option? Could you expand on why this additional option [is proposed], as far as forming a company is concerned, and how it would it affect the responsibilities or actions of such a company?" Number 453 REP. THERRIAULT: "Well, it would allow no more or no less of liability than a corporate structure does. But the corporate structure has a disadvantage in the tax consequences. So what we're doing is blending the liability advantages that you can get through a corporate structure with the tax benefit that you can get through a partnership. We're just melding those two together, basically." Number 468 REP. DAVIDSON: "And how is the public treasury impacted by this efficiency?" Number 469 REP. THERRIAULT: "I don't believe that the public treasury would be impacted at all. I think there was some concern expressed at the earlier committee that maybe we would be prompting corporations who pay a corporate tax to dissolve themselves and go into an LLC structure. If they did that, there would be some fairly serious capital gains consequences, which I think would actually preempt people from doing that. What we're really going to do, is just give those people who are thinking of forming a new company one more option. Now, they may have chosen a corporate structure, but I don't know that there's any way that you can really quantify what people may have done in the future when selecting those different business forms and what the potential impact could have been on the treasury." Number 482 REP. JAMES: "Is it possible to determine that a lot of people that may have filed corporations will now file this LLC, and so therefore we as a state might be deprived of any corporate income tax?" REP. THERRIAULT reiterated that this would be difficult to quantify. He was skeptical that corporations already in existence would be dissolving in large numbers to reform as LLCs. CHAIRMAN PORTER introduced the teleconference testimony from Anchorage. Number 501 CHARLES SCHUETZE, ATTORNEY, DAVIS & GORDON, testified via teleconference from Anchorage in support of HB 420. Mr. Schuetze was present as a member of the legislative drafting committee for the tax section of the Alaska Bar Association. MR. SCHEUTZE said, "The primary purpose of the bill is to enable these companies to reorganize to have the tax characteristics of a partnership combined with the limited liability of a corporation. In the past when business organizations have been organized they've had to make a significant compromise. If they wanted to have all the entire panoply of tax [options of] a partnership they'd choose to be general partners but then they would be unlimitedly liable. If they wanted to have most of the type of characteristics of a partnership they could organize a limited ownership, but still there would be a general partner who would be unlimitedly liable. If they wanted to have most of the type of characteristics of a partnership, they could organize a limited partnership, but still there would be a general partner who would be unlimitedly liable. With S corporations, as it's been discussed, certain restrictions are imposed, on the number, the nationality, etc., and it's not exactly treated like a partnership. C corporations of course gave unlimited liability, but the corporations could be taxed as corporations." MR. SCHUETZE went on to analyze HB 420 in detail. Testimony was often difficult to discern due to paper shuffling and other background noise. Included in his discussion was a delineation of the characteristics of an LLC as well as the advantages for estate planning for families in its use. He concluded by introducing Brian Durrell from Anchorage for continued discussion. CHAIRMAN PORTER thanked Mr. Schuetze for his testimony. Chairman Porter requested that any teleconference participants in Anchorage who had written testimony forward a copy to the committee via telefax, 465-3834. Number 577 REP. THERRIAULT acknowledged that the length of the bill might give committee members pause. He explained in detail how the bill provides default language for the formation and operation of limited liability companies. Number 600 BRIAN DURRELL, ATTORNEY, BOGLE AND GATES, AND CERTIFIED PUBLIC ACCOUNTANT, testified via teleconference from Anchorage in support of HB 420. Noting that he has served as one of the members of the working group of the joint tax and business section of the Alaska Bar Association that drafted the legislation, Mr. Durrell championed the bill as being very good for business in Alaska. He said it would help streamline and stimulate business activity in Alaska. Mr. Durrell said the LLC would not be a substitute for partnerships or corporations but rather a choice appropriate for certain circumstances. MR. DURRELL characterized the primary distinction between an LLC and a partnership as the ability of the LLC to enjoy limited liability. He acknowledged SB 348 which deals with the formation of a limited liability partnership but whose principles are different. Mr. Durrell described limited partnerships in relation to LLCs. "There are differences...primarily that a limited partnership always must have at least one general partner who would not enjoy those limitations of liability, and secondly, the management of a limited partnership would be much different because a limited partner to enjoy the benefits of the limited liability cannot be involved in the management of the limited partnership and an LLC would allow for management by the members who would also enjoy the limited liability. MR. DURRELL went on to contrast LLCs and corporations. He said, "To distinguish [LLCs] from corporations, setting aside for the moment S corporations, so we're talking about a normal corporation, C corporation subject to taxation, the primary distinction is the double taxation issue. Limited liability. Companies would not be subject to the double taxation. If they are properly formed they are going to be taxed as a partnership with flow-through taxation and avoid the double tax that is paid by corporations. And the last type of entity, the S corporation, which is for state law purposes no different than any other corporation, it's merely an election that is made under the federal tax code, to be taxed as a corporation, that has a flow-through tax structure much like a partnership. But there are limitations on who can form S corporations, the number and types of shareholders; there can not be more than 35 shareholders in an S corporation; the corporation shareholders cannot be nonresident aliens. Those types of individuals, corporations, can be members of LLC. So it has distinctions from each one of these existing business entities, and again in some instances, it may be better; in others, one of these existing entities may be a better choice. We're simply trying to provide the business community a full array of options that should be available to them in selecting the manner in which they want to structure their business." Number 678 CHAIRMAN PORTER: "Is it your understanding that the bill that we are considering is without significant difference from the bills that have been introduced in other states in the past?" Number 689 MR. DURRELL: "Well, I have not reviewed each of those 34 bills that have been passed in the other states, so I can't speak from personal knowledge. My understanding is this is very similar. I think if we looked at each one of those bills that every state made minor variations into the bill, but the general concept is the same. The concept being the limitation of liability afforded to members and the partnership tax attributes." Number 711 BOB MANLEY, ATTORNEY, HUGHES THORSNESS GANTZ POWELL & BRUNDIN, testified via teleconference from Anchorage in support of HB 420. "Thank you for letting us testify, and I mean that seriously, because after running through tort reform, I imagine you guys are just sick and tired of lawyers. I'd like to say that we're different. We're CPAs, tax and estate planning and business lawyers that are interested in the development of the law. We want to make more and better options available to our clients. "Last week I went to a legal seminar outside, and the speaker was discussing various business entities that you could offer to your client. He indicated that the count was now with 37 states with limited liability company statutes, and he boldly predicted that by 1995 we'd have all 50 states with LLC legislation. The California senate just passed an LLC bill expected to be on the governor's desk very shortly." Mr. Manley went on to express concern that Alaskans would lose business to other states from individuals desiring the formation of LLCs. "Our drafting committee worked from the ABA prototype act. That was put together by a national panel with the American Bar Association business law section, and basically, all the LLC acts throughout the country are substantially similar. And I think the ABA prototype distills the best of all of these various bills. We've got a fair amount of experience with LLC. The first was Wyoming in 1977, then Florida in 1982, so we've got a certain amount of history even though this is happening relatively rapidly. "To explain: An LLC has a blend of corporate and partnership characteristics with a flexible operating system. It meets the needs of Alaska business and provides a federal tax advantage. And, as Mr. Durrell pointed out, it facilitates foreign investment because foreign investors, nonresident aliens, cannot be in an S corporation. So accordingly, they are either subject to general partnership rules regarding liability or, in the alternative, subject to corporate double tax." MR. MANLEY posited a hypothetical Japanese consortium seeking a location to set up a timber mill in either Alaska, Washington or Oregon. He described the negative response of consortium accountants to Alaska upon learning that only Oregon and Washington offered the option of an LLC, with "pure individual one-bite taxation, and limited liability." He concluded that LLC legislation was necessary from an international point of view in order to keep up with developments in the law. Turning to the subject of revenue, Mr. Manley said he did not believe LLC legislation would have "any impact on Alaska state corporate income tax, because existing C corporations are not going to dissolve because of the tax and transfer costs. And, really, this is primarily going to replace, for the appropriate people, partnerships and S corporations that don't pay tax right now." [Concurrent conversation in hearing room reduces testimony sound quality.]. Mr. Manley finished his testimony by opining it would be a rare situation in which someone forming a corporation who had been seriously considering a C corporation, which pays corporate income tax, would elect a limited liability company. Number 780 CRAIG INGHAM, ALASKA BANKERS ASSOCIATION, testified via teleconference from Fairbanks in opposition to HB 420. "I represent the Alaska Bankers Association. I am not an attorney. I am a business person and the Alaska Bankers Association opposes this bill. We oppose it for some very fundamental reasons and some technical reasons as well." MR. INGHAM discussed the very broad spectrum of entities to be affected by the legislation, including sole proprietorships, where the risk factors in start-up are enormous. He addressed the situation of third party vendors who must sustain considerable losses in the failure of new, and especially small and sole-proprietor, businesses; the vulnerability of these vendors provided reason, he said, for sole proprietorships and partnerships to be liable personally for the debts of their business. MR. INGHAM went on to discuss management aspects of the bill. He explained that "...in a corporation, the shareholders or owners of a corporation are prohibited, are not allowed to manage the affairs of a corporation. They in turn have to elect directors who manage the affairs. And the directors manage those affairs by appointing officers of the corporation to act as agent. And they're given specific authority to corporate resolutions and so forth that carry on the business at hand for the corporation. In a partnership or a sole proprietorship, the owner is the manager." MR. INGHAM said, "Now, when you mix the two worlds together, you give the owner limited liability and not unlimited liability, you are allowing for the manager, basically to provide, from a management standpoint, the duties and responsibilities of carrying out the business of the entity without having to worry about any personal liability. That could be very confusing. Especially to other businesses that are trying to do business with this new entity. If you look at this, just look at the first paragraph under management, Section 10.51.10 on page seven, it says, `Except as otherwise provided by this chapter, the members of a limited liability company manage the affairs and make the decisions of the company unless an operating agreement of the company names a manager for the company. Management by members is subject to a provision in an operating agreement or this chapter limiting or increasing the management rights and duties of the members, including limits or increases placed on a class of members or individual members.' "So now we have this operating agreement saying who can manage the affairs of the company and what they can and cannot do. And this is for small business, that we're talking about here, as well as big business. If you go further through the section as it deals with management and you go over to page nine, at the top of the page, line three, under subsection (b), it says, unless otherwise provided in that operating agreement of the company, or by this chapter, if an operating agreement of a company means more than one manager for the company -- in other words, now we can have the operating agreement saying, well, instead of just one person appointed by the members, we can now have, you know, five or ten managers; the consent of more than one half of the number of managers of a limited liability company is required to decide the affairs of the company. Does that mean if I do business with one of these entities I better make sure that the manager has gone out there and gotten a majority rule on doing business with him? "So if we move on, here, to the section that I think is most important of all, article seven, `Relationship to Third Parties,' that's who these people will be doing business with. Their customers and other businesses. At the top of page 14: `Agency Power of Members and Managers.' It goes on to say, `Except as provided in (b) and (c) of this section, a member of a limited liability company is an agent of the company for the purpose of conducting the company's affairs. A member that, including the execution of an instrument in the name of the company, that appears to be performed in the usual way of conducting the affairs of the company, binds the company.' Well, does that mean now I need to know what is usual and customary as far as the affairs of the company? I guess I'm running out of time here. "But the big issue here is, there are a lot of big questions that have not been asked by the business community, and the people that are going to have to do business with this new entity as to how it's going to work when it comes down to relating to third party interests. And let's not think that we're treading over something brand new here. This was tried one hundred years ago, in what was called the Business Trust. And the Business Trust was originated to obtain certain advantages of corporate status, such as limited liability. It was very popular in the few years it was in existence in the 1900s. However, a number of states ruled that the partners should be held personally liable. The state legislature enacted laws requiring that. I wonder why they would do that?" [Tape ends abruptly.] TAPE 94-49, SIDE B Number 000 REP. DAVIDSON asked Mr. Ingham if he had any other points. Number 007 MR. INGHAM: "I do have other points, and I would like to have a few more minutes of time if I may." Chairman Porter invited him to continue. "I talked about the management problems here, how that could be confusing to deal with other business entities out there as far as this new business entity. Well, let's talk about the access of a particular company, or, you know the property that company owns. If you go now to ownership and transfer of property, which is Article 10, it basically says that the limited liability company can hold property in either the name of the company or the name of the individual member or manager. That could be extremely dangerous, for the simple reason that it enables someone to move assets around fairly easily. There certainly should be language prohibiting property being held in any other manner but the company's name. That's pretty clear. If you have a corporate structure and you go out there and you have vehicles or real estate, it's in the name of the corporation. It can't be in the name of the officers of the corporation or the managers. In a partnership, sure, the assets of a partnership can be flexible, but that's because those partners are personally liable for their business actions and their business dealings. That's a very important issue. And when you really sit down and look at this bill, from a business standpoint, I am sure it has all the tax benefits that they say it does have. "But if you're looking to come up with a new kind of business structure, I think it's very, very critical that not only the legal profession should be brought into this equation, but the business profession be brought in as well, and that a good amount of time is spent going through these issues and coming up with some of the fire walls that you have in a corporate structure to make sure that assets can't be moved around and the lines of management are clear and concise, people doing business with this entity can feel comfortable doing business with it. And I know we may not be the first state to adopt this sort of legislation, but I'd rather be the last state than the first state to adopt something that changes the way we've done business for the last three or four hundred years. And I'll just leave it on that note." Number 107 WILLIS KIRKPATRICK, DIRECTOR, DIVISION OF BANKING, SECURITIES AND CORPORATIONS, DEPARTMENT OF COMMERCE AND ECONOMIC DEVELOPMENT, testified in support of HB 420. "I would encourage the committee to consider HB 420 and pass it out." Describing his division, Mr. Kirkpatrick observed, "...we look at and view it as one of our goals to make Alaska one of the most easiest places in which to do business. We feel that is a paramount responsibility of the Department of Commerce and Economic Development." MR. KIRKPATRICK noted that the Department of Commerce "...is a member of what we call the International Association of Corporation Commissioners. That includes other countries besides the United States, but it primarily has to do with the old British Crown corporation type of formation. And we became aware of limited liability companies and the Wyoming experience. And so we had been looking at it and how it might be beneficial to the state of Alaska, especially with some of the activity that we've been trying to do in the Far East and eastern Russia." MR. KIRKPATRICK continued, "In early 1992 we were approached by members of the Alaska Association of Certified Public Accountants to encourage us to consider drafting a limited liability company law. We got a hold of those states that did have those provisions and tried to seek out what problems they had. There was a little bit of confusion because of the IRS ruling as to what is a corporation type of organization or a partnership type of an organization. We then took a look at the state of Wyoming, which is what is called a bullet-proof state, because they were the only state at that time that had an IRS ruling, so most of the states early on then following Wyoming's law which meant that if you had the characteristics of the Wyoming law, then you were assured a proper ruling from the IRS, relying upon Wyoming's ruling. "We then were approached by members of the Alaska Bar Association and we told them of our efforts and they indicated that they were interested in working on such legislation, so we sent them our draft. What has resulted from their effort is a little different from our draft - not substantially - but they included in their draft language of our draft that had to do with the administration of the Act. So, what has been, as a Sponsor Substitute, includes those items of administration ability that we had in exercising this type of law." Noting that he himself was not a lawyer, Mr. Kirkpatrick went on to describe the extensive history of the origins of the legislation at hand. Mr. Kirkpatrick discussed the origins of the Alaska Corporation Code and the evolution of corporation law in Alaska and acknowledge a need to recognize the risks of doing business. Number 249 REP. DAVIDSON: "Mr. Kirkpatrick, you heard Mr. Ingham's comments and concerns. Could you take say one or two or three of those concerns and give us your perspective as far as - you seem to be very much for the bill and don't see any downsides. Mr. Ingham, of course, who is a banker, saw considerable downsides. I was wondering if you could give us return fire." Number 266 MR. KIRKPATRICK responded, "I think Mr. Ingham has some very good points." He compared the process of drafting the legislation at hand with protracted formulation of the controversial Alaska Corporation Code and noted there would always be room for debate in determining the nature of proposed business structures. "Maybe," Mr. Kirkpatrick suggested, "there should be somebody else taking those points [to] debate them on the other side.... I don't have any problem at all with some of the suggestions that he makes in tightening up property ownership...." MR. KIRKPATRICK recommended that some issues raised in HB 420 requiring further discussion be considered at a later date in amendments. He stated that he did not feel that in a business organization law the law could be structured to protect creditors and went on to describe the criteria courts could use in evaluating the responsibilities of debtors. Mr. Kirkpatrick concluded by reiterating that he did not see how one could structure a corporate organization that would protect creditors from risk, but that he did understand and appreciate Mr. Ingham's concerns. Number 350 REP. THERRIAULT: "I am certainly willing to consider any proposed changes to the bill. I know there have been negotiations and discussions going on between the regulator, the regulatees, the people that want to be involved in forming these new business ventures. I think one thing that's important to point out, the previous speaker just brought up, that creditors can require personal assurances, just like they can with corporations. I was involved in a business. We wanted to get a bank loan, and they required personal guarantees. They can do that, they do that right now with corporations because of the limited liability, and some concern, and being risk adverse. They can do that same thing with limited liability. So we're not forming a new structure that has any more of an ability to leave creditors hanging out there than existing business structures. I understand that Mr. Ingham represents a trade group that is severely risk averse. I think they have means at their disposal to protect themselves." MR. INGHAM asked if he might respond to that; Chairman Porter first recognized Rep. Davidson's question. Number 378 REP. DAVIDSON posed a question concerning the possibility of providing some protections under law for smaller business entities to mitigate the risk of new business organizations. Number 395 CHAIRMAN PORTER, acknowledging the extensive information and analysis yet to be prepared before the bill could be properly evaluated, referred HB 420 to a subcommittee to be chaired by Rep. James and to include Representatives Kott and Davidson. He noted, moreover, that while in general he was supportive of the legislation, he wished to know the effects of removing extant limitations of businesses - limitations for which reasons existed-before seeing them eliminated. Number 425 REP. DAVIDSON: "Mr. Chairman, thank you. In view of what you've just said, it seems to me that we are a different kind of state. We are a resource rich state. And one of the problems we see, and it's not always a problem, but we have a tremendous amount of foreign investor ownership in our state, already. For comparative purposes, it seems we're more like a third world country in terms of business practices, than part of more up to date modern societies or states, but that is a concern that I have. And I was wondering, you know, if in fact a bill like this is going to encourage additional foreign ownership of our resources. Where does that leave us protection to ensure that our children and their grandchildren are going to be in a position to control the picture up here? And that's one of my main concerns." CHAIRMAN PORTER responded that he would refer this inquiry to the subcommittee and suggest to them that they consult with Mr. Ingham and Mr. Manley on this and other aspects of HB 420. This was acceptable to the committee.