Legislature(1997 - 1998)

04/30/1997 04:53 PM L&C

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
 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 repealed those regulations.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                     
 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                      
 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                   
 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              
 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             
 CHAIRMAN ROKEBERG said he has several other questions regarding the           
 bill and would contact him directly.                                          
 CHAIRMAN ROKEBERG adjourned the House Labor and Commerce work                 
 session on HB 266 at 5:40 p.m.                                                

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