In almost all states, the limited liability company in recent years has become the business organization form of choice for closely held entities. By far the most popular LLC Act for use in forming sophisticated LLCs is the Delaware Act. There are presently something like 7 million U.S. LLCs of which approximately 600,000 are Delaware LLCs.
As a New York practitioner who handles all types of messy disputes between business co-owners, I know first hand the outsized claim of Delaware law on jurisdictional choice of entity as well as the powerful influence of Delaware decisional law even in disputes involving non-Delaware entities. I also know — because it’s written right into the Delaware LLC Act — that freedom of contract is the cornerstone of Delaware LLC jurisprudence, and therefore nothing contributes more to the long-term health and welfare of a Delaware LLC — or any LLC, for that matter — than having a carefully planned, comprehensive, forward-looking, well-drafted operating agreement.
In 2009, Wolters Kluwer Law & Business published what quickly has become the preeminent formbook and practice manual on forming Delaware LLCs entitled Drafting Delaware LLC Agreements. The co-authors are John M. Cunningham and Vernon R. Proctor. I am very pleased to present this first of a two-part interview of the authors of this extremely well-written and user-friendly manual, which also includes a CD containing over two dozen sample Delaware operating agreements.
In this first part of the interview I talk with John Cunningham (pictured left), a member of the New Hampshire and Massachusetts bars whose practice focuses on forming LLCs for business start-ups and on restructuring existing businesses. Among his many achievements John was a principal drafter of the New Hampshire LLC Act. He is not only the co-author of Drafting Delaware LLC Agreements but also is the sole author of Drafting Limited Liability Company Operating Agreements, the leading U.S. general (i.e., non-state specific) LLC formbook and practice manual. I hope you find the interview, which begins after the jump, as interesting and useful as I did.
Mahler: John, who are the principal readers for whom you and Vern wrote your book and what is the book’s main purpose?
Cunningham: We wrote the book for Delaware and non-Delaware lawyers who represent clients in Delaware LLC formations. The book’s purpose is to provide these lawyers with all of the basic knowledge and practice tools—including, above all, model LLC agreements—they will need in order to handle these formations at a high level of competence and efficiency.
Mahler: How have you and Vern allocated the work of writing and updating your book?
Cunningham: I’m the principal idea man and the scrivener. Vern is the guy who makes sure that the book’s analysis of Delaware law is correct. Vern has an amazing knowledge of Delaware statutory and common law.
Mahler: Pardon my nosiness, but do you and Vern ever disagree about significant issues in the book?
Cunningham: Frequently; and sometimes on very basic issues. For example, I think that under the first sentence of DLLC Act § 18-402, it’s clear that the members of Delaware LLCs have broad voting powers on LLC fiduciary matters such as indemnifications. Vern disagrees. But since other leading Delaware lawyers support Vern’s view, I’ve yielded on this issue. But the key point here for lawyers handling Delaware formations is this: When in doubt, resolve arguable ambiguities in the DLLC Act by careful drafting in your LLC agreement. Under the freedom-of-contract provision of DLLC Act § 18-1101(b), you can be very confident that your drafting will be legally valid. That’s the approach Vern and I take in our book when we disagree on key issues of Delaware statutory or common law.
Mahler: In your view, what constitutes a good Delaware LLC form?
Cunningham: First of all, lawyers forming Delaware LLCs shouldn’t think in terms of “a” form but rather in terms of sets of forms. On the basis of their ownership structure, their management structure and their federal tax structure, there are 10 quite distinct types of Delaware LLCs. To be fully equipped to form these LLCs, you need 29 main forms. For example, the provisions in LLC agreements for Delaware single-member LLCs owned by individuals should be significantly different from those owned by entities; for Delaware multi-member LLCs, you need separate forms for those with general partnership management structures, limited partnership management structures and corporate management structures; and for a Delaware series LLC, you need a highly specialized form.
Mahler: And once you decide upon the basic template that’s right for the structure of the particular LLC, what optimal form features should one look for?
Cunningham: Above all, the form should identify in its captions all of the business organization law issues, tax issues and other issues likely to be relevant to the type of LLC for which it is drafted. In the case of manager-managed multi-member LLCs taxable as partnerships, this means more than 200 principal and subsidiary issues, including, for example, member dissociation issues, manager fiduciary issues, buy-sell issues, dispute resolution issues, and a slew of federal tax issues. Finally, Vern and I share the common-sense view that all good Delaware forms should be written in plain English that, for the most part, even non-specialists can understand on a careful first reading.
Mahler: What principal types of knowledge do you think lawyers need in order to form Delaware LLCs competently?
Cunningham: Above all, they need a detailed knowledge of the provisions of the DLLC Act relevant to Delaware LLC formations. By our count, this includes about 168 main provisions. And they need to be able to categorize each of these provisions accurately as mandatory, definitional, default, non-self-enabling permissive and self-enabling permissive, since these characterizations can critically affect how you negotiate specific issues in an LLC deal. But they also need a lot of “meta-knowledge”—that is, knowledge that is based on the relevant statutory and case law but that is essentially know-how on how to perform key Delaware formation tasks. These tasks include choosing between Delaware LLCs and Delaware corporations for clients; and choosing whether to form clients’ LLCs under the Delaware LLC act or some other act.
Mahler: What main factors do you think lawyers should consider in choosing between the DLLC Act and non-Delaware acts?
Cunningham: The issue is complex, but here are some key considerations:
- If you’re representing the promoter of an investment LLC who will appoint the LLC’s manager and who wants him or her to have substantial protection from member fiduciary claims, you should generally form the LLC under the Delaware LLC Act. This is because the Delaware Act provides greater scope and flexibility in drafting these protections in LLC agreements than any other act; and because DLLC Act § 18-1101(b) and the Elf Atochem case go very far in ensuring the validity of these protections.
- If your clients’ LLC’s businesses will involve substantial financial stakes and a significant risk of internal disputes, you need to form the LLC under the DLLC Act in order to ensure access to the Delaware Court of Chancery—in my view, the best business court in the U.S. I recently formed an investment LLC with 100 members and an initial capitalization of $600 million. I couldn’t imagine forming that LLC under any non-Delaware LLC act even though none of its members resides in Delaware. The key factor was the excellence and efficiency of the Court of Chancery.
- Not that there aren’t reasons for not forming LLCs under the Delaware Act. For example, it’s often said that “everybody’s second choice is Delaware”—i.e., that when an LLC has two or more members and none of them wants to use the others’ LLC act, you should use the Delaware Act. This saying sometimes makes sense. However, the DLLC Act is tricky, and you shouldn’t form LLCs under it unless you have the necessary expertise. And do you really want to have to try LLC internal disputes in Wilmington, Delaware?
Mahler: John, thanks for taking the time to share your expertise with my readers. I look forward to learning even more from your co-author, Vern Proctor, in next week’s Part II interview.