Forming an LLC in Tennessee can provide a number of legal benefits.
Freedom of Contract
The Tennessee LLC Act gives LLC members contractual freedom to customize their contributions, rights, and distributions of profits and losses. In addition, it gives members contractual freedom to customize the duties each party to the LLC agreement owes to the other parties, protects both majority and minority members’ membership interests, and allows members to protect their control of an LLC.
The Tennessee LLC Act gives LLC members contractual freedom to customize their capital contributions and their shares of profits and losses. Section 304 states that “[a]ny profits and losses of an LLC shall be allocated among the members or holders of financial rights in the manner provided in the LLC documents.” This gives members contractual flexibility to adapt their income streams and risks of loss to further their broader asset management plans.
Privacy for Owners
The Act does not require filing of members’ names. A “person” may form an LLC by filing its articles of organization, and the definition of “person” includes almost any kind of business or legal entity. An LLC’s members may therefore have an entity or person who is not a member file the LLC’s articles of organization with the Tennessee Secretary of State.
Perpetual Duration
The Tennessee LLC Act provides for an LLC’s unlimited life. It states that if the articles of organization do not limit an LLC’s existence to a specific time period, the LLC’s existence is perpetual. An LLC’s existence can therefore outlive its members’ lifetimes.
Benefits for Business Partners
The Act enables members to create classes of membership. An LLC agreement may establish classes of membership interests with different rights, powers, and duties, including voting and non-voting interests. Section 303 states “[t]he LLC documents may provide for classes or groups of directors, managers, members or holders of financial rights having the relative rights, preferences, limitations, powers and duties provided in the LLC documents ….” This facilitates everything from complex, high-dollar-volume transactions to succession planning in family businesses and estate planning by gifts of non-voting interests.
The Tennessee LLC Act gives members contractual freedom to customize the duties each party to the LLC agreement owes to the other parties. Section 403 establishes limited duties of loyalty and care for members of member-managed LLCs. Section 205 allows members to narrow the scope of the duty of loyalty, but prohibits them from completely eliminating it. For example, an LLC agreement may (1) “[i]dentify specific types or categories of activities that do not violate the duty of loyalty …, if not manifestly unreasonable”; and (2) “[s]pecify the number or percentage of members … that may authorize or ratify, after full disclosure of all material facts, a specific act or transaction that otherwise would violate the duty of loyalty.” This second element is a “safe harbor” provision for “interested” transactions, which are transactions between an LLC and one or more of its members or managers. Section 404 contains a similar safe harbor provision. In addition, Section 205 allows members to narrow, but not unreasonably reduce, the duty of care.
The result is the Act protects both majority and minority members. It protects minority members because an LLC agreement may not completely eliminate fiduciary duties, even though it may identify activities that do not violate them and prescribe standards for measuring them. These provisions make minority interests safer investments and therefore more valuable.
The Act protects majority members because it provides a “safe harbor” to facilitate contracts and transactions between an LLC and one or more of its managers or members, or an entity in which they own an interest, if the contracts or transactions meet minimum disclosure, approval, or fairness requirements. These rules give majority members and the LLC certainty in business planning and the ability to take advantage of mutually beneficial opportunities.
Protections Against Unwanted Parties
The Tennessee LLC Act allows members to protect their control of an LLC. It distinguishes between a member’s “governance rights” and “financial rights.” The Act provides that if a member transfers his or her governance rights, the transferee cannot become a member or exercise the governance rights unless the non-transferring members give unanimous approval. Sections 501 and 508 state members may “unreasonably” withhold their approval because the decision is in their sole discretion.
If a member transfers his or her financial rights, the transferee receives “only the share of profits and losses and the distributions to which the transferor would otherwise be entitled.” Section 507 states the transfer of financial rights does not entitle the transferee to exercise any governance rights, become a member, or dissolve the LLC, and “any attempt by the transferee to do any of the foregoing shall be null and void.”
Creditors Cannot Obtain Controlling Rights
In addition, the Act states that a person ceases to be a member of an LLC when the person makes an assignment for the benefit of creditors, files a bankruptcy petition, or fails to contest a petition seeking his or her reorganization, liquidation, dissolution, or similar relief. § 503. But “[t]he pledge of, or granting of a security interest, lien or other encumbrance in or against, all or any portion of the membership interest of a member is not a transfer of ownership and shall not cause the member to cease to be a member or to cease to have the power to exercise any rights or powers of a member.”
If a judgment creditor of a member obtains a charging order against the member’s membership interest, “the judgment creditor has only the rights of a transferee.” Furthermore, a charging order is a judgment creditor’s “sole and exclusive remedy.”
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