Bulletin: NJ000009

Dear Associates:

Limited Liability Companies are a relatively new form of business entity created by statute to take advantage of the most advantageous features of both corporations and partnerships. A Limited Liability Company combines the advantage of limited liability such as is enjoyed by the shareholder in a corporation with the tax treatment benefits enjoyed by partners in partnerships while providing additional flexibility in the management and distribution of profits. First created in 1977 in Wyoming, approximately 37 states have enacted limited liability company statutes with legislation pending in the 13 additional states. New Jersey adopted a limited liability company law effective January 26, 1994 (N.J.S.A. 42:2B-1 et.seq.

For convenience in identifying limited liability companies, different terminology is used relative to persons with interest in the entity and enabling documents. Examples of the most commonly used terms are as follows:

• Manager - A manager is a person designated by members to manage the limited liability company (hereinafter LLC). This person is similar to a corporate officer or a managing partner of a partnership.
  
  
• Member - This is an owner of an interest in the LLC. A member may be a partnership, general or limited, another limited liability company, a trust, an estate, an association, a corporation, a custodian or nominee or an individual.
  
  
• Operating Agreement - This is the document agreed to by the Members (owners) which governs the management of the LLC in the conduct of its business and distribution of profits. This document must be in writing. This document is similar to the corporate charter and bylaws for a corporation or the partnership agreement for a partnership.

Formation

A Limited Liability Company is formed upon the filing of a document called the Certificate of Formation with the Office of the Secretary of State (N.J.S.A. 42:2B-2). The Limited Liability Company must have two or more members. However, the Certificate of Formation may be signed by any authorized person (including non-members) and need only be signed by one person (N.J.S.A. 42:2B-11(a)). Please see referenced forms at the end of this bulletin.

For the purpose of searching and examining title, it will be necessary to request proof of the filing of the Certificate of Formation from the Secretary of State's Office in a manner similar to which we now require proof of due incorporation of corporations or limited partnerships. Similar to limited partnerships which must state that they are limited partnerships, all LLCs must have in their name "limited liability company" or "LLC" (N.J.S.A. 42:2B1-3(a)). This allows anyone dealing with the company to immediately identify it as a LLC. This will, of course, be beneficial to us in determining what searches must be conducted.

Alternate Name

Much like a partnership or corporation may adopt a trade name, an LLC may adopt an "alternate name" pursuant to N.J.S.A. 42:2B-4(b). This is done by filing a Certificate of Registration of Alternate Name with the Secretary of State. Please see referenced forms at the end of this bulletin.

When searching for judgments and other liens against a LLC it will be necessary to search both the name of the LLC as set forth on the Certificate of Formation and any alternate name used by the LLC. Accordingly, we will require disclosure prior to closing of any alternate names used by the LLC. It may be possible to request such information also from the Secretary of State's Office.

Authority of Members and Managers

The LLC Act does not specifically provide for the authority of either members or managers. This authority is generally derived from the operating agreement. In absence of specific authority mentioned in the operating agreement, it is generally assumed that the courts will apply the general principles of partnership law. However, we will require that the actions of the manager in either conveying or mortgaging real property be authorized in the operating agreement. For our purposes a general authority conferred upon the manager to operate the company will be sufficient, absent any specific prohibition in the agreement prohibiting the conveyance or mortgaging of its property. Where the sale or mortgaging constitutes all or substantially all of the property of the LLC, caution must be exercised in determining authority. Consult the office of State Counsel if any doubt exists.

It will, therefore, be necessary to call for and review the operating agreement in most transactions. Where the operating agreement is not available State Counsel's office must be consulted.

Mergers/Conversions

The LLC Act specifically provides for the merger of any "other business entity" into a newly formed LLC (N.J.S.A. 42:2B-20(a)). It would appear from this statutory authority that existing corporations, limited partnerships or general partnerships may be "converted" into a LLC by merger. This would be accomplished by filing merger documents in the Secretary of State's Office. The Act specifically provides that title will vest in the resulting entity after the merger. It may be, therefore, that you will not find a deed of record from the old business entity but only find merger documents filed with the Secretary of State's office. We shall treat such mergers as any other merger. We will require proof by way of the filings in the Secretary of State's Office of the merger.

However, the New Jersey Business Corporations Act (N.J.S.A. 14A:10-1 et.seq.) does not specifically permit the merger of a corporation into an LLC. This conflict in the law may simply be caused by the fact that the New Jersey Business Corporation Act was enacted into law before the LLC act was enacted. However, it does create an apparent conflict in the two statutes. Some of the commentary on the subject cautions that to avoid this apparent conflict in the laws it may be desirable to merge the New Jersey corporation first into a Delaware domestic corporation and then merge the Delaware corporation into a New Jersey LLC. This practice may develop as the "better practice" which would require us to search the Secretary of State's Office in Delaware for the first set of merger documents.

Assignability of Members Interest

Pursuant to the statute a membership interest in a LLC is assignable (N.J.S.A. 42:2B-44(a)). The statute also provides that a membership interest does not necessarily include any right to participate in the management of the company. It is somewhat akin to ownership of stock. Where the operating agreement provides for no management right for its members, we will not be concerned about the transfer of the membership interest.

Vesting of Title

Title to real property owned by a LLC is vested in the LLC, similar to the way title is vested in a partnership or corporation. A member has no direct ownership interest in the assets of the LLC. Therefore, any judgments or obligations of the members cannot reach the assets of the LLC. Again, similar to partnership law, judgments against the individual members will not be liens on the LLC's property. Similarly, a bankruptcy of a member of a LLC should not affect the title to the LLC.

Dissolution or Termination

An LLC is dissolved upon the occurrence of the first of the following:

• Time specified in the operating agreement. If no date is specified, 30 years from the formation.
  
  
• Upon happening of events specified in the operating agreement.
  
  
• Written consent of all members.
  
  
• The death, retirement, resignation, expulsion, bankruptcy or dissolution of a member. The LLC is continued by the consent of the remaining members within 90 days.
  
  
• The entry of a decree of a Court dissolving the LLC.

Underwriting Guidelines

In general, LLCs should be treated in a manner similar to the way in which we underwrite corporations or partnerships in the chain of title.

Lien Searches

The name of the LLC and all its alternate names must be searched for the statutory lien periods in the N.J. Superior Court, U.S. District Court, Bankruptcy Court and County lien books. It is not necessary to search the names of members.

Vesting

Title may be vested in an LLC either by deed or merger.

Authority to Act

Proof must be obtained as to the authority of the member(s) executing deed and/or mortgages. The operating agreement of the LLC must be reviewed in this regard.

Schedule B, Section I Requirements

Where an LLC is found in the chain of title the following additional proofs should be required in Schedule B, Section I of the Commitment to Insure:

• Proof that _______, an LLC is a validly formed Limited Liability Company must be provided to the Company prior to closing by providing a copy of the Certificate of Formation duly filed with the Secretary of State (the Company has requested such proof directly from the Secretary of State's Office but same have not yet been received.
  
  
• The Company requires a copy of the Operating Agreement of the LLC and any amendments thereto together with a certification stating that the copy is a complete copy of the agreement; that the agreement has not been further amended; and the names of the current managers of the LLC. The Company requires that any conveyance/mortgage executed on behalf of the LLC be done in conformity with the provisions of the operating agreement.
  
  
• The Company requires a certificate setting forth all the alternate names used by the LLC. The Company reserves the right to make such additional searches and amend this Commitment as may be warranted when these names are provided.
  
  
• Deed of Conveyance must be executed by manager(s) in compliance with the terms of the operating agreement.
  
  
• Mortgage to the Insured must be executed by managers(s) in compliance with the terms of the operating agreement.
  
  
• Title of Record is found in _______ corporation. Application states title is vested in _______ LLC. Proof will be required as to the merger of _______ corporation into _______ LLC. Please provide copies of Certificates of Merger filed with the Secretary of State's Office (copies of these certificates have been independently ordered from the Secretary of State's Office, but have not yet been received). The Company reserves the right to amend this commitment as may be warranted by its review of the merger certificate.

Conclusion

The LLC is a particularly useful form of business entity for real estate investment. It provides a number of features which are attractive to those wishing to manage their own property. Accordingly, we can anticipate that this form of entity will in the future become more and more common. As with any new law we can expect a certain learning curve as we become more involved with this new type of entity. Please do not hesitate to call the State Counsel's Office with any questions you may have as to the proper underwriting of LLCs or to discuss problems you may be having in implementing these underwriting guidelines.