Limited Liability Company
By Robert Moore, Research Specialist and Attorney, Agricultural & Resource Law Program
Prior to LLCs becoming available for common use, Limited Partnerships (LP) were used extensively to hold farmland. LPs provide liability protection for the limited partners and usually allow the land to be distributed out to the partners without tax liability. Additionally, the land in the LP can receive a stepped-up tax basis upon the death of a partner. LPs were a good choice to hold farmland.
The primary disadvantage of an LP is the liability exposure of the general partner. Because the general partner is tasked with management responsibilities for the LP, they receive no liability protection. Therefore, any liability created by the activities of the LP will transfer to the general partner and put all of the general partner’s assets at risk.
LLCs were developed in the 1990’s and started to become popular in the early 2000’s. LLCs can be taxed as partnerships and thus provide all the tax benefits of an LP. Also, LLCs provide liability protection for all owners regardless of their management roles. Therefore, LLCs provide all the benefits of an LP plus provide liability protection for the manager. Due to the superior lability protection of LLCs, LPs have been made obsolete in Ohio.
If you have an LP, you should consider converting it to an LLC. The conversion will extend liability protection to all the owners while maintaining the partnership taxation structure. Converting from an LP to an LLC is relatively easy.
The conversion is performed by completing Form 700 provided by the Ohio Secretary of State. The form can be filed through the mail or by submitting online. A $99 fee is required to be paid when the conversion is submitted. The form asks for the identification and structure of the current entity and the name and structure of the future, converted entity.
Any asset held by the LP is automatically owned by the LLC after conversion. For real estate, an affidavit is recorded with the county recorder stating the LP has been converted to an LLC. Because both the LP and LLC will have a partnership taxation structure, the same tax identification number can be used after the conversion. An operating agreement should be drafted for the new, converted LLC as the old LP agreement will no longer be in effect.
Consider the following example. XYZ Farms Ltd. is an LP and holds farmland. The owners of the LP wish to convert to an LLC to provide liability protection for the manager partner. Form 700 is filed with the Ohio Secretary of State along with the $99 fee. The conversion form states that XYZ Farms Ltd. is converting to an LLC and will have the new name of XYZ Farms LLC. After the conversion, the LLC files an affidavit with the county recorder stating that XYZ Farms was converted from an LP to an LLC and the farmland is now owned by the LLC. The owners of XYZ Farms LLC draft a new operating agreement with terms and provisions applicable to an LLC.
LLCs have replaced LPs as the entity of choice to hold farmland. LPs that were established prior to the availability of LLCs can be converted to LLCs relatively easily. Owners of an LP should consider converting to an LLC to provide liability protection for the managing partner.
 Form 590, “Consent for Use of Similar Name”, and Form 610, “Articles of Organization”, must also be filed with the conversion form.
Sometimes you happen upon a question that you want an answer to, and the answer you find raises more questions. That’s exactly what happened when we started examining Limited Liability Company (LLC) statutes from across the Midwest.
Originally, we wanted to determine whether there are any significant legal differences between the LLC statutes of different states. While we may be based in Ohio, we find projects that examine how different states compare to one another on the same legal topic fascinating. The comparisons allow us to see trends and different ideas, and we had the chance to do this in our recently completed projects on CAUV and agritourism.
Ultimately we found the Midwestern states to have functionally similar LLC statutes, with about half of the Midwest having adopted a uniform statute. When a state adopts a uniform statute, it intends for its law on a given topic to match those of other states with the same uniform statute. There are other examples of these like the Uniform Commercial Code, Uniform Probate Code, and more. Uniform codes are designed to make it easier for people to do business and live their lives across state lines. For Midwestern LLC statutes, even in states that have not adopted a uniform statute, the key elements are still very similar. The statutes have filing procedures for creating the entity, default rules for operating agreements, and rules that govern LLCs in general.
When we answered our questions about the state statutes, we became curious about some of the benefits offered by using an LLC instead of some other business form. We found that LLCs offer great liability protection, with some specific limitations such as the application of piercing the veil from corporate law. Further, pass through taxation can provide great tax benefits and avoid double taxation. Since states allow operating agreements to be highly customizable, LLCs also provide a flexible entity structure that may be adapted to suit the needs of a business or family.
That last word led us to another question: what benefits does the LLC structure offer a family farm in its estate and business transition plan? The previous three benefits are well known and thoroughly discussed; however, this last one, while done a lot in practice, is not commonly mentioned in academic writing. Ultimately, the benefits in estate and transition planning come from the flexible nature of the operating agreement.
How can LLCs be helpful in an estate and business transition plan for a farm? Here’s a few ways:
- Restrict the transfer of an ownership interest through rights of first refusal and buy-out provisions
- Restrict membership and voting power of non-family members
- Transition equity ownership more easily than in a corporation
- Transition the business in relative privacy
Once we learned about these benefits, the question arose of how common farming LLCs now are. Using data from the USDA’s Census of Agriculture, we found that by 2012, there were almost as many farms organized as LLCs as there were farms organized as corporations, while the vast majority of farms remained owned outright by individuals with no formal legal entity. We are waiting for the next Census of Agriculture to spot any trends, because 2012 was the first year that farms were asked to identify whether they were organized as LLCs.
Throughout the paper, we made some observations and predictions for what we expect to see in the future. We are also history buffs, so of course there had to be a section on the origins of the LLC, and why Wyoming was the first state to adopt an LLC statute. It is an interesting and dramatic history that we had not heard about before.
Our project examining farm LLCs is available on our OSU Extension Farm Office website HERE, as well as the National Agricultural Law Center’s website HERE. This material is based upon work supported by the National Agricultural Library, Agricultural Research Service, U.S. Department of Agriculture.
Written by Chris Hogan, Law Fellow, OSU Agricultural & Resource Law Program
The Agricultural and Food Law Consortium is holding a webinar regarding Using LLCs in Agriculture: Beyond Liability Protection this Wednesday, August 16th at 12:00 (EST).
The Limited Liability Company (LLC) is a relatively new type of business entity. The first LLC statute passed in Wyoming in 1977. Since then, all fifty states passed legislation permitting LLCs as an operating entity. Many Ohio farmers use the LLC as their preferred operating entity.
In Ohio, an LLC is a legal entity created by Ohio statute. An LLC is considered to be separate and distinct from its owners. An LLC may have a single owner in Ohio, or it may have numerous owners. LLCs combine the best attributes of a corporation and a partnership. Individuals, corporations, other LLCs, trusts, and estates may be members in a single LLC. There is no limit on maximum members.
The Importance of an Operating Agreement
When an agricultural operation chooses to operate as an LLC, that operation must consider drafting an operating agreement. An operating agreement specifies the financial responsibilities of the parties, how profits and losses are shared among members within the LLC, limitations on transfers of membership, and other basic principles of operation.
If an LLC does not choose to draft an operating agreement, Ohio’s default rules apply. Ohio law prescribes default rules of operation for LLCs in R.C. Chapter 1705. However, LLC members often wish to modify state rules to tailor an LLC to their business. Ideally, agricultural operators should draft an operating agreement with the assistance of an attorney.
Single Member LLCs
Every state in the Midwest permits single-member Limited Liability Companies (SMLLCs). A single member LLC is an LLC which has one member or manager; that means that there are no other owners or managers of that LLC. In 2016, Ohio enacted R.C. 1705.031 which states that Ohio LLC laws apply to all LLCs, including those with only one member. Therefore, small agribusinesses that have only one member are not prevented from forming an LLC.
Will a Personal Guaranty on a Loan Affect Limited Liability Protection?
Ohio farmers operating as an LLC enjoy the benefits of limited liability protection. Usually, that means that the debts and obligations of a farm LLC operation are solely those of the LLC. That means that a farmer is not personally liable for any debts or obligations incurred by the LLC.
However, lenders, implement dealers, financial institutions, and others are finding ways around an LLC’s personal liability protection. Those parties are increasingly requiring that the members and managers of LLCs provide personal guarantees. That is, a member or manager of an LLC agrees to be personally liable for a debt or obligation, if an LLC is not able to pay.
A full discussion of personal guarantees and LLCs in an earlier blog post is here.
LLCs are not Invincible
Limited Liability Companies are extremely popular among Ohio farmers. However, LLCs merely limit liability. LLCs don’t create a perfect liability shield, they are subject to a concept known as “veil piercing” where the owners of a company are held personally liable for the actions of the company.
Generally, a person cannot use a corporation to commit fraud on others or to use a corporation as an alter ego for a member’s own personal gain. Plainly speaking, Ohio courts may hold an owner of an LLC liable in certain cases of fraud committed by the LLC or where an LLC is undercapitalized and is not treated as a separate entity from a member (i.e. the LLC is used as an “alter ego”). While this is not a common scenario among farm business LLCs, LLC members should be aware that a business’s status as an LLC will not shield it from liability in all instances.
Carrying Liability Insurance
Many LLC owners consider the protections under Ohio’s LLC laws to be sufficient. Some LLC members are satisfied that their personal assets are sufficiently protected and separated from LLC assets and LLC liabilities. However, every business should have liability insurance. Liability insurance is a relatively inexpensive means of managing liability exposure for injuries and physical damage to a third party. While insurance doesn’t lower liability, it gives the business a way to pay for damages in the event of an incident.
The question of “how much liability insurance should a farm operation have?” is a difficult one. The amount of insurance that a farm should have must be determined on a case-by-case basis. Factors such as farm size, type of operation, location, and other factors impact the insurance needs of a farm operation.
More information on LLCs and other alternative business organizations through the National Agricultural Law Center is here.