Considerations in Drafting Limited Liability Company Agreements and Limited Partnership Agreements

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1 PRESENTED AT 38th Annual Conference on Securities and Business Law February 11 12, 2016 Dallas, TX Considerations in Drafting Limited Liability Company Agreements and Limited Partnership Agreements Hillary H. Holmes Brad L. Whitlock The University of Texas School of Law Continuing Legal Education utcle.org

2 AUTHORS Hillary H. Holmes Baker Botts L.L.P. 910 Louisiana Street Houston, TX phone: (713) Practice Hillary Holmes is a corporate partner with Baker Botts L.L.P. Ms. Holmes practice focuses on securities laws and capital markets transactions for master limited partnerships (MLPs) and corporations in the energy industry. She has been named one of the top young securities and capital markets lawyers in the United States and assisted clients with some of the most complicated and exciting capital markets deals in the energy industry. Ms. Holmes also has deep experience with structuring equity investments and joint ventures in energy companies and partnerships, mergers and acquisitions in the energy industry and corporate governance matters for public companies. Ms. Holmes clients include issuers and underwriters in securities offerings; management and energy companies in formation and joint ventures; buyers, sellers, conflicts committees and financial advisors in M&A transactions; and public corporations and partnerships in day to day counseling. Ms. Holmes has been recognized by Chambers USA, Legal 500 U.S., Who s Who Legal - Energy, Law 360 s Rising Stars (the only Texas-based capital markets lawyer), Texas Super Lawyers and the Houston Business Journal s 40 Under 40. She was the sole recipient of the 2014 Outstanding Young Lawyer of the Year Award by the Houston Young Lawyers Association. Publications / Engagements Ms. Holmes speaks and writes frequently on issues and practices relating to securities law, MLPs, capital markets, and M&A and capital formation in the energy industry. Ms. Holmes has been selected as a Houston Bar Association Ambassador, served as co-vicechair of the State Bar of Texas Women in the Profession Committee and served as co-chair of the Houston Young Lawyers Associations Non-Profit Committee for several years. Ms. Holmes is chairperson of Baker Botts Houston Pro Bono Program, which donates an average of 10,000 hours of free legal services to the Houston community each year and is a regular leader among large law firms committed to the Houston Volunteer Lawyers Program. Education Ms. Holmes received a J.D. from the University of Pennsylvania Law School and a B.A., cum laude, in public policy studies and women s studies from Duke University. Active

3 Brad L. Whitlock Scheef & Stone, L.L.P. 500 N. Akard, Suite 2700 Dallas, TX phone: (214) Practice Brad Whitlock is a partner with Scheef & Stone, L.L.P. His practice focuses on business transactions, including mergers and acquisitions (including stock and asset purchases and tender offers), securities matters (including representation of issuers, underwriters, venture capitalists, and private equity and hedge funds in connection with public and private offerings of debt and equity securities), and lending transactions (including the representation of lenders and borrowers in connection with loan documentation). He also has considerable experience representing companies in connection with their general legal needs, including labor and employment, contracts, and real estate. He was a partner in the corporate section of a large Dallas-based law firm for many years and has served as the general counsel for a large Dallasbased manufacturing company, where he was responsible for all of the legal aspects of the company. Mr. Whitlock has been named as one of the best lawyers in Dallas by D Magazine and as a Texas Super Lawyer by Texas Monthly magazine. He has also been included in several editions of The Best Lawyers In America. Memberships In addition to his law practice, Mr. Whitlock is involved in many bar and professional activities. He is a past Chair of the Business Law Section of the State Bar of Texas. From he served as Chair of the Corporation Laws Committee of the Business Law Section and he has helped draft sections of the Texas Business Organizations Code. Mr. Whitlock has served as chairman of the Securities Law Section of the Dallas Bar Association, as Chairman of the Texas Business Law Foundation, and on the Council of the Business Law Section. Mr. Whitlock has served on the board of several civic organizations, including the Greater Dallas Youth Orchestra and the Arts District Friends. He is a 2001 graduate of the Leadership Dallas program sponsored by the Greater Dallas Chamber of Commerce and served as chair of the Chamber s Leadership Advisory Council. Publications / Engagements Mr. Whitlock is the co-author of the four volume Texas Practice Guide Business Transactions published by Thompson Reuters/West. This treatise analyzes a number of Texas contracts, including employment agreements, technology agreements and service agreements. Mr. Whitlock is also a frequent speaker on a variety of transactional topics. Education Mr. Whitlock received his J.D. degree from the Southern Methodist University School of Law where he was a member of the Journal of Air Law & Commerce and a Hatton W. Sumners Scholar. He received his B. A. degree from Westminster College in Fulton, Missouri. Active

4 INTRODUCTION Given their structural flexibility and tax advantages, it is little wonder that limited liability companies ( LLCs ) and limited partnerships ( LPs ) have eclipsed the corporation as the primary entities of choice for new businesses in Texas. LLCs and LPs offer a myriad of almost limitless options on ownership structure, company governance and almost all other aspects related to the operation of the entity. However, as it is often said, with much freedom comes much responsibility. A practitioner who puts together a limited liability company ( LLC agreement ) or an agreement of limited partnership ( LP agreement ) for a client should be well versed in the overall structure of these entities and the variables that should be considered in drafting the operative agreement. Both LLCs and LPs are so-called creatures of contract in that the Texas Business Organizations Code ( TBOC ) chapters on LLCs and LPs give great deference to the LLC agreement or LP agreement to define the rights and obligations of the members and partners, respectively, of these entities. This paper analyzes select provisions of the LLC agreements and LP agreements that practitioners are likely to have to address in drafting an agreement for a client. Drafters Notes: 1. Both LLCs and LPs are usually, absent an election to the contrary, both considered pass-through entities, in that the entities themselves pay no federal income taxes, but rather those taxes are reported to and paid by the members or partners as per the terms of the LLC agreement or LP agreement. Accordingly, the tax allocation provisions of these agreements are usually the most important provisions for the drafter. However, these are also very complex provisions and should always be drafted or at least reviewed by an experienced tax expert. Since neither of the authors is an expert in tax law, a discussion of the tax provisions of LLC agreements and LP agreements is beyond the scope of this paper. 2. The decision on whether to use an LP or an LLC when forming an entity is beyond the scope of this paper. For a discussion of all Texas business entities, see Byron Egan, Choice of Entity Decision Tree After Margin Tax and Texas Business Organizations Code, 42 Tex. J. of Bus. Law No. 1 (2007). The authors acknowledge the influence of Mr. Egan and the contents of that article in helping with the development of this paper. The authors also wish to thank Mr. David Turner, partner of Scheef & Stone, L.L.P., for his assistance with the sample agreement provisions included with this paper. 3. The sample agreement provisions included with this paper are meant to be used as starting points but have not been drafted based on any particular fact pattern. Such provisions, if used, should be tailored to be consistent with the desires of the client and the other terms of the applicable agreement. The authors do not intend that these provisions serve as legal advice in any respect. 4. This paper focuses on private LLC agreements for operating companies that have multiple members and a manager. This paper does not address LLCs in the buyout context with a private equity sponsor. This paper does not address the special requirements applicable to LLCs formed for professional services or the joint practice of doctors or as a real estate Active

5 investment trust. 1 This paper does not address the governing agreements of publicly traded LLCs or LPs, commonly referred to as master limited partnerships, which are more complex. 5. Many of the sample agreement provisions provided in this paper are drafted for an LLC. In the interest of brevity, this paper does not present sample provisions for both LLCs and LPs but many of the sample provisions presented can be revised and tailored for either entity. A. Basics of Limited Partnerships and Limited Liability Companies Limited Partnerships A limited partnership is a partnership formed by two or more persons, with one or more general partners and one or more limited partners. 2 Limited partnerships are statutorily authorized entities. In Texas, all domestic limited partnerships are governed by the TBOC. The limited partners and general partner of the LP will enter into a contract governing their relationship, the management of the LP and the economics of the LP. This contract is the LP agreement. The TBOC assumes the existence of an LP agreement. The TBOC contains a number of default provisions that govern the LP in the absence of any relevant provisions in the LP agreement. Except as provided in the TBOC, the partners generally have the freedom to contract around these default provisions and to provide for the rights and obligations of the partners in the LP agreement. 3 The LP agreement may be either written or oral, but an oral agreement is not recommended. 4 An oral LP agreement is subject to the statute of frauds and more likely to be disputed. 5 The owners of the LP are the limited partners and the general partner. The limited partners have an economic interest in the LP, which is generally passive. The LP is managed by the general partner, which may or may not have any economic interest in the LP. Limited Liability Companies Limited liability companies are statutorily authorized entities. In Texas, all domestic limited liability companies are governed by the TBOC. An LLC is a distinct type of entity that has the powers of both a corporation and a partnership. An LLC offers substantial flexibility and combine the liability protection of a corporation with the tax treatment of a partnership. Unlike the partnership, where the key element is the individual, the essence of the limited liability company is the entity, requiring for its creation more formal requirements. 6 The LLC is based in large part upon a contract between its members governing the members rights and responsibilities with respect to each other and the LLC in great detail. This contract is the LLC Agreement. As a result, fundamental principles of freedom of contract imply that the owners of 1 See TBOC , , et seq. 2 TBOC 1.002(50). 3 TBOC , TBOC (5). 5 An oral agreement which is not to be performed within one year from the date of making of the agreement is barred by the statute of frauds. TEX. BUS & COM. CODE ANN (B)(6) (Vernon Supp. 2011). 6 1 William D. Bagley & Pillip P. Whynott, The Limited Liability Company, 2.10 (2d ed. 2d rev. James Publishing, 1995). Active