PUERTO RICO FORMS OF ORGANIZATION McConnell Valdes LLC Antonio Escudero Viera

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1 Last Updated: July 2012 PUERTO RICO FORMS OF ORGANIZATION McConnell Valdes LLC Antonio Escudero Viera Table of Contents 1. Nonprofit Corporations 2. For-Profit Corporations 3. Limited Liability Companies 4. Joint Ventures 5. Partnerships and Limited Partnerships 6. Sole Proprietorships 7. Charitable Trusts The most common legal form of organization utilized by the social sector is the nonprofit corporation. However, for-profit corporations, limited liability companies (LLCs), joint ventures and various kinds of partnerships, including limited partnerships, are increasingly being used typically to accommodate plans to earn revenues or access capital markets. Each of these forms of organization has advantages and disadvantages and sometimes, with the help of experienced counsel, they are used in combination to maximize strengths and minimize weaknesses of a particular form. The following chart provides a high-level overview of various organizational forms that can be used in the social sector. More detailed descriptions of each form follow in the subsequent text.

2 Formation Management and Control Liability Tax Factors Capital and Loans Nonprofit Corporation File and receive approval by the Department of State of Puerto Rico of its certificate of incorporation. The board of directors or incorporators adopt bylaws which establish the general operation and management of the corporation. Only gross negligence on the part of a member, director or officer will result in personal liability. To apply for tax exemption, nonprofit corporations must comply with section of the Puerto Rican Tax Code. Nonprofit corporations are specifically organized to not earn profits. However, reasonable compensation may be paid for services rendered. For-Profit Corporation File and receive approval by the Department of State of Puerto Rico of its certificate of incorporation. Managed by or under the direction of a board of directors and its officers; although its shareholders vote on important corporate issues. Only gross negligence on the part of a member, director or officer will result in personal liability. The for-profit corporation pays taxes on the income it earns and its shareholders pay taxes on dividends distributed by the corporation. For-profit corporations (and LLCs) offer the most flexibility in raising capital, ranging from various kinds of equity to numerous types of debt instruments

3 Limited Liability Companies (LLCs) File a certificate of organization with the Puerto Rican Department of State. LLCs are formed and owned by members rather than shareholders. The debts, obligations and liabilities of an LLC are solely the responsibility of the LLC, regardless of whether these debts arise from contract, damages or liabilities of the LLC. LLCs are eligible for pass-through income tax treatment. Under the Internal Revenue Code for a New Puerto Rico ("2011 Code") limited liability companies ( LLCs ) continue to be subject to tax in the same manner as corporations, but may elect to be treated for tax purposes as partnerships An LLC offers the same flexibility in raising capital as a for-profit corporation. Partnerships Recognized as statutory entities under Puerto Rican law. Partnerships provide almost unlimited flexibility in governance and management. Limited liability partnerships (LLPs) function like general partnerships but provide extra protections for the general partners The total assets of each partner in a general partnership are at risk, not just the capital that has been put into the enterprise. Can raise capital through contributions by partners and by borrowing money through loans or other debt instruments. 3

4 Limited Partnership Recognized as statutory entities under Puerto Rican law. Partnerships provide almost unlimited flexibility in governance and management. Provide extra protection for general partners. Such as personal immunity for liability arising from the negligence and wrongful acts of other partners, unless the other partners were under their direct supervision In limited partnerships, the limited partners are shielded from liability beyond their capital contributions, but the general partner who manages the affairs of the limited partnership does not have this liability protection. Limited partnerships are often used as financing vehicles and are most useful when investors are to have no role in management and a simple or flexible governance structure is needed. Sole Propietorships A sole proprietorship has no legal existence apart from its owner and may be formed without any expense or formality. The proprietor may operate under a trade name that is registered. Such registration provides limited protection for exclusive use of the name, absent trademark or service mark registrations. The main disadvantage of forming a sole proprietorship is that the owner is wholly liable for all debts and obligations of the enterprise. Not taxed as an entity. Owner reports business profits and losses on personal tax return. A sole proprietorship itself cannot be sold since there is complete unity between the enterprise and its owner, but the assets used in the enterprise can be sold. 1. Nonprofit Corporations a. Overview Puerto Rico's General Corporation Law of 2009 (the Corporation Law ) governs the formation, operation and dissolution of nonprofit corporations in Puerto Rico. A nonprofit corporation in Puerto Rico is managed by its board of directors and operated by its officers and employees. Instead of shareholders, a nonprofit corporation may, but is not required to, have members. Nonprofit corporations, are specifically organized to not earn profits. No part of the income or surplus of a Puerto Rican nonprofit corporation may be distributed to its members, directors or officers; however, reasonable compensation may be paid for services rendered

5 A nonprofit corporation has an existence of its own, independent of the terms of office or employment of members, directors or officers. It can sue or be sued in its own name and can own real estate in its own name. b. Advantages of Incorporation: pros and cons of nonprofit vs. for-profit The principal advantage of incorporation is that it protects the shareholders or members from personal liability for the obligations and liabilities of the corporation, including unlawful actions of officers, directors and staff acting on its behalf. In addition, incorporation establishes continuity; corporations (both nonprofit and for-profit) are subject to a body of statutes that provide very specific guidance as to their formation and operation; and incorporation brings stature to the organization and implies stability. Where profit is not a goal and the enterprise can be funded without the need for access to capital markets, the nonprofit corporation is the preferred vehicle for pursuing social objectives. Although nonprofit corporations are not prohibited from engaging in commercial activities, the directors of a nonprofit are duty-bound to devote primary attention to the promotion of the social mission of the corporation rather than the production of net income. On the other hand, if access to capital markets is needed, a for-profit corporation (or limited liability company, discussed below) is likely to be the preferred option because nonprofit corporations cannot issue capital stock. The directors of a for-profit corporation, however, owe strict duties to the shareholders to maximize profits and value. Therefore, unless the directors and managers can tie the social mission of their for-profit corporation directly to its business purpose, they can be sued for breach of their duties to shareholders and for misuse of corporate assets if they focus too much on the social mission and forgo profits. This problem can be avoided if all shareholders agree to pursue a social mission or devote a percentage of revenues to charitable causes but such agreements may be temporary because a change in control or a drop in earnings can lead to amendment or abrogation of shareholder agreements. c. Formation A nonprofit corporation attains its separate legal status through the filing and approval by the Department of State of Puerto Rico of its certificate of incorporation. This document is in essence a contract between the state and the nonprofit corporation in which Puerto Rico grants individual legal status to the corporation in exchange for the corporation s commitment to follow its rules. Under the laws of Puerto Rico, any person or recognized entity may organize a corporation by filing a certificate of incorporation with the Department of State which 5

6 shall be executed, certified, filed and recorded as required by the law. This certificate of incorporation must be accompanied with a fee of $5 in the form of a voucher of the Puerto Rican Department of Treasury. There may be one or more incorporators. The following should be included in the certificate of incorporation: 1. The name of the nonprofit corporation. This name should include the term corporation, Corp., Inc. or its equivalent in another language, such as GmbH. This name should also be unique to the nonprofit seeking incorporation. 2. The name of the resident agent and the physical address of the designated office. 3. The nature and purpose of the nonprofit corporation. 4. The name and address of each incorporator. 5. If the duties of the incorporators will cease once the incorporation is complete, the name and address of each member of the initial board of directors. The board of directors may consist of two or more members and this number must be included in the bylaws. 6. The certificate should also identify the corporation as a nonprofit and specify the nature of the services provided or the purposes of the corporation. The nonprofit corporation may change its nature and purpose in the future. The nonprofit must also identify the category it qualifies under as a nonprofit. 7. The certificate may also include the following optional information. This information may also be included in the nonprofit s bylaws: a. It may increase the necessary majority, create a super majority, or even require unanimity of the members or a certain class of members. b. The certificate of incorporation may also include information that would usually be included in the corporation s bylaws. However, this means that any change to these provisions requires an amendment to the certificate of incorporation. c. The term of existence of the corporation if the incorporators do not intend for it to last indefinitely. d. A clause limiting or eliminating the personal responsibility of the directors in the case of claims regarding the breach of duty of due cases

7 For a copy of the certificate of incorporation for nonprofit corporations or any issue related to incorporation in Puerto Rico, contact the Commonwealth of Puerto Rico Department of State at (787) or The Department of State is located at San José Street, Old San Juan, Puerto Rico. It is at these offices that the certificate of incorporation is to be filed. If the nonprofit corporation intends to obtain exemption from federal and state income taxation, the articles or certificate of incorporation must conform with applicable statutes and regulations (discussed below in section g). d. Management and Control Once the nonprofit corporation has been established, the incorporators or the initial board of directors should meet either in person or by any other means of communication. During this meeting, the board of directors or incorporators should ratify the acts in connection with the initial formation of the corporation. During this meeting, the board of directors or incorporators should also adopt bylaws which set forth the rules and procedures governing the decision-making process of the board of directors. The bylaws also establish the general operation and management of the corporation consistent with the applicable statutes of Puerto Rico and the certificate of incorporation. The organizations declared exempt from tax should have a board of directors composed of at least three members, less than fifty percent of which may be members of the family group of the person who established, or is one of the principal executive officers of the organization or holds the position of president of the board of directors. The term family group includes, but is not limited to, the mother, father, brother or sister (whether by whole or half blood), spouse, son or daughter ( natural or by adoption, father in-law or mother in-law, grandparents, uncles (by consanguinity or affinity), cousins up to the fifth degree (by consanguinity or affinity) and any person living under the same household. Typically, the bylaws of a nonprofit corporation contain provisions governing the meetings; voting; the number of director positions that the organization will have, the methods to select and terminate the directors, powers, and officers; the requirements for these positions; the length of their duration; property holding and any other issue that is pertinent to the business or the internal operation of the corporation such as the indemnification of directors and officers; committees; bank accounts; fiscal year audits and financial reports; conflicts of interest; and amendment and dissolution procedures. The bylaws may contain any provision that is not contrary to law or to the certificate of incorporation. 7

8 Aside from adopting the bylaws, this initial meeting also serves to elect the board of directors if not already designated in the certificate of incorporation, select the officers if the initial board of directors is already in place, and carry out any other act needed to perfect the corporation. e. Liability of Members, Directors and Officers The members, directors, and officers are obligated to dedicate themselves to the corporation and to exercise their duties with due care and their best judgment. Only gross negligence on the part of a member, director or officer will result in personal liability. As a rule, under Puerto Rico law, the distinction between the corporation and its owners is respected. In other words, an injured party must sue the corporation, and not its shareholders (what is known as piercing the corporate veil), unless the injured party can prove that (1) that the corporation was a fiction used to legitimize illegal acts, (2) that the corporation and its owners are not two separate entities, or (3) that the corporation was not properly capitalized or funded. Under Puerto Rico law, the corporation may indemnify a director, officer, employee or agent of the corporation who is or has been a party to a legal action relating to their role in the corporation if they succeed in the legal controversy or can prove that they acted in good faith. f. Mergers, Acquisitions and Dissolution To dissolve a nonprofit corporation, the corporation shall follow the procedure set forth in Chapter 9 of Puerto Rico s General Corporation Law. If the nonprofit corporation has members with voting power, they will vote on a resolution to dissolve the nonprofit. If the nonprofit has no voting members, the governing body will vote on the resolution to dissolve the nonprofit. The remaining procedure to dissolve nonprofit corporations conforms to the procedures for the dissolution of for-profit corporations. The nonprofit must also turn in the Certificate of Dissolution form to the Puerto Rican State Department. A nonprofit corporation may merge with another nonprofit corporation or a for-profit corporation. The process of merger or consolidation under the laws of Puerto Rico begins with the approval of a resolution by each governing body of the corporations involved adopting and authorizing the merger. The resolution should include; (1) the terms and conditions of the merger or consolidation; (2) the mode of implementing the merger or consolidation;(3) provisions required by law to be included in the certificate of incorporation for nonprofit corporations; (4) the manner in converting each membership affected by the merger; (5) and any other details deemed necessary. Once this resolution - 8 -

9 has been approved by the members of the governing body by a 2/3 vote, the resulting entity shall present a certificate of merger or consolidation to the Puerto Rican State Department. g. Record Keeping, State Reports and State Taxes The Corporation Law requires the filing of an annual state report at the Department of State or by Internet by the 15th of April. This report must be authenticated by the signatures of a director, authorized official or the incorporator. The corresponding form is available through the Puerto Rico Department of State web page. The cost of filing the annual state report is $5, except for religious corporations. This report must contain: A financial statement prepared according to the generally accepted rules of accounting. This report must then be sworn before a notary public or an officer empowered by the laws of Puerto Rico to administer oaths; A list of the names and mailing addresses of those directors and officers of the corporation holding office on the date of the filing of the report and the expiration dates of their respective offices; The nonprofit s main category of service and form of organization; Any other information required by the Puerto Rico Secretary of State. This report should be filed with the fee of $100 in the form of a voucher of the Puerto Rican Department of Treasury. Letters of endorsement of the Civil Defense Agency of the Commonwealth of Puerto Rico in the case of a nonprofit corporation whose purpose is to provide volunteer civil defense services. If the corporation fails to comply with this requirement, it shall be subject to fines and/or penalties of no less than $100. Every nonprofit corporation organized under the laws of Puerto Rico must maintain accounting books, documents, and records sufficient to: Establish the yearly gross profit and other information that would appear on the Puerto Rican tax returns; and Evidence of the total investments in and out of Puerto Rico, the property owned by the for-profit, and the amount of capital utilized in the business operations in and out of Puerto Rico. 9

10 To apply for tax exemption under Puerto Rican law, nonprofit corporations must comply with section of the Puerto Rican Tax Code (. For further details, please refer to the Nonprofit Taxation section. h. Insurance Nearly every type of activity by a nonprofit corporation can become the target of some kind of a claim by a firm or an individual that alleges damage or injury by the corporation or individuals responsible for it (i.e., directors, officers or employees). Even if the claim is without merit, the costs of defending against the claim can be very substantial. To encourage qualified individuals to accept positions as directors and officers, many nonprofit corporations purchase insurance to cover director and officer (D&O) liability. In addition, most responsible nonprofit corporations purchase a basic comprehensive general liability policy that covers liability for accidents in the corporation s offices, at sponsored meetings and the like. Liability insurance for nonprofit corporations is often a very complicated matter. Consultation with an experienced and knowledgeable agent or consultant is essential to obtain the right coverage at the lowest premium. i. Resources Certificate of Incorporation, Department of State, Annual State Report. Department of State, Certificate of Dissolution, Department of State, Carlos E. Díaz Olivo, Derecho corporativo: Corporaciones (Publicaciones Puertorriqueñas ed. 1999). Takagi, Gene. Nonprofit Bylaws - Common Issues Nonprofit Law Blog See Department of State of Puerto Rico, Formularios del Registro de Corporaciones (Forms for the Registration of Corporations),

11 2. For-Profit Corporations a. Using For-Profit Corporations to Pursue Social Objectives The for-profit form of organization can and frequently is used as a vehicle for conducting a business that also has a social mission or objective. Although for-profit corporations are usually formed for the purpose of making money and distributing it to managers and shareholders, there is no reason why a for-profit corporation cannot include a social mission in the purposes clause of its certificate of incorporation. While such a provision would authorize the corporation to pursue social objectives, it would not require the corporation to do so only the shareholder/owners have this power. And unless all shareholders agree to pursue social aims, dissenters could sue the corporation s directors and managers for failing to operate the corporation in the best economic interests of the shareholders. A shareholders agreement is probably the best way to address this problem. Such an agreement, entered into by all shareholders and the corporation, would require the corporation to be managed and operated so as to pursue specified social objectives thereby overriding fiduciary duties and similar legal principles that govern normal behavior of for-profit corporations. But even the most skillfully drafted shareholders agreement is not a perfect solution because agreements can always be abrogated and amended and the owners of the shares can change via sale, gift or inheritance. Moreover, a tightly drafted shareholders agreement which makes it difficult to respond to business changes over time would tend to render the for-profit corporation much less attractive to investors (potential new shareholders). b. Formation Puerto Rico's General Corporation Law of 2009 (the Corporation Law ) governs the formation, operation and dissolution of for-profit corporations in Puerto Rico. Under the laws of Puerto Rico, any person, regardless of residency, may form a for profit corporation, either singly or in conjunction with another person or entity. To form a corporation, it is necessary to file a certificate of incorporation with the Puerto Rican Department of State along with a filing fee of $100. The certificate of incorporation should also include the following information: The name of the corporation along with the word or phrase corporation, Corp., Inc., or its equivalent in other languages, such as GmbH. This 11

12 name should be unique to the corporation, making it easily distinguishable from other corporations. The mailing and physical address of the principal office in Puerto Rico and the name of the Resident Agent of that same office. The nature of the business. It is sufficient to state that the corporation will dedicate itself to any purpose allowed under the laws of Puerto Rico without limiting itself to any specific purpose. The name of each incorporator along with the physical and mailing address. If the responsibilities of the incorporators are to end with the incorporation, then the certificate should include the names and addresses of the initial board of directors. The number of the board of directors will be set in the bylaws of the corporation, but Puerto Rican law requires at least two (2) members on the board. The certificate shall also include information regarding the classes and numbers of authorized shares and voting rights. If the corporation chooses to issue only one class of stock, the certificate must include the total number of shares and the par value of each, or a statement stating that all shares are to be without par value. If the corporation chooses to issue more than one class of stock, then the certificate must include the number of shares of each class which will have par value and the par value of each share of each class, or the number of shares which will not have par value, or both. The certificate may also expressly grant authority to the board of directors to fix by resolution every right or restriction of the classes of stock. The certificate of incorporation shall also contain any of the following provisions: Provisions which require the vote of a larger proportion of the stock or of any class or series of such stock or of any other voting securities, or of a larger proportion of directors than is required by this subtitle for any corporate action. Provisions to grant to the holders of the capital stock of the corporation, or the holders of any class of stock, or series of class of stock, the preemptive right to subscribe respecting all or each of the additional issues of all or each one of the classes of stock of the corporation, or any of the securities issued by the corporation convertible into such class of stock. No stockholder shall have a

13 preemptive subscription right respecting the issue of additional capital stock or securities convertible into such stock unless, and only to the extent that, the certificate of incorporation expressly grants such right. Any provision for the management of the business or for the conduct of the affairs of the corporation, or to create, define, limit or regulate the powers of the corporation, of the directing, supervising or consulting bodies, or of its directors, supervisors, consultants, and any provision authorizing the directors to execute management contracts for the affairs of the corporation, whose terms shall not exceed three (3) years, if such provisions do not violate the laws of the Commonwealth. A provision limiting the duration of the existence of the corporation to a specified date. If no such provision is included, the corporation shall have perpetual existence. Provisions to impose personal liability for the debts of the corporation on the stockholders or members up to a specified extent and under specified circumstances. If the certificate of incorporation does not contain any provision to such effect, the stockholders or members shall not be personally liable for the debts of the corporation, except by reason of their own acts. A provision to eliminate or limit the personal liability of the directors or stockholders of a corporation in cases of monetary claims for damages resulting from the breach of the fiduciary duties as director, provided that such provision does not eliminate or limit the liability of the director for: o Any breach of the duty of loyalty of the director to the corporation; o acts or omissions not in good faith, or which involve intentional misconduct or knowing violations of law; o Any transaction where the director derives an improper personal benefit. For a copy of the certificate of incorporation for for-profit corporations or any issue related to the incorporation in Puerto Rico, contact the Puerto Rico Department of State at (787) or The Department of State is located at San José Street, Old San Juan, Puerto Rico. It is at these offices that the certificate of incorporation is to be filed. 13

14 c. Management and Control A for-profit corporation has a hierarchical control structure. It is managed by or under the direction of a board of directors and its officers; although its shareholders vote on important corporate issues, such as election of directors, mergers, sale of all assets and dissolution. Similar to a nonprofit corporation, once the for-profit corporation has been established, the initial board of director s meets, ratifies the acts in connection with initial formation of the corporation and adopts bylaws which set forth the rules and procedures governing the operation and management of the corporation consistent with the applicable statutes of Puerto Rico and the certificate of incorporation. In general, the bylaws of a for-profit corporation contain provisions governing director and officer qualifications, powers and duties; voting; meetings of shareholders, directors and officers; filling of vacancies; committees; property holding and transfer; indemnification of directors and officers; bank accounts; fiscal year audits and financial reports; conflicts of interest; and amendment, merger and dissolution procedures. d. Liability of Shareholders, Directors and Officers The directors, and officers are obligated to dedicate themselves to the corporation and to exercise their duties with due care. Only gross negligence on the part of a member, director or officer will result in personal liability. As a rule, Puerto Rico law respects the distinction between the corporation and its owners. In other words, an injured party must sue the corporation and not its shareholders (what is known as piercing the corporate veil) unless the injured party can prove that (1) the corporation was a fiction used to legitimize illegal acts, (2) the corporation and its owners are not two separate entities, or (3) the corporation was not properly capitalized or funded. The corporation may indemnify a director, officer, employee or agent of the corporation who is or has been a party to a lawsuit relating to their role in the corporation if they succeed in the legal controversy or can prove that they acted in good faith. e. Raising Capital For-profit corporations (and LLCs) offer the most flexibility in raising capital, ranging from various kinds of equity (common stock, preferred stock, options, warrants) to numerous types of debt instruments (convertible notes, subordinated notes, bonds, commercial paper)

15 f. Record Keeping and State Reports The Corporation Law requires an annual report to be filed by the 15th of April. This report must be authenticated by the signatures a director, authorized official or the incorporator. The corresponding form is available through the Puerto Rico Department of State web page. This report must contain: A financial statement prepared according to the generally accepted rules of accounting. This report should be audited by a certified public accountant, who is neither a shareholder nor employee of the corporation, unless the forprofit corporation s volume of business did not exceed three million ($3,000,000) dollars. This report must then be sworn before a notary public or an officer empowered by the laws of Puerto Rico to administer oaths; A list of the names and mailing addresses of those directors and officers of the for-profit corporation holding office on the date of the filing of the report and the expiration dates of their respective offices; and Any other information required by the Puerto Rico Secretary of State. This report should be filed with the fee of $100 in the form of a voucher of the Puerto Rican Department of Treasury. Every for-profit corporation organized under the laws of Puerto Rico must maintain accounting books, documents, and records sufficient to: Establish the yearly gross profit and other information that would appear on the Puerto Rican tax returns; and Evidence of the total investments in and out of Puerto Rico, the property owned by the for-profit, and the amount of capital utilized in the business operations in and out of Puerto Rico. g. Taxation Unlike other business forms such as sole proprietorships, partnerships and LLCs, forprofit corporations in Puerto Rico are subject to double taxation. That is, the for-profit corporation pays taxes on the income it earns and its shareholders pay taxes on dividends distributed by the corporation. With a few exceptions, for-profit corporations in Puerto Rico do not pay federal income taxes, only state taxes. 15

16 h. Resources Department of State of Puerto Rico, Formularios del Registro de Corporaciones (Forms for the Registration of Corporations), Department of Treasury of the Commonwealth of Puerto Rico, 3. Limited Liability Companies (LLCs) a. Using LLCs to Pursue Social Change The Chapter 19, Limited Liability Companies, Puerto Rico's General Corporation Law of 2009, governs the formation, operation and dissolution of LLCs in Puerto Rico. Combining certain characteristics of both partnerships and corporations, LLCs are privately owned legal entities that can be formed for the purpose of earning profits, pursuing a social mission, or both, although some states require an LLC to be formed only for a business purpose. LLCs differ from for-profit corporations because they are formed and owned by members rather than shareholders; however, like partnerships, LLCs are eligible for pass-through income tax treatment. This means that income and expenses are reported as though the members incurred them directly, and profits or losses are taxed at the ownership (member) level, rather than the entity (company) level. Members of LLCs can be individual investors as well as for-profit corporations and taxexempt nonprofit corporations. For this reason and also because of pass-through taxation which eliminates double taxation (the effect of taxing income at the corporate level and again when it is included in the owner s income), LLCs are preferred over for-profit corporations as vehicles for social enterprise, especially for joint ventures between a taxexempt nonprofit with a social change mission and a for-profit business. LLCs are akin to partnerships because the members have broad discretion to allocate profit and loss and management powers among themselves (via an operating agreement ). On the other hand, as with the shareholders of corporations, the members of an LLC can be divided into classes, each with its own economic rights, and members have limited personal liability (discussed below). Assuming state laws permit formation of nonprofit LLCs, the IRS will recognize such an LLC as exempt under Section 501(c)(3) if it elects to be treated as a separate legal entity for tax purposes and its operating agreement includes the language mandated by the organizational test (purposes, distribution of assets upon dissolution, etc.) and it meets

17 numerous requirements largely designed to guard against inurement and private benefit. These conditions will be discussed in the Nonprofit Taxation section. b. Formation To form an LLC under the laws of Puerto Rico, it is necessary to file a certificate of organization with the Puerto Rican Department of State along with a filing fee of $100 in the form of a voucher from the Puerto Rican Department of Treasury. One or more authorized persons must execute this certificate of formation. The certificate of organization should also include the following information: The name of the LLC. This name should be unique and should include the designation of Limited Liability Company, L.L.C., or LLC; The physical and mailing address of the designated principal office in Puerto Rico as well as the name of the resident agent of the LLC in charge of this office; The nature or purpose of the LLC. This purpose may be anything permitted under the laws of Puerto Rico; The names and addresses of each person authorized to file the certificate of organization; If the powers of the authorized persons will end upon the filing of the certificate of organization, the certificate should also include the names and addresses of those who will act as administrators until the first meeting of the LLC members; The certificate should also indicate the term of existence of the LLC, if it will be indefinite, perpetual, or a until a specified date; Last, the certificate should specify if the LLC will become effective on the date of the filing of the certificate with the Puerto Rico Department of State or on a specific date with 90 days of the filing date. While the law in Puerto Rico does specifically provide for a nonprofit LLC, it does state that an LLC may undertake any purpose that is not contrary to the law or the Constitution of Puerto Rico. For instance, an LLC may be formed to be the member of a nonprofit corporation or may enter into a joint venture with a not for profit corporation. 17

18 c. Management and Control Typically, an LLC operating agreement among the members governs the management of an LLC. The operating agreement which is like the articles of incorporation, bylaws and a shareholder agreement all in a single document may contain provisions requiring adherence to a social purpose and such purpose and the values it embodies may be interwoven throughout the operating agreement. Under Puerto Rico law, the operating agreement essentially functions as a contract adopted by the members of an LLC to govern the internal matters and management of the LLC. The law governing LLCs includes standard provisions for the management of an LLC. However, an operating agreement in Puerto Rico may change these standard provisions. An operating agreement in Puerto Rico may include: The method of admitting new members after the initial formation of the LLC. The types and classes of members, including: who has management authority; voting rights; admission of members; classes of members of the LLC, along with the rights, responsibilities, and voting rights of each type of member. The operating agreement may also define types and classes of administrators. The members responsibility regarding third parties. Although the law stipulates that it is the LLC and not its members that are responsible for damages to third parties, the members may agree in the operating agreement to assume this type of responsibility. Limitations on a member s right to access the records of the LLC. Remedies and penalties for a member s or manager s breach of the operating agreement. How the LLC will be managed if the members choose to deviate from the statutory scheme The operating agreement may also define: Each member s responsibility to contribute to the LLC. How the profits and losses of the LLC should be distributed among the members

19 The events that justify or require the resignation of a member or manager and the distribution of their interest in the LLC.) The assignment of a member s interest in the LLC to another party and the rights of the assignee. d. Limited Liability of Members and Managers Under Puerto Rico law, the debts, obligations and liabilities of an LLC are solely the responsibility of the LLC, regardless of whether these debts arise from contract, damages or liabilities of the LLC. No member or manager will be held personally liable for these debts. However, members and managers may agree in operating agreement to be personally liable for any such debts, liabilities and obligations. e. Merger, Dissolution and Term of Existence Under the laws of Puerto Rico, mergers of an LLC are governed by the same procedure as for corporations. The governing body of each LLC that wishes to execute a merger must draft a resolution which includes: The terms and conditions of the merger, The chosen method implementing the merger, The relevant changes to the certificate of organization, etc., The method of converting the interests and voting rights of each business entity, and Any other detail deemed important by the governing bodies. This resolution will be put to a vote by the LLC s members. The members will be called to a special meeting in accordance with Article 9.5 of the Corporation Law. The resolution will pass with a majority vote. This resolution must be filed in the Department of State. The dissolution of LLCs in Puerto Rico is governed by the same provisions concerning the dissolution of corporations in Puerto Rico. Each member of an LLC will have the same rights under the law given to shareholders for such proceedings. The governing body of an LLC will draft a resolution for the dissolution of the company to be approved by the absolute majority of the governing body. This resolution will then be sent to each voting member and a meeting will be called. During the meeting, the members will vote 19

20 on this resolution and, if approved by a majority of the members, the Certificate of Dissolution will be filed at the Department of State. The LLC must also turn in the Certificate of Dissolution form to the Puerto Rican State Department. This certificate must include: The name of the LLC; The date that the dissolution was authorized; That the dissolution was authorized under Article 9.5 of the Corporation Law; and The names and addresses of the governing body of the LLC. In Puerto Rico, an LLC may have an indefinite or perpetual term of existence or it may have specific date in which it will cease to exist. f. Raising Capital An LLC offers the same flexibility in raising capital as a for-profit corporation. g. Record Keeping and State Reports The Department of State exempts LLCs from submitting an annual report. However, each LLC in Puerto Rico must submit an annual fee of $150 in the form of a voucher of the Puerto Rican Department of Treasury each 15 th of April

21 h. Taxation Under the Internal Revenue Code for a New Puerto Rico ("2011 Code") limited liability companies ( LLCs ) continue to be subject to tax in the same manner as corporations, but may elect to be treated for tax purposes as partnerships. However, if the LLC is treated for purposes of the U.S. Internal Revenue Code of 1986 as amended, or similar provision of a foreign country, as a partnership or pass-through entity, then, unless it is exempt under the Economic Incentives for the Development of Puerto Rico Act or prior similar incentives acts, or the Puerto Rico Tourism Development Act or prior similar acts as of January 1, 2011, must also be treated as a partnership for Puerto Rico income tax purposes. In such case, the LLC will not be allowed to be taxed as a corporation. i. Resources Certificate of Dissolution LLC, Humphreys, Thomas, Limited Liability Companies and Limited Liability Partnerships (Incisive Media, 2009) Puerto Rico State Department, 4. Joint Ventures A joint venture is not a statutory entity or form of doing business in Puerto Rico. Rather, it is a contractual arrangement whereby more than one person or entity join forces to operate a venture. Many joint ventures operate by agreement only; the participants do not have to create a separate entity as the vehicle for a joint venture. However, nonprofit corporations, for-profit corporations and LLCs can each function as the entity vehicle for joint ventures. When liability protection and maximum flexibility are required and the number of participant/investors is small, the LLC is the preferred entity or vehicle for the joint venture. Thus, for example, a tax-exempt nonprofit corporation pursuing a social mission and a forprofit corporation operating a business can join together and form a joint venture using an LLC as the vehicle for the enterprise. The operating agreement would spell out the rights and obligations of each member. However, each member would be bound by the laws and rules governing its own existence, so that the nonprofit may not confer an undue economic benefit on the for-profit co-venturer, nor may the business corporation use the joint venture to do something that it could not do directly. 21

22 The IRS has addressed the circumstances in which tax-exempt social and charitable enterprises may engage in joint ventures with for-profit entities, and has adopted rules that govern the kinds of benefits that tax-exempt enterprises can confer on for-profit entities in the context of joint ventures. The IRS rules are extremely complicated. A tax-exempt social enterprise should not enter into a joint venture with a for-profit entity without first seeking advice from expert counsel. Sanders, Michael I., Joint Ventures Involving Tax-Exempt Organizations (John Wiley Sons, 3d revised ed 2007). 5. Partnerships and Limited Partnerships a. Overview Partnerships, limited partnerships and limited liability partnerships are forms of organization that can be used to pursue social objectives and are recognized as statutory entities under Puerto Rican law. Partnerships provide almost unlimited flexibility in governance and management. Profits and losses are allocated according to the capital contributions of each partner but unlike LLCs and nonprofit corporations, the total assets of each partner in a general partnership are at risk, not just the capital that has been put into the enterprise. Limited partnerships changed this by permitting the creation of a special class of partners, known as limited partners, who provide capital but do not participate in management. In limited partnerships, the limited partners are shielded from liability beyond their capital contributions, but the general partner who manages the affairs of the limited partnership does not have this liability protection. Limited partnerships are often used as financing vehicles and are most useful when investors are to have no role in management and a simple or flexible governance structure is needed. Limited liability partnerships (LLPs) function like general partnerships but provide extra protections for the general partners. Such protections include personal immunity for liability arising from the negligence and wrongful acts of other partners, unless the other partners were under their direct supervision. Thus, a partner s loss with respect to the LLP is usually limited to his/her investment in the partnership. b. General Partnerships To form a general partnership under the laws of Puerto Rico, the parties must execute a contract where the partners agree to establish a common fund for the functioning of the partnership. Before starting operation, each general partnership must record its

23 establishment, agreements, and conditions in a public instrument and file it in the mercantile registry. The social contract or articles of the partnership should include: The names, and domiciles of the partners; The partnership s name; The names of the managing partners; The capital which each partner will contribute in cash, credit, or property; The duration of the partnership; The amount given to each partner for costs and expenses; and Any other agreement that the partners wish to include. The partnership must operate under a collective name. This name may include all of the partners, some or only one of the partners. In these last two cases, the name of the partnership must include the phrase and company. All of the partners manage the company. Decisions must be made with unanimous approval of the partners; although, it is possible to delegate the management of the partnership to one or more members. Each entity operating as a business in Puerto Rico must register with the Merchants and Businesses Mandatory Registry by July 15 th of each year. Visit the Puerto Rico Trade, Merchants and Businesses Mandatory Registry. c. Limited Partnerships The formation of a limited partnership under the laws of Puerto Rico is very similar to that of a general partnership. The social contract is identical to that of the general partnership except that it must identify the regular partners from the limited partners. The name of the limited partnership should also include limited partnership. The limited partners are only required to make capital contributions and are shielded from liability. However, the limited partner must indemnify the limited partnership from any harm resulting from an abuse of the partner s position or negligence. d. Limited Liability Partnerships (LLPs) To form an LLP in Puerto Rico, the partners must present to the Department of State a certified copy of the partnership agreement or articles of the partnership. This contract should include the name of the LLP, the address of the principal office, the name and address of the promoter, the names and addresses of the partners, and a short description 23

24 of the type of business that the LLP will dedicate itself to. The name of the LLP should include the phrase limited liability partnership. This certified contract should be filed with the Department of State along with a fee of $110 in the form of a voucher of the Puerto Rican Department of Treasury. The LLP must also pay a fee of $10 for the registry of the company name. The LLP must renew its registration each year. The partners of an LLP are not personally liable for damages incurred by the partnership beyond their contribution to the LLP. However, if the partner was personally involved or knew of the act that caused the damage to the third party, they may be held personally liable. i. Resources Limited Liability Partnership Registration Form, Department of State, 6. Sole Proprietorships Persons conducting a social enterprise alone in Puerto Rico without the protections afforded by incorporation are called sole proprietors. A sole proprietorship has no legal existence apart from its owner and may be formed without any expense or formality. Profits and losses are borne directly by the proprietor. The proprietor may operate under a trade name that is registered. Such registration provides limited protection for exclusive use of the name, absent trademark or service mark registrations. To register a trade name in the Puerto Rico Department of State, a sole proprietor must present: A written application addressed to the Secretary signed by the applicant or their representative. The application should specify the activity designated by the trade name. A sworn statement to the effect that, to the best of the applicant s knowledge, no other person is entitled to the trade name. Facsimiles of the trade name as used. Evidence that the applicant has applied for or obtained the licenses or permits required by law or regulations in order to engage in the commerce for which the registration of a trade name is being requested. Fee of $150 in the form of a voucher of the Puerto Rican Department of Treasury