LLC Law Monitor : Northwest Limited Liability Corporation Lawyer & Attorney : Doug Batey : Stoel Rives Law Firm : LLC Formation, Tax Liability

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Congress is considering a bill that would require organizers of LLCs to disclose the LLC’s members on formation and periodically thereafter. (The bill also applies to corporations and corporate shareholders.) On June 18, 2009 the U.S. Senate Committee on Homeland Security and Governmental Affairs held a hearing on the Incorporation Transparency and Law Enforcement Assistance Act, S. 569. This bill was introduced in 2008 and re-introduced in 2009. One of the co-sponsors in 2008 was then-Senator Barack Obama. Gary Rosin has reported on the hearing here.

This bill would require all the states to change their laws so that organizers of LLCs would be required to provide the state at the time of formation with the names and addresses of the LLC’s “beneficial owners”. Each LLC would have to update its list of beneficial owners in an annual filing, or if the state does not require annual filings, each time a change is made in the ownership. S. 569 § 3. “Beneficial owner” is defined broadly as an individual who has “a level of control over, or entitlement to, the funds or assets of a corporation or limited liability company that, as a practical matter, enables the individual, directly or indirectly, to control, manage, or direct” the corporation or LLC. Id. Since a beneficial owner has to be an individual and not an entity, any multiple levels of ownership would have to be traced to find the individuals who are the beneficial owners.

This definition is breathtakingly broad. For a variety of investor requirements and legitimate financing and tax efficiency reasons, many businesses involve complex structures with multiple entities, various ownership and voting rights, and contractual relationships with nonmembers. The terms “control” and “as a practical matter” are undefined and will be difficult to interpret in some contexts. In many cases individuals who are not members of an LLC could nonetheless fall within the definition of beneficial owner, requiring that their names and addresses be reported to the state.

The information that the states must collect is to be given to the federal government or other states in response to:

·         subpoenas from any state or federal agency or congressional committee;

·         written requests by a federal agency on behalf of another country under an international treaty, agreement or convention; or

·         orders from a federal court responding to a request by a foreign or international tribunal or litigant.

This bill has so many things wrong with it that a critic can view it as a target-rich opportunity. Professors Ribstein, Bainbridge and Verret have criticized the bill’s weak justification, lack of clarity, high costs and low benefits, ineffectiveness, unconstitutionality, and lack of wisdom in federalizing an area of law that has traditionally been a matter of state control.

S. 569 would be a radical change because in this country members of LLCs (and shareholders of corporations) are not generally required to be identified when the entity is formed or at any later time. There are some specific occasions when members and shareholders must be identified, such as in response to discovery requests in litigation, in response to law enforcement subpoenas, or when a shareholder or member makes a request in compliance with the applicable state LLC or corporate statute, but those are event-driven and relatively infrequent.

There is one case where some states require that members of an LLC be routinely identified, and that is when the LLC is member-managed. Many states require that the identity of corporate directors and LLC managers be provided to the state, and make that information publicly available. But if there are no managers other than the members, then all members are managers, and some states require in that case that all the members be identified. Washington and California, for example, require that all members of a member-managed LLC be periodically identified in a statement filed with the state. RCW 25.15.105(1)(e); Cal. Corp. Code § 17060(a)(4). Oregon requires that at least one member of a member-managed LLC be identified in an annual report to the state. ORS 63.787(1)(d).

S. 569 does not require public disclosure of the member and shareholder information that it would require the states to collect, but it does not bar disclosure by the states. It’s likely that over time this member and shareholder information would be made publicly available by at least some states, under the combined pressure of the feel-good label “transparency” and the usual legislative and bureaucratic mission creep.

All of this information would be collected to further the goals stated in the bill of preventing wrongdoing by U.S. corporations and LLCs with unknown owners. Since LLCs and corporations cannot act except through human agents, i.e., directors, managers, and officers, the ownership of a wrongdoing LLC can be investigated through application of the existing law enforcement tools to the agents of LLC. The testimony in the hearing on the need for this information to be collected is not compelling.

But even assuming that there is a law enforcement need for uniform collection of ownership information, it seems unlikely that a criminal who forms an LLC for an illegal enterprise will dutifully use his correct name. An alias or a straw man can easily be used, or the wrongdoer can use an entity not covered by the bill. Meanwhile, the nearly two million new LLCs and corporations formed in this country each year, and all ongoing LLCs and corporations, will be attempting to comply with the new filing requirements. Only law-abiding businesses would be burdened by these requirements.