United States: Choice Of Business Entity - Extraterritorial Recognition Of LLC And LLP Limited

A. General. Courts of other states should recognize the Texas statutory liability shield of LLC's and LLP's under the "internal affairs" doctrine, which treats the laws of the state of organization as governing the liability of members of business organizations, such as corporations and limited partnerships. The principal case that did not follow this doctrine was a Texas case, which has been effectively overturned by H.B. 278. The extent to which LLC or LLP status will be recognized in other jurisdictions absent a specific statute, however, remains a question for which there is little case-law precedent.

B. Texas Statutes. The LLC Act states that it is the "intention of the legislature by the enactment of this Act that the legal existence of limited liability companies formed under this Act be recognized beyond the limits of this state and that, subject to any reasonable registration requirements, any such limited liability company transacting business outside this state shall be granted the protection of full faith and credit under Section 1 of Article IV of the Constitution of the United States."

There is no comparable statement of legislative intention in the LLP Provisions. TRPA § 1.05, however, provides that (1) a partnership's internal affairs are governed by the law of the state chosen by the partners if the law chosen bears a reasonable relationship to the partnership's business and affairs under applicable choice of law principles and (2) the law governing a partnership's internal affairs also governs the liability of its partners to third parties. Texas has thus codified the internal affairs doctrine recognized by the courts of other states, as discussed below.

C. Texas Cases. Texas appears to be the only state with a reported decision denying limited liability to owners of an unincorporated entity formed under another state's law (such as the LLC Act) because the forum state did not have such a statute. In Means v. Limpia Royalties, suit was brought in Texas by a purchaser of trust interests for rescission of the purchase because of misrepresentations by the defendant that holders of trust interests could not be liable for trust obligations. Limpia Royalties was an unincorporated association operating under a declaration of trust, was organized under the laws of Oklahoma and had its principal office in Oklahoma. In holding that the representations were materially misleading, the court wrote:

The sections of the LLC Act providing for qualification of Foreign LLC's were intended to repudiate, and resolve the concern raised by, the Limpia Royalties case with respect to limited liability of non-corporate entities created under the laws of other states but not authorized to be created under Texas law. The Bill Analysis used by the Legislature in connection with the consideration of H.B. 278 states:

D. Decisions in Other States. There is precedent in other jurisdictions suggesting that their courts would apply the internal affairs doctrine to unincorporated entities not organized or qualified to do business as foreign entities under local law, thus preserving the liability shield of Texas law for LLC's and LLP's. Further, there apparently are no reported cases in other jurisdictions that follow the reasoning of, or reach the same result as, the Limpia Royalties case.

This issue of which jurisdiction's law governs liabilities of partners to third parties arose in King v. Sarria, an 1877 New York case of first impression. The defendants entered into a contract of partnership in Cuba, which was then ruled by Spanish law. Under the contract, defendant Sarria became a special partner whose liability was expressly limited to a fixed amount. As a special partner under Spanish law, Sarria was entitled to participate in the profits of the partnership, but could not be made liable for its debts. The plaintiffs sought to recover from Sarria a sum of money due under a contract with the partnership.

The court held that the partnership agreement was governed by the laws of Spain and that the liability of Sarria and the extent of the authority of his partners to bind him were to be determined by those laws. The court stated:

In King v. Sarria, the court held that the Spanish statute limiting liability of particular partners was not contrary to New York public policy and therefore applied the Spanish statute to limit Sarria's liability. However, in reaching this conclusion, the court noted that the Spanish statute resembled New York's own statute for the formation of limited partnerships.

The 1982 New York case of Downey v. Swan helps answer the question of what happens when the forum state has no corresponding statute. In Downey, the defendant Swan was a member of a limited partnership association formed under New Jersey law. Under New Jersey law, the members and managers of a limited partnership association were not personally liable for a wrongful death that occurred on property owned by the partnership. In remanding the case to the trial court for a determination whether the association was operating after its term had expired, the court held that if the association were still in existence, the liabilities of its members would be governed by New Jersey law and the limited liability afforded by that law would be given full effect. Because New York had no limited partnership association law, the New York court could not have applied analogous New York law to reach the same result.

In a recent case involving a Texas LLP law firm, the internal affairs doctrine was recognized by a federal district court in Massachusetts. In Liberty Mutual Insurance Co. v. Gardere & Wynne, L.L.P., although the court granted a motion to transfer a case to a federal court in Texas largely to avoid having to decide numerous questions about the effect of the Texas LLP status on a case pending in Massachusetts which did not have an LLP statute, the limited liability of partners under the LLP Provisions was recognized under the internal affairs doctrine as follows:

The Gardere case illustrates the difficult procedural issues which can be encountered when liability is asserted against an LLC or an LLP outside of the jurisdiction of its creation. Under general conflict of law principles, (i) for contract claims, in the absence of a valid contractual choice of law provision, the law of the jurisdiction with the most significant contacts will govern, and (ii) for tort claims, the law of the state with the most significant relationship to the occurrence and the parties will generally govern. Whether a court adjudicating a claim against a foreign LLC or LLP, after applying one state’s laws in determining that an LLC or LLP is liable for a contract or tort claim, will then apply the internal affairs doctrine or the full faith and credit clause of the Constitution to uphold the liability shield of the entity’s jurisdiction of organization remains an issue in those few jurisdictions still lacking statutory guidance, although the better authority to date would apply the internal affairs principle and uphold the statutory liability shield.

F. Qualification as Foreign Entity and Other Ways to Reduce Extraterritorial Risk. Since all 50 states (including Texas) plus the District of Columbia now have LLC statutes, the LLC extraterritorial risk analysis requires analysis of the applicable LLC statute in each of the states in which the LLC contemplates doing business. Generally qualification as a foreign LLC in a jurisdiction will protect Members' limited liability, but failure to qualify may not result in the loss of limited liability, although it may result in the imposition of statutory penalties. The LLC statutes in Texas, New York and Delaware, which each contain provisions for the registration/qualification of foreign LLC's, expressly provide that the failure of a foreign LLC to so qualify shall not affect the limited liability of its members or managers, which shall be determined by the laws of the LLC's jurisdiction of organization. Likewise, since at least 48 states (including Texas) plus the District of Columbia have LLP statutes and other states have them under consideration, foreign qualification needs to be considered as a means of reducing extraterritorial risk. The various statutes are not consistent as to the availability or necessity of foreign qualification as a means of obtaining local limited liability recognition, with Delaware relying on the internal affairs doctrine and not providing for foreign qualification and with New York and Maryland providing for foreign qualification.

Although the LLP is the entity of choice for many professionals, not all states permit all types of professionals to avail themselves of limited liability for professional malpractice (whether through a professional corporation, a PLLC or an LLP), thus necessitating additionally a review of the applicable professional rules in each jurisdiction in which the entity proposes to transact business.

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