by LLC attorneys Richard C. Keyt, JD, MS (accounting), and Richard Keyt, JD, LL.M. (federal tax law)
Because we have formed 9,200+ LLCs and we don’t charge to answer questions about forming California LLCs we hear the same frequently asked questions about California LLCs. This article asks and answers CA LLC FAQs about creating and operating a California limited liability company under California’s Revised Uniform Limited Liability Company Act effective January 1, 2014.
For a detailed explanation of how to form a CA LLC see our article called “How to Form a California Limited Liability Company.”
Pre-Formation
- The name must end with: L.L.C., LLC, Limited Liability Company, Ltd. Liability Company, Limited Liability Co. or Ltd. Liability Co.
- The name may not contain trust, trustee, incorporated, inc., corporation, corp or bank.
- The name may not contain insurance company, insurer or any other words suggesting that the company engages in the business of issuing insurance policies or assuming insurance risks.
The first step in picking a name for your new LLC is to review the California Secretary of State’s LLC name rules. Step two is to search for a conflicting name on the SOS’ business search database. If your name seems good you won’t know if it will be accepted to the SOS unless you actually file the Articles of Organization with the SOS.
If you are forming an LLC to own rental real estate, use a portion of the street address in the name because more often that not the name will be approved by the SOS. For example, if the street address were 4134 West Paradise Street you could name the LLC 4134 Paradise Investments, LLC.
Warning: You should also do a search of the U.S. Patent & Trademark Office trademark database to see if there are any federal trademarks or service marks identical or similar to your desired name. If your search of the trademark database finds a registered trademark or service mark that conflicts with your desired name you should not use the name because using the name could cause the owner of the trademark or service mark to take legal action against your LLC for infringing on its mark.
Expedited filing requests must be delivered in person at the public counter in Sacramento, 1500 11th Street, Room 390, during regular business hours. Regular business hours are Monday through Friday from 8:00 a.m. to 5:00 p.m., excluding state holidays. The expedited filing service is available only in the Sacramento office.
A document submitted to the Secretary of State for expedited filing will be reviewed and a filing response will be provided within the time frame requested, indicating whether the document has been filed or rejected. If the Articles of Organization are rejected, the filing response will state the reason(s) for the rejection. You may request delivery of the filing confirmation or filing response by one of the following means: customer pick up; email; fax; first class mail; or overnight courier (prepaid, pre-addressed overnight courier envelope must be included).
For more about expedited review services go to “Preclearance and Expedited Filing Services.”
Anybody who can read can prepare and file the one page Secretary of State’s form Articles of Organization (Form LLC-1), but if you want the liability protection provided by California law to the owners of the LLC you must comply with RULLCA. Document preparers and most attorneys will not tell you how to comply with RULLCA, but a good LLC attorney will. We give our LLC clients two very important tools to educate them on what they must do to comply with RULLCA. All of our LLCs get:
- A copy of our book called the “California LLC Operations Manual.” We wrote this book because we want our clients to know what they must do to comply with RULLCA so a court will not pierce the company veil and hold the owners liable for the LLCs debts.
- Emails from us sent regularly for several years to the members that remind them to do things like open the LLCs bank account, sign the Operating Agreement, set up the books, consult with a CPA, file the Statement of Information (the original one and the one due every two years thereafter), pay the $800 minimum tax, document major actions with minutes or resolutions of the members, hold an annual meeting of the members and document it with minutes or resolutions, deed real estate to the LLC (if the LLC was formed to own real estate), prepare and file the first tax return (federal and state) and many other topics.
Another reason why you don’t want to use a document preparer or a less than experienced attorney is because you don’t know if they will give you pre-RULLCA LLC Operating Agreement or one that is customized for your LLC and that is written to comply with RULLCA. Our Operating Agreement is customized for each LLC and has been drafted with by our experienced LLC attorneys after extensive studying of every provision in the new California RULLCA.
Formation
For example, if a plaintiff wanted to sue World Wide Widgets, LLC, the plaintiff can search the records of the California Secretary of State to find the name and address of the LLC’s resident agent. The plaintiff can then arrange to serve the legal documents on the resident agent. Service of documents on the resident agent is legal service of the documents on the LLC.
Pursuant to California Corporations Code (“Code”) Section 25110, the offer and sale of securities in California must be qualified, unless exempt. If exempt, the firm should file the appropriate limited/small offering exemption notice. The definition of “Security” is found in Code Section 25019. The interests in a limited liability company and any class or series of such interests are considered a security and thus subject to either qualification of the securities or the filing of an exemption notice unless all of the members are actively engaged in the management of the limited liability company. The appropriate securities/notice filing should be made with the Commissioner or, if you are not making the securities/notice filing, please provide the reason(s) the filing is not being made and a copy of your Articles of Organization showing that all members are managing members of the company. Please note that, if required, limited liability companies organized in California generally file a notice of transaction pursuant to either Corporations Code Section 25102(f) or 25102(h).
- If the LLC has only one member upon formation, the person becomes a member as agreed by that person and the organizer of the limited liability company.
- If a limited liability company is to have more than one member upon formation, those persons become members as agreed by the persons before the formation of the limited liability company. California RULLCA allows people and entities to agree to be members and sign an Operating Agreement before the LLC is actually formed. When a lot of money will be invested by members into an LLC we recommend that the prospective members agree on and sign the Operating Agreement before filing the Articles of Organization.
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After formation of a limited liability company, a person becomes a member as follows:
(1) As provided in the operating agreement.
(2) As the result of a merger or conversion.
(3) With the consent of all the members.
Warning: Note that after the LLC has filed its Articles of Organization the only way to document and prove who owns the LLC is by an Operating Agreement signed by all of the members. DO NOT FORM A CALIFORNIA LLC AND FAIL TO HAVE ALL THE MEMBERS SIGN AN OPERATING AGREEMENT.
If you are a resident of California and the LLC will engage in business outside California or own real estate outside California the foreign LLC may still be required to register to do business in California. To learn more about when a foreign LLC must register to do business in California real our article called “Warning for Non-California LLCs that Have Members, Managers or Agents in California.”
Caution: If you form an LLC outside California for a business operated in California or investment real estate located in California and the LLC is a party in a California lawsuit, the California court will apply California law to the dispute regardless of where the LLC was formed.
When an LLC Must Comply with Securities Laws
any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security”, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.
Although the term “LLC membership interest does not appear in the above definition of security that does not mean that LLC membership interests are never securities. If a membership interest is considered “an investment contract” then for federal securities law purposes the membership interest is a security.
The term “investment contract” was defined in the famous U.S. Supreme Court securities law case called “SEC v. Howey, 328 U.S. 293 (1946). In the Howey case the U.S. Supreme Court found that the sale of real estate was an investment contract and therefor a security under the 1933 Securities Act. The court said:
[A]n investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party . . .
(328 U.S. at 298). Later court opinions have loosened the “solely” part of this definition with the result an investment contract exists if the purchaser of the investment contract expected that profits would be derived primarily through the efforts of others. In other words if the promoter says give me money and you can site back on the couch while we make profits for you then you are buying an investment contract, which is a security.
Courts that have considered whether California LLC membership interests have used the general partnership vs. limited partnership analysis. The general rules are that: (i) a general partnership does not involve the issuance of a security because all of the general partners have management powers, and (ii) a limited partnership issues a security when it issues a limited partnership interest because limited partners by definition lack management powers. Many California securities attorneys believe that courts will equate member managed LLCs with the general partnership and manager managed LLCs with the limited partnership.
The courts may find that California LLCs that are manager managed that issue membership interests are issuing securities to the non-manager members in the form of investment contracts. The courts may also find that California LLCs that are member managed do not involve investment contracts or securities, but if a member is prohibited from being involved in management the court may find that the member acquired a security in the form of an investment contract.
A California LLC cannot offer or sell a membership interest without registering or qualifying the security or unless the offer or sale is exempt from registration or qualification. When a membership interest is a security the LLC must comply with the anti-fraud provisions of federal and California securities laws, including the requirement that the LLC disclose all material facts with respect to the membership interests and the LLC and it cannot omit any material facts.
Corporations Code Section 25019 defines security as follows:
“Security” means any . . . interest in a limited liability company and any class or series of those interests (including any fractional or other interest in that interest), except a membership interest in a limited liability company in which the person claiming this exception can prove that all of the members are actively engaged in the management of the limited liability company; provided that evidence that members vote or have the right to vote, or the right to information concerning the business and affairs of the limited liability company, or the right to participate in management, shall not establish, without more, that all members are actively engaged in the management of the limited liability company. [emphasis added].
Translation: California law starts with the assumption that all membership interests in an LLC are securities subject to California’s securities laws, but if all the members are ACTIVELY engaged in management the membership interest is not a security.
- Membership Interest Not a Security. California LLCs that are owned by one person, a husband and wife, registered domestic partners or a small group of people who are all actively involved in managing the member managed company should not be subject to federal or California securities laws.
- Membership Interest is a Security. If the California LLC is manager managed there is a presumption that the LLC membership interests acquired by members not involved in management are securities. There is little case law on this issue, but whether the issuance of a membership interest is a security depends on whether the interest is considered to be an “investment contract.” Federal and California securities laws define “investment contract” in the definition of a security.
The first bullet point above states the general rule, but there are exceptions to that rule. A member managed California LLC can be a security under California securities law if any of the following facts exist:
- Any member fails to be actively engaged in management. Even in a two member member managed LLC if one member is not regularly involved in management the membership interests are securities under California securities laws. All members must be regularly and continuously involved in management.
- The member managed LLC has too many members, which can by itself cause a court to find that one or more members is not actively engaged in management. For example, if there are 30 members of a member managed LLC the court could say that 1 vote out of 30 (s opposed to 1 out of 2 or 3) equates to little or no voice in actual management.
- There are facts that indicate that one or more members are not actually involved in management.
Warning: If your new California LLC will be deemed to be issuing investment contracts, i.e., securities, then at a minimum the LLC should have each member sign a Subscription Agreement that contains representations and warranties and the LLC should prepare and file a Notice of Transaction with the California Department of Business Oversight. For more about the Notice of Transaction see the following FAQ.
It is unlawful for any person to offer or sell in this state any security in an issuer transaction (other than in a transaction subject to Section 25120 [a recapitalization or reorganization]), whether or not by or through underwriters, unless such sale has been qualified under Section 25111, 25112 or 25113 (and no order under Section 25140 or subdivision (a) of Section 25143 is in effect with respect to such qualification) or unless such security or transaction is exempted or not subject to qualification under Chapter 1 (commencing with Section 25100) of this part.
California Corporations Code Section 25102 states,”The following transactions are exempted from the provisions of Section 25110:”
(f) Any offer or sale of any security in a transaction (other than an offer or sale to a pension or profit-sharing trust of the issuer) that meets each of the following criteria:
(1) Sales of the security are not made to more than 35 persons, including persons not in this state.
(2) All purchasers either have a preexisting personal or business relationship with the offeror or any of its partners, officers, directors or controlling persons, or managers (as appointed or elected by the members) if the offeror is a limited liability company, or by reason of their business or financial experience or the business or financial experience of their professional advisers who are unaffiliated with and who are not compensated by the issuer or any affiliate or selling agent of the issuer, directly or indirectly, could be reasonably assumed to have the capacity to protect their own interests in connection with the transaction.
(3) Each purchaser represents that the purchaser is purchasing for the purchaser’s own account (or a trust account if the purchaser is a trustee) and not with a view to or for sale in connection with any distribution of the security.
(4) The offer and sale of the security is not accomplished by the publication of any advertisement. The number of purchasers referred to above is exclusive of any described in subdivision (i), any officer, director, or affiliate of the issuer, or manager (as appointed or elected by the members) if the issuer is a limited liability company, and any other purchaser who the commissioner designates by rule. For purposes of this section, a husband and wife (together with any custodian or trustee acting for the account of their minor children) are counted as one person and a partnership, corporation, or other organization that was not specifically formed for the purpose of purchasing the security offered in reliance upon this exemption, is counted as one person. The commissioner shall by rule require the issuer to file a notice of transactions under this subdivision.
The failure to file the notice or the failure to file the notice within the time specified by the rule of the commissioner shall not affect the availability of the exemption. Any issuer that fails to file the notice as provided by rule of the commissioner shall, within 15 business days after discovery of the failure to file the notice or after demand by the commissioner, whichever occurs first, file the notice and pay to the commissioner a fee equal to the fee payable had the transaction been qualified under Section 25110. Neither the filing of the notice nor the failure by the commissioner to comment thereon precludes the commissioner from taking any action that the commissioner deems necessary or appropriate under this division with respect to the offer and sale of the securities.
If your California LLC will issue a security it must file a Notice of Transaction with the California Department of Business Oversight not later than 15 calendar days after the first sale of a security in the transaction in California. The first sale in California occurs when the LLC obtains a contractual commitment in California to purchase one or more of the securities the LLC intends to sell in connection with the transaction. No subsequent notices are required for sales in connection with the same transaction. The information in the Notice relates to the entire transaction, not just the first sale or sales in California.
The Notice of Transaction must be filed online using the California Department of Business Oversight’s DOCQNET online filing system. The Notice of Transaction shall be signed and dated by an authorized officer, director, general partner or trustee of the issuer (or a person occupying a position with the LLC of equivalent responsibility) or by the authorized attorney of the LLC. The LLC must print a copy of the Notice of Transaction and manually sign and date the Notice. The notice shall be executed before or at the time the electronic filing is made and shall be retained by the issuer for a period of five years from the date of filing.
Operating the LLC
Each limited liability company shall maintain in writing or in any other form capable of being converted into clearly legible tangible form at . . . [an office in California] all of the following:
(1) A current list of the full name and last known business or residence address of each member and of each holder of a transferable interest in the limited liability company set forth in alphabetical order, together with the contribution and the share in profits and losses of each member and holder of a transferable interest.
(2) If the limited liability company is a manager-managed limited liability company, a current list of the full name and business or residence address of each manager.
(3) A copy of the articles of organization and all amendments thereto, together with any powers of attorney pursuant to which the articles of organization or any amendments thereto were executed.
(4) Copies of the limited liability company’s federal, state, and local income tax or information returns and reports, if any, for the six most recent fiscal years.
(5) A copy of the limited liability company’s operating agreement, if in writing, and any amendments thereto, together with any powers of attorney pursuant to which any written operating agreement or any amendments thereto were executed.
(6) Copies of the financial statement of the limited liability company, if any, for the six most recent fiscal years.
(7) The books and records of the limited liability company as they relate to the internal affairs of the limited liability company for at least the current and past four fiscal years.
Warning: We cannot overstate the importance of complying with Section 17701.13. If the LLC fails to comply with this statute the failure will be used by a creditor in court who seeks to pierce the company veil and hold the LLC’s members liable for the LLC’s debts and by disgruntled members who sue the LLC and/or the parties who manage the LLC.
a person that has become a member of a limited liability company under Section 17704.01 and has not dissociated under Section 17706.02.
Corporations Code Section 17704.01 states that after the LLC is formed a person becomes a member as provided in the Operating Agreement with the consent of all members. If the LLC does not have an Operating Agreement then apparently California LLC law does not allow the LLC to add any new members unless and until the members adopt an Operating Agreement.
If the LLC members have an Operating Agreement, but it does not authorize adding new members the LLC cannot add any new members until after the members amend the Operating Agreement to allow new members. If the Operating Agreement allows new members then the existing members must consent to the new member(s) and satisfy any requirements set forth in the Operating Agreement.
“Operating agreement” means the agreement, whether or not referred to as an operating agreement and whether oral, in a record, implied, or in any combination thereof, of all the members of a limited liability company, including a sole member, concerning the matters described in subdivision (a) of Section 17701.10. The term “operating agreement” may include, without more, an agreement of all members to organize a limited liability company pursuant to this title. An operating agreement of a limited liability company having only one member shall not be unenforceable by reason of there being only one person who is a party to the operating agreement. The term includes the agreement as amended or restated.
Warning: Please do not adopt an oral Operating Agreement. Save all the members of your LLC from future grief and stress by having all of the members sign an Operating Agreement that has been drafted to comply with the new California Revised Uniform Limited Liability Company Act that became law on January 1, 2014.
(a) Upon the request of a member or holder of a transferable interest, for purposes reasonably related to the interest of that person as a member or a holder of a transferable interest, a manager or, if the limited liability company is member-managed, a member in possession of the requested information, shall promptly deliver, in writing, to the member or holder of a transferable interest, at the expense of the limited liability company, a copy of the information required to be maintained by paragraphs (1) [ A current list of the full name and last known business or residence address of each member and of each holder of a transferable interest in the limited liability company set forth in alphabetical order, together with the contribution and the share in profits and losses of each member and holder of a transferable interest.], (2) [If the limited liability company is a manager-managed limited liability company, a current list of the full name and business or residence address of each manager.], and (4) [Copies of the limited liability company’s federal, state, and local income tax or information returns and reports, if any, for the six most recent fiscal years] of subdivision (d) of Section 17701.13, and any written operating agreement of the limited liability company.
(b) Each member, manager, and holder of a transferable interest has the right, upon reasonable request, for purposes reasonably related to the interest of that person as a member, manager, or holder of a transferable interest, to each of the following:
(1) To inspect and copy during normal business hours any of the records required to be maintained pursuant to Section 17701.13.
(2) To obtain in writing from the limited liability company, promptly after becoming available, a copy of the limited liability company’s federal, state, and local income tax returns for each year.
a spouse who is operating or managing a business or an interest in a business that is all or substantially all community personal property has the primary management and control of the business or interest. Primary management and control means that the managing spouse may act alone in all transactions but shall give prior written notice to the other spouse of any sale, lease, exchange, encumbrance, or other disposition of all or substantially all of the personal property used in the operation of the business (including personal property used for agricultural purposes), whether or not title to that property is held in the name of only one spouse. Written notice is not, however, required when prohibited by the law otherwise applicable to the transaction.
The table below illustrates the franchise tax amount due during a year depending on the amount of gross receipts or net profits. The center column shows the gross receipts tax payable by all California LLCs taxed as sole proprietorships and partnerships. This tax is $800 + gross receipts fee based on income over $250,000. The right column shows the net profits tax payable by LLCs taxed as corporations and corporations. This tax is the greater of $800 or 1.5% of gross profits.
| Gross Receipts or Net Profits | Gross Receipts Tax on LLC Taxed as Partnership or Sole Proprietorship | Net Profits Tax on LLC Taxed as Corporation & on Corporations |
|---|---|---|
| less than $250,000 | $800 | $800 |
| $250,000 | $1,700 | $3,750 |
| $499,999 | $1,700 | $7,500 |
| $500,000 | $3,300 | $7,500 |
| $750,000 | $3,300 | $11,250 |
| $999,999 | $3,300 | $15,000 |
| $1,000,0000 | $6,800 | $15,000 |
| $2,000,000 | $6,800 | $30,000 |
| $4,999,999 | $6,800 | $75,000 |
| $5,000,000 or more | $12,590 | $75,000 + 1.5% of profits over $5,000,000 |
Except as otherwise provided by statute, all property, real or personal, wherever situated, acquired by a married person during the marriage while domiciled in this state is community property.
Family Code Section 770 contains the exceptions to the above rule. It says that separate property is: (1) All property owned by the person before marriage. (2) All property acquired by the person after marriage by gift, bequest, devise, or descent. (3) The rents, issues, and profits of the property described in this section.
Warning for Married People Who Want to Own their Membership Interest as Separate Property: The legal significance of these two statutes taken together is that if a person is a married resident of California at the time he or she acquires a membership interest in an LLC the couple will own the membership interest as community property unless the non-owner spouse signs a Disclaimer in which he or she acknowledges that the non-owner spouse does not own any interest in the LLC and the owner spouse owns it as separate property.
Note: When we are hired to form a California LLC and a married California resident member tells us that he or she is to own the membership interest as separate property we will prepare a Disclaimer for the non-owner spouse to sign. If the owner spouse fails to get the non-owner spouse to sign the Disclaimer then the couple will own the membership interest as community property.
If you have questions about forming a California LLC, contact California LLC lawyer Richard C. Keyt at 480-664-7472 or his father Arizona LLC attorney Richard Keyt at 480-664-7478. We do not charge for entity formation related questions.
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