One of the unique features of the limited liability company (LLC) and the LLC statutes involves how the company is managed.
With most business organizations it is either all of the owners who manage (like in a general partnership) or there is a separation of ownership and management (like in a corporation).
But this is not the case with the LLC. The owners of an LLC are called members, and those members have a choice. Their LLC can be member-managed, or it can be manager-managed. Deciding how their LLC will be managed is one of the most important decisions members will make before forming the company.
Defining member-management vs. manager-management
A member-managed LLC is an LLC in which all the members participate in the decision-making process. Where there is a dispute, the vote of a majority generally rules, while certain extraordinary actions require unanimous consent.
In a manager-managed LLC, the members do not participate in the day-to-day management. The LLC has one or more managers who make business decisions. A member can also be one of the managers—just as a shareholder can also be one of a corporation’s directors. Or the manager may be an outsider. Even a single-member LLC can be manager-managed if the member does not want to manage the business himself or herself.
Where is the decision made?
The LLC statutes have a default rule under which an LLC will be member-managed.
However, the members can opt-out of that rule and provide for manager-management. In some states the choice of member-management or manager-management must be set forth in the formation document (e.g., Articles of Organization or Certificate of Formation). In others, it can be provided for in the operating agreement without providing notification in the formation document.
What is the significance of member-management or manager-management?
The choice of member-management or manager-management has important implications for the members.
Right to participate in day-to-day decision making
If the members choose manager-management, they will not have a say in ordinary business decisions and will have to rely on others to ensure their goals in investing in the LLC are met.
On the other hand, if they choose member-management they need to be prepared to make these business decisions.
Right to bind the LLC
In general, a member in a member-managed LLC is an agent of the LLC and can bind the LLC by his or her actions in the ordinary course of business—such as by signing a contract with a vendor or hiring or firing employees.
On the other hand, a member in a manager-managed LLC is not an agent of the LLC and cannot bind it—only a manager can.
In many states this agency is statutory. The LLC act specifically says that a member in a member-managed LLC and a manager in a manager-managed LLC is an agent of the LLC.
In other states, however, it is not statutory, meaning that the general laws of agency will determine if the person acting on the LLC’s behalf had the authority to bind it.
If a member acts without authority and it is harmful to the LLC, the member could end up being liable to the LLC for damages.
A fiduciary is someone who controls the assets of others. A member in a member-managed LLC and a manager in a manager-managed LLC is a fiduciary and owes fiduciary duties to the LLC and its other members. In general, this means the members who are also managing, whether in a member-managed or manager-managed LLC, need to put the LLC’s interests over their own and make informed decisions. Breaching these duties can result in liability for the member.
This is a simplified explanation of the rights, powers, and duties of the members—or non-members—who manage an LLC. The members can allocate these powers and duties among themselves in their operating agreement. For example, one member may be solely responsible for hiring and firing. Or, if the statute allows, they may eliminate liability for breaching fiduciary duties.
How does this impact third parties?
It is also important for people who may be considering doing business with the LLC to know if it is member-managed or manager-managed. Someone contemplating entering into a contract or other transaction with an LLC needs to be sure that the individual acting on the LLC’s behalf has the authority to bind the LLC. Otherwise, they run the risk of the LLC trying to avoid contractual obligations by claiming the contract was not authorized.
It is helpful when the formation document—which is publicly available—sets forth whether an LLC is managed by members or managers, as well as setting forth the names of those with management authority.
But not all state forms require that. And even then, it is often the operating agreement that contains most provisions regarding who has managing authority. This document is not publicly available and would have to be provided by a member or manager upon request.
When would the members choose member-management?
Although every situation is unique, in general it may be appropriate for an LLC to be managed by members in the following situations:
- The members want to play an active role in day-to-day management
- There are a small number of members (since it can be hard to get a lot of people together to make daily decisions)
- The members are familiar with the business and able to make informed decisions
When would the members choose manager-management?
Again, it depends on the individual situation, but management by members may be appropriate in the following situations:
- Some or all members just want to be passive investors
- There is a large number of members
- The members lack expertise in the type of business being conducted or management skill and expertise.
LLCs are the most common choice of business entity. Every business owner deciding to form an LLC has a number of important decisions to make, including choosing the formation state, the LLC’s name, how it should be taxed, and who should be its registered agent.
But equally important is whether the LLC will be member-managed or manager-managed. This decision has significant consequences for the members and should be given serious consideration.