Member-managed or manager-managed?

In a member-managed company the owners run it themselves. In a manager-managed company they appoint one or more managers to run it and keep a vote over the decisions that matter most.

Most small LLCs are member-managed, and for an owner-operator business that is usually right. Manager-management earns its keep when some owners are passive, when there are enough owners that unanimity is impractical, or when the person who actually runs the business is not an owner at all.

This is where most advice on the subject goes wrong. Under the Illinois Limited Liability Company Act a company is a member-managed limited liability company unless the operating agreement expressly provides that it is or will be manager-managed, that it is or will be managed by managers, that management is or will be vested in managers, or includes words of similar import.

So the switch is thrown in the operating agreement, not on a form. The articles of organization do ask for the name and business address of all of the managers and any member having the authority of a manager — but that is the state recording who your managers are, after your operating agreement has made you manager-managed. A tick on a form with nothing in the agreement behind it is not a structure.

The rules below are Illinois. Other states’ LLC acts differ on both the default and on who can bind the company, so if your LLC is organised somewhere else, read that state’s act rather than assuming this one.

The Act sets a default for each structure, and the operating agreement is where you change it.

Appointing managers does not hand the company over. The Act lists matters that require the consent of all of the members whether the company is member-managed or manager-managed, and they are the ones that change what the company is rather than what it does day to day. Among them:

The familiar rule — that in a member-managed LLC any member can sign a contract that binds it — has not been Illinois law since 1 July 2017. The Act now says plainly that a member is not an agent of a limited liability company solely by reason of being a member.

That does not make members powerless; ordinary agency law still applies, so someone who has been held out as having authority may still bind the company. It means the authority has to come from somewhere real — the operating agreement, a resolution, a course of dealing — rather than from the bare fact of ownership.

Where it needs to be provable to outsiders, the Act provides a statement of authority, filed with the Secretary of State, which can state the authority or the limitations on the authority of a member, a manager or anyone else to enter into transactions on the company’s behalf or to execute an instrument transferring real property held in the company’s name. Banks and title companies are the usual reason anyone files one.

This is the consequence people discover late, and it is the strongest argument for being deliberate about the choice.

In a member-managed company each member owes the company and the other members a duty of loyalty — accounting for any profit or benefit derived from the business or from company property, not taking the company’s opportunities, dealing fairly when on the other side of a transaction, and not competing with the company before dissolution. The duty of care is narrower: refraining from grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law.

In a manager-managed company a member who is not also a manager owes no duties to the company or to the other members solely by reason of being a member. The managers are held to the standards the members would otherwise have carried. And a member who exercises some or all of the authority of a manager is held to those standards anyway — you cannot take the decisions without taking the duties.

It does not change how the company is taxed. Management structure and tax classification are separate questions: the tax one is answered by the default classification, or by Form 8832, or by Form 2553 for an S election.

It does not change the liability shield either. Members are not personally liable for the company’s obligations because of the structure they chose; that protection comes from the entity itself.

What it does change is your paperwork. The articles of organization and every annual report have to give the name and business address of all of the managers and any member having the authority of a manager, and the annual report is executed by a manager or, if there is none, by a member designated by the members.