I’ve been thinking…Why is Delaware so dominant in chartering limited liability corporations and companies? This blog analyzes key aspects of Delaware C-corporations versus Delaware Limited Liability Companies (LLCs). With few exceptions (e.g., super voting shares, staggered boards and outsized Board appointment rights of preferred shareholders), the typical corporate governance model of a Delaware C-corporation works as follows: pursuant to the terms and conditions of a set of Articles of Incorporation and By-Laws, the Shareholders, as Owners, vote their shares annually for a slate of Board Members to manage the company; in turn, the newly elected Board appoints the Officers to run the company on a day-to-day basis.
The comparable set of documents for a Delaware LLC is the Certificate of Formation and the Operating Agreement. Like the Articles of Incorporation, the Certificate of Formation is publicly disclosed when initially filed. In contrast, the internal governance documents–C-corporation By-Laws and LLC Operating Agreements–are typically undisclosed. Among others, a key difference between a Delaware C-corporation and a Delaware LLC is the terms of the Operating Agreement: a contract entered into between all of the Members, as Owners. All Members must sign the initial Operating Agreement as well as each subsequent amendment to the LLC’s legally enforceable Operating Agreement. Since the nature and extent of individual contract terms are virtually unlimited, the LLC structure offers extremely wide latitude in setting up even the most complicated of governance structures. For example, the management default structure is that the LLC is comprised of Members and one Manager; however, the Members may opt to manage the LLC themselves or the Members may choose to hire an External Manager.
Although a discussion of taxation is beyond the scope of this blog, there are important federal tax differences between C-corporations and LLCs. For example, a Delaware C-corporation must file its own corporate tax return and pay income taxes according to the corporate tax rate schedule. In contrast, the tax default structure of a Delaware LLC is the filing of a so-called information return, which allocates taxable income to Members pursuant to the terms in the Operating Agreement.