In structuring a transaction, the selection of the right entity can be compared to choosing a golf club. You can default to your 7 iron for most strokes, use a putter on the green, or pick another stick more suited to the conditions and where the ball lies. But the golfer is always limited by what is in the bag. In transaction structuring, the bag will usually have a company, trust or partnership, depending on which better matches the commercial, regulatory and tax drivers of the parties.
However, the Cayman Islands is introducing a new club for the caddy to carry: the limited liability company (LLC). Limited liability companies are not new, and have been a cornerstone of commerce in the US since the 1970s. In 2014 alone, more than 120,000 LLCs were formed in Delaware. The LLC has a variety of potential uses, from funds and management platforms to estate planning vehicles, incentive plans, joint ventures and charitable foundations.
Like its Delaware cousin, a Cayman LLC is a versatile body corporate that brings together, in one entity, a number of attractive attributes of companies and exempted limited partnerships (ELPs), including separate legal personality, limited liability of members, and the flexibility of using capital accounts. A Cayman LLC is, essentially, a hybrid drawing from statutory rules familiar to those who have dealt with Delaware LLCs, supported by the body of common law and equity applicable to Cayman companies.
Put simply, an LLC is a new form of entity that will be governed by the new Limited Liability Companies Law and (what can be an extremely flexible) limited liability company agreement. Unlike an ELP, but like a company, an LLC has separate legal personality and is capable of contracting in its own right, without a separate general partner.
Another significant feature is that the members and managers (if designated) do not owe fiduciary duties among themselves unless provided for in the LLC agreement, although the manager will owe a duty of good faith. Contrast this to the fiduciary duties of a company director or, subject to the ELP agreement, the general partner of an ELP. Couple this feature with the fact that the LLC Law specifically provides that an LLC is capable of exercising all functions of a natural person irrespective of any questions of corporate benefit, and members have significant flexibility to dictate the terms of their own arrangements.
The structure is also streamlined. There is no need for both directors and shareholders, or for establishment of a separate general partner to control the conduct of the business. Rather, an LLC can consist of one single member, and can be formed by a short LLC agreement and filing of a simple statement with the Registrar. This can accelerate the formation process, resulting in significant cost savings.
A further significant feature is that the LLC dispenses with the concept of share capital. Rather, members of LLCs hold an interest, the rights, privileges and obligations of which are provided in the LLC agreement. This means that the LLC can adopt capital accounting, familiar to those who use Delaware LLCs and ELPs. This creates significant flexibility to structure voting and economic rights of the members.
Finally, it is our understanding that for US tax purposes, LLCs should be able to “check the box” to be treated as a partnership for US tax purposes. This should enable the LLC to avail itself of certain potential tax advantages such as look-through treatment.
Separate legal personality combined with the application of capital accounts means that an LLC can easily fulfil commercial objectives more difficult to achieve with companies and ELPs. For example, replacing the general partner in a “three tier” private equity fund (set up as an ELP) with an LLC can allow flow through of carry to the underlying owners of the general partner in proportions determined by management, rather than by reference to share numbers or complex class rights, and without the need for a separate general partner of the GP ELP.
Using an LLC, incentives and bonuses can be distributed to employees on a differentiated basis, referable to performance criteria, without the complications and expense of multiple share classes. In a joint venture, parties can distil their agreement as to management of the entity, and their voting and economic rights, with significant contractual freedom directly into the LLC agreement without the need to deal with complications that often arise in connection with share rights, or conforming a complex shareholders’ agreement to articles of association.
The commencement order for the Cayman LLC is expected to be passed very shortly. From then on we expect that the new club will help the handicaps in a number of transactions.
JAMES GADEN is a partner at the Hong Kong office of Maples and Calder
Maples and Calder | Hong Kong
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