One way limited liability companies (“LLCs”) are classified, for state law purposes, is either member-managed or manager-managed. This classification clarifies who may legally bind the LLC. The easiest way to explain these concepts is to discuss what an LLC is not and therefore, why it is necessary to clarify who may act for and bind the LLC.
An LLC is not a partnership or a corporation (although they are often mistakenly called limited liability corporations). In a general partnership, each and every partner (equity owners) can act for and legally bind the partnership. This could be binding the partnership to perform a certain service (as many law firms do) or could be borrowing money on behalf of the partnership. In a corporation, the corporate officers and not the shareholders (equity owners) act for and bind the corporation. Imagine if every shareholder of a large corporation were to be able to borrow money on behalf of the corporation and obligate the corporation to repay that debt.
LLCs are a blending of partnership and corporate law. As such, many of the things that are mandatory with partnerships and corporations are optional with an LLC. One such option, specifying whether an LLC is member-managed or manager-managed, is selecting which of the two systems described above will govern a particular LLC.
A member-managed LLC is most akin to a partnership where all of the members (equity owners of an LLC) can bind the LLC. A manager-managed LLC is most similar to a corporation where only the corporate officers (typically called “managers” in an LLC, although other officer titles are permissible) act for and bind the LLC. It is important to point out that nothing prohibits the members of the LLC from also being managers so in many cases, the members (or at least those with large holdings in the LLC) will be managers, although they can only act on behalf of the LLC as a manager.
Selecting whether to be a member-managed or a manager-managed LLC must be set forth in the LLC’s articles of organization (the LLC equivalent of articles of incorporation). There are several reasons why one way is chosen over another, but the most common reason for choosing one system over another is to limit the ability of a “silent partner” to act for the LLC. For example, if an LLC had several members (there is no limit on the number of members) and was member-managed, even the smallest investor could bind the LLC. Conversely, by specifying that the LLC is manager-managed, the organizer is able to eliminate the members’ ability to legally bind the LLC.
Overall, when representing those forming LLCs, I favor manager-managed LLCs as they provide a way to limit who may speak on behalf of the LLC. Typically, this benefits the members who have the largest membership interest.