Manager-Managed Limited Liability Company
By John W. Cones
The manager-managed LLC is one of the more popular passive investor vehicles for project financing of feature and documentary films. Its formation is similar to the creation of a member-managed LLC, in that articles or organization need to be prepared and filed with the office of the Secretary of State in the state in which the LLC is being created. Generally, the form or articles used will provide a space for designating that the LLC is to be a manager-managed LLC as opposed to member-managed. In addition however, an LLC operating agreement must be drafted, approved by the members and signed, so that the LLC will have a set of rules by which to operate. And, the operating rules for a manager-managed LLC or significantly different, more lengthy and more complex than the corresponding LLC operating rules (agreement) for a member-managed LLC. The LLC operating agreement usually does not have to be filed with the Secretary of State, but is kept in the LLC’s files. Formation of the manager-managed LLC is neither the end of the task, nor the most significant portion of the work involved in using such a vehicle to raise capital (see discussion re “Choice of Securities Offering” below).
Particularly of importance to low budget filmmakers, the manager-managed LLC offers limited liability protection to one or more individuals or a fictitious name company serving as the LLC’s manager without the time, trouble and expense of creating and maintaining another entity. This means that an individual or a fictitious name company (dba) can serve as the manager of the manager-managed LLC and enjoy limited liability protection, without creating and maintaining a corporation or a member-managed LLC to serve as the manager.
When to Form the LLC
In many instances, entertainment attorneys and accountants advise filmmakers to first go out and form a limited liability company, for example, without ever discussing whether it should be a member-managed LLC or a manager-managed LLC, or that there are securities law implications for the latter.
In addition, there exists differing opinions as to when to form a manager-managed LLC that is being used as the investment vehicle to raise money from a large group of passive investors. Some practitioners insist that forming the LLC must be the first step in the process. They suggest that investors will not invest in a company that has yet to be formed. However, hundreds if not thousands of successful manager-managed LLC securities offerings have been conducted in the U.S. selling what are termed “pre-formation units in an LLC to be formed upon funding”, thus the argument that investors won’t invest in a company to be formed is not based on an adequate sampling of real world experience.
The same is true of many corporate and limited partnership offerings over the years. The advantage of this deferred approach is that no out of pocket expense is incurred by the manager/producer until the investor funds are known to be in the bank, and therefore available for prompt reimbursement, as soon as the LLC is formed and a second bank account as been opened in the name of the newly formed LLC.
The liability most commonly associated with the production of films (negligence on the set or defamation) does not occur until after principal photography has begun or, in the latter instance, after the film is released, thus, so long as the manager-managed LLC is formed before principal photography begins, the manager will still enjoy the limited liability protection needed.
Many independent film producers are either being misled by somebody or they are simply misunderstanding what they are being told about LLCs. These independent producers repeatedly indicate that they have been advised that all they need to do to raise money from passive investors using an LLC is to create the LLC, and that merely involves the preparation and filing of the articles of organization with the Secretary of State’s office in the state in which the LLC is to be formed. This is bad advice on several levels:
(1) There is another aspect to the actual creation of an LLC. Not only should the articles of organization be properly prepared and filed with the Secretary of State, but also an LLC operating agreement must be drafted, approved and signed. Without an operating agreement, there are no rules set out for operating the LLC, thus it cannot function effectively.
(2) When the articles of organization are filed and the operating agreement is drafted, the producer must be certain that he or she properly designates in the articles which form of LLC is being created, a member-managed or manager-managed LLC, and carry over this distinction into the LLC operating agreement, because the provisions associated with each different form of LLC are significantly different in the respective operating agreements. Before a producer can make that designation, he or she must understand the difference between the two LLC forms and to what purpose they will be devoted.
(3) Assuming the LLC is being created to serve as the investment vehicle for a large group of passive investors (the manager-managed LLC – the form of LLC being discussed in this chapter) the filing of the articles and the drafting of the LLC operating agreement amount to a small part of the tasks involved. Since the units or interests in a manager-managed LLC are securities, compliance with the federal and state securities laws is required. That involves an informed choice with respect to the appropriate form of registration or exemption, the proper drafting of a securities disclosure document and an understanding of and compliance with other applicable securities laws and rules.
Number of investors. There are no limits on the number of investors imposed by the LLC statutes, but such limitations may be imposed by the securities laws, although Regulation D, for example, permits 35 unaccredited investors and an unlimited number of accredited investors (see discussion of the SEC’s Regulation D below).
No creative control issues. Since the manager-managed LLC is controlled and operated (pursuant to statutory law and agreement) by the manager or managers, and the investor/members are passive, there are no conflicts with the investor/members over creative matters.
Less oversight. So long as the manager of a manager-managed LLC acts in the manner described in the securities disclosure document, the manager does not have to go back to any board of directors or the investor/members for approval to conduct the business. Significant departures from the original plan of business may need the approval of the investor/members, but provisions in the LLC’s operating agreement control this question.
Securities compliance required. Compliance with the applicable federal and/or state securities laws are required because manager-managed LLC interests are being offered and sold to passive investors (i.e., such interests are securities).