by Lee Lashway
Membership interests in limited liability companies (LLCs) are not expressly included or excluded from the statutory definition of a security under ORS 59.015. As a result, the membership interest must be an “investment contract” to be a security under Oregon law. Whether a particular membership interest constitutes an investment contract requires a case-by-case factual analysis.
In Oregon, an investment contract is (i) an investment of money or money’s worth (ii) in a common enterprise (iii) with the expectation of profit (iv) to be made through the management and control of others.
Usually, management and control is the element most in contention.
Membership interests in LLCs that are manager-managed per designation in the Articles of Organization are almost certainly securities.
The success of the investment will, for all practical purposes, be dependent on the management and control of the managers, and the members will have no actual or apparent authority to exercise control over the LLC’s business.
Membership interests in LLCs that are member-managed may be, but probably are not, securities.
The presumption is that such membership interests are analogous to general partnership interests: members have statutory authority to bind the LLC and participate in management, thereby defeating the 4th prong of the investment contract test. Like most general partnerships, interests in member-managed LLCs with relatively few members, all of whom are actively involved in the business at some level, will likely fail to meet the investment contract standard, and will not be securities.
However, management authority given by statute can be delimited by provisions in the operating agreement. When the operating agreement for a member-managed LLC provides for a delegation of management control and authority from members to a manager or a management committee, the analysis becomes more ambiguous. The more comprehensive the delegation of authority, the closer the membership interest becomes to an investment contract.
Some factors to consider: (1) how are managers selected and removed? (2) what limitations are there on manager or management committee authority? (3) what authority do the members retain, and, (4) given the number of members, their location and actual involvement with the business, what is their practical ability to exercise that authority?
The Oregon Securities Division has taken the position in at least one enforcement action involving a number of LLC’s with 15 or more members that a membership interest in the member-managed LLC with substantial delegation of authority to an elected management committee was a security, even though (1) the management committee of each LLC was comprised of members elected by the membership, and subject to removal with or without cause by vote of members; and (2) the authority of the management committees was circumscribed by the requirement of membership vote to approve certain major actions.
There is no precise guidance from the Securities Division as to how many members or how comprehensive the scope of delegation of management authority must be to bring the membership interest within the investment contract definition. Analogizing to shareholders in a corporation is not a perfect fit, given that shareholders do not have underlying statutory authority to bind a corporation in any case. Organizers of LLC’s with members having different practical ability to exercise their management authority for any reason (e.g., geographic location, business acumen or interest, etc.), or different levels of involvement in the day-to-day activities of the business, should be wary of proceeding without considering possible requirements for securities compliance – particularly in an LLC with more than a relative handful of members.
If the LLC is manager-managed by designation in the Articles of Organization, the membership interests should be assumed to be securities.
If the LLC is member-managed, the membership interests are probably not securities, but watch out for substantial delegations of management authority to some subgroup of members or a third party, especially if those delegations are not accompanied by retention of meaningful ability of members to remove managers and/or otherwise exercise significant control over major management committee decisions; and keep in mind that although there are no controlling cases in Oregon at this time, the Securities Division will likely take an aggressive position if the overall context of the deal suggests it should be subject to regulation under securities law in the interest of investor protection.
At Harrang Long Gary Rudnick P.C., we have several years of experience with securities exemptions, registrations, and related transactions and compliance activities for small businesses and individuals. Please contact J. Lee Lashway for assistance on any of these matters.