A Myth Deconstructed: The 'Emperor’s New Clothes' on the Low Profit Limited Liability Company
40 Pages Posted: 17 Feb 2010 Last revised: 21 Nov 2010
This article was previously titled, “The Snare and Delusion of the L3C”.
In 2008, the Vermont legislature enacted and Vermont’s governor signed into the law the first “low profit limited liability company” statute. Since that time, four other states have followed, and institutions as diverse as the Federal Reserve, the ABA’s Real Property, Probate and Trust Section, and the Vermont Law School have given credence to the notion that the “L3C” is a socially beneficial add-on to the law of limited liability companies. Indeed, L3C proponents have touted the device as: (i) a break-through in charitable giving, enabling “socially beneficial enterprises” to leverage foundation money to attract market-rate investors through “tranched investing;” (ii) a simple, wise, and useful development in the law of limited liability companies; and (iii) a method destined to be fast-tracked for special treatment under the provisions of the Internal Revenue Code (“Code” or “IRC”) dealing with “Program Related Investments” (“PRI”) by charitable foundations.
Unfortunately, these glowing characterizations are each flatly wrong. The “L3C” is an unnecessary and unwise contrivance, and its very existence is inherently misleading. Due to technical flaws, the L3C legislation adopted to date is nonsensical and useless. Moreover, the notion that an L3C should have privileged status under the Code is inescapably at odds with the key policies that underpin the relevant Code sections. The L3C is not on track (let alone a fast track) to any special status under the Code.
Debunking “the emperor’s new clothes” should be done painstakingly, and this article therefore proceeds through several parts: (1) summarizing the L3C concept and the claims of its proponents; (2) providing background information on the limited liability company and highlighting the aspects of LLC statutes that are relevant to a discussion of L3Cs; (3) explaining the concept of the Program Related Investments; and (4) critiquing the L3C construct and exposing its fundamental flaws under several different areas of law, including the law of limited liability companies, securities regulations, and PRIs.
The article concludes that L3C legislation is no “friendly amendment” to a state LLC statute. Using foundation funds to offer market-rate returns to “tranched” investors is at best a complicated device, not appropriate for “branding” and simplistic appeals to social conscience. When a foundation contemplates making a program related investment, the matter requires careful, individualized, professional assessment, not reliance on a branded template.
Keywords: Limited Liability Company, LLC, Low Profit Limited Liability Company, L3C, Program Related Investment, PRI, tax exempt organizations, Socially Beneficial Investing, Tranch, foundations, charities, private foundations, hedge funds, leverage
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