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One of the biggest questions we’re asked when clients are forming an LLC is: Should we be manager managed or member managed?

The LLC allows for great flexibility. You can be managed by all the members, which is actually the case in most common business settings. The owners (or members) come together and agree on what is next. But such member managed informality, while suitable for on-the-go entrepreneurs and investors, is not always best from a legal stand point.

By contrast, a manager managed LLC is one in which one or more persons are appointed in the Operating Agreement to serve as management under specific guidelines. The manager(s) may be members or they can be non-owners brought in from the outside to administer operations. But the LLC’s members (either one, all or some) can always be appointed as managers of the LLC. A manager managed LLC, which may managed by the members, is our first choice. We prefer this strategy for three reasons.

First, piercing the veil of protection (whereby someone is owed money by a broke LLC and wants to personally collect from the monied owners) is much easier with a member managed LLC. A standard reason courts allow veils to be pierced is because there is no separation between ownership and management. With a member managed LLC, the owners run the show typically without much formality. The members are the managers without any clear separation between ownership and administration. When the lines are so blurred the courts will pierce the veil of protection and hold the members personally liable for claims against the LLC. This is not the protection you were hoping for when you set up your LLC.

With a manager managed LLC the lines of authority much clearer. The members elect the manager(s) and the managers (whether an owner or not) must adhere to the management requirements of the Operating Agreement. Management is distinctly separate from ownership, which is what courts in a piercing case like to see. Minutes of manager meetings can further highlight the separation, whereby the members have their elected managers guide the LLC and keep a record of such decisions. Courts appreciate such formality.

A second reason for choosing the manager managed has to do with apparently authority. In a member managed LLC who has the authority to sign a contract? Does every member get to sign anything and everything? Do you want every member to have such a power?

Apparent authority is the ability of a member to act on behalf of the LLC, even though such powers haven’t been formally granted. If a third party learns that an LLC is member managed (which can be easily seen on each secretary of state’s website) and deals with a member who has the apparent authority to act, the third party is protected if the member’s signature did not bind the LLC. Apparent authority means that if a third party could reasonably believe that a member had the ability to bind the LLC then the contract is binding.

For example, XYZ, LLC is a member managed. One member, Bob, wants to lease space at the mall. Bob doesn’t have the authority to sign a lease but the landlord, learning that the LLC is a member managed and that Bob is a member, reasonably assumes Bob does have the authority to sign a lease. Apparent authority protects innocent third parties such that the LLC (even though the other members didn’t agree) can be held liable for the lease. Now assume that XYZ, LLC is a manager managed. The landlord doesn’t have it so easy. They must insure that they are dealing with the correct manager, one who has been granted authority to sign a lease on behalf of the LLC. A manager managed LLC limits the people with authority to just specific managers. A prudent landlord may want to see the manager managed Operating Agreement to make doubly sure they are dealing with the manager with the specific and express authority to sign on behalf of the LLC.

As is clear, a manager managed LLC will help reign in those members you don’t want to imply one iota of authority towards.

Finally, in many states where members are not listed on state websites, a manager managed LLC does not imply LLC ownership. A manager may be an owner or not. Some of our clients prefer the vagueness of a manager managed LLC whereby ownership is not certain.

All in all, when all the factors are considered, manager managed is the superior way for operating an LLC.