Client Alert | California Revised Uniform Limited Liability Company Act
The California Revised Uniform Limited Liability Company Act (the “New Act”) became effective on January 1, 2014. The New Act entirely replaces prior California law (the “Old Act”) governing California limited liability companies (“LLCs”). The New Act applies to all existing and new California LLCs. The New Act also applies to the acts or transactions by an LLC or by its members and managers occurring, and contracts entered into by an LLC or its members and managers, on and after January 1, 2014. The Old Act will continue to govern actions taken by an LLC and its members and managers, and contracts entered into by members and managers (including the LLC operating agreement), prior to January 1, 2014.
Although the New Act is similar in many respects to the Old Act, the New Act includes a number of substantive changes. Because the New Act applies to all actions taken by members and managers (including votes and consents) on and after January 1, 2014, if the operating agreement of an LLC does not adequately address the changes made by the New Act, these changes could have the effect of significantly altering the rights and intentions of members and managers in a way that conflicts with or overrides the written operating agreement.
The following is a summary of some of the important changes to the Old Act and the implications of the New Act to members and managers.
Articles of Organization
Under the Old Act, in the event of a conflict between the LLC’s Articles of Organization (the “Articles”) and the LLC’s operating agreement, the Articles control. Under the New Act, if there is a conflict, the operating agreement will prevail.
Under the Old Act, an LLC is by default member-managed unless the Articles state otherwise. However, under the New Act, an LLC is by default member-managed unless both the Articles and the operating agreement state otherwise. Accordingly, an LLC’s Articles and operating agreement should be reviewed to ensure that they do not conflict in any material way, and, in particular, for manager-managed LLCs, that the Articles and the operating agreement expressly state that the LLC is to be manager-managed.
The Operating Agreement
Similar to the Old Act, the New Act provides that the LLC’s operating agreement governs the relations among the members and between the members and the LLC, as well as the rights and duties of a manager, the activities of the LLC and the conduct of those activities. One change made by the New Act is the default rule that an amendment to an LLC’s operating agreement requires unanimous member approval. Thus, if the LLC’s operating agreement does not address the approval required to amend the operating agreement, each member will have the right to approve of the proposed amendment, which means that a member with a small ownership interest will have veto power over the vote of the majority.
Another of the default rules under the New Act limits the manager’s authority to (a) sell, lease or exchange the assets of the LLC or (b) take any action “outside the ordinary course of business” without the consent of all the members. This rule can be modified by the LLC’s operating agreement. Thus, if the LLC’s operating agreement does not expressly grant those powers to a manager, the consent of all the members would be required for such actions, which means that the members or even a member with a small ownership interest will have veto power over the authority of the manager.
The New Act also allows existing members to significantly alter the LLC’s debt, obligation, or other liability to a “dissociated” member (discussed below) or a transferee, neither of whom have the right to vote on such a change. Thus, this change by the New Act can alter the expectations of a member who transfers the member’s interest to an assignee who is not admitted as a member (i.e., a transferee).
Additionally, the New Act contains more specificity than the Old Act regarding certain provisions that are not permitted in operating agreements. Under the New Act, an operating agreement may not, among other things: (A) alter the rights of a member or a transferee to access certain information required to be maintained by the LLC; (B) vary the New Act’s rules relating to: (i) winding up the LLC upon dissolution, (ii) mergers and conversions, (iii) creation of different classes of members, and (iv) the agency power of members and managers; or (C) restrict the rights of members with respect to class-action lawsuits and members’ approval of a merger, conversion or dissolution. In addition, limitations are placed on the modification or elimination of fiduciary duties and certain other obligations.
Unlike the Old Act, the New Act is specific about the fiduciary duties (i.e., the duties of loyalty and care) owed by managers and members of an LLC. The New Act clarifies limitations to which the duties of loyalty and care can be modified:
(A) Under the New Act, the duty of loyalty cannot be eliminated, but the LLC’s operating agreement may identify specific types or categories of activities that do not violate the duty of loyalty, if “not manifestly unreasonable.”
(B) Under the New Act, the duty of care cannot be eliminated or “unreasonably” reduced.
The New Act also provides that the fiduciary duties of a manager can be modified only by a written operating agreement with full disclosure and the “informed consent” of the members.
In light of the changes made by the New Act, we recommend that if a client wishes to modify the fiduciary duties, the LLC’s operating agreement should specifically define the duty of loyalty and the duty of care and specifically authorize certain actions that might otherwise be viewed as conflicting with the duty of loyalty (e.g., engaging in any competing business or taking a corporate opportunity) or the duty of care (e.g., allowing the manager to be involved in other businesses and activities or allowing the manager to delegate power to officers or agents of the LLC). Modifications of fiduciary duties should be made in order to avoid violating the “not manifestly unreasonable” standard and to facilitate showing informed consent of the members.
Under the Old Act, the Articles or operating agreement may provide for indemnification of members and managers. However, the New Act mandates indemnification of members of a member-managed LLC and managers of a manager-managed LLC. This right can be altered or eliminated in an operating agreement. Thus, if the LLC’s operating agreement does not adequately address the indemnification of members and managers, the New Act could alter the expectations of members and managers who believe that indemnification is not required.
Also, unlike the Old Act, the New Act provides that an operating agreement may eliminate or limit a member’s or a manager’s liability to the LLC and members for monetary damages, except for breach of the duty of loyalty, a financial benefit to which the member or manager is not entitled, a member’s liability for excess distributions, intentional infliction of harm on the LLC or on a member, or an intentional violation of criminal law. This is a change that member-managers or managers of the LLC may wish to incorporate into the LLC’s operating agreement.
The departure of a member under the Old Act is referred to as a “withdrawal,” while under the New Act it is referred to as a “dissociation.” Under the Old Act, a member can withdraw at any time by giving notice to the members, notwithstanding any restrictions in the operating agreement or the Articles. The New Act provides that a member has the power to dissociate at any time, rightfully or wrongfully, by withdrawing as a member by express will and giving notice to the LLC. Additionally, the New Act provides that certain events automatically result in a member’s dissociation. These events include (a) the death of a member, (b) if the LLC is member managed, the appointment of a guardian or conservator for the individual who is a member, a member becomes a debtor in bankruptcy, or a judicial order that a member who is an individual is incapable of performing the member’s duties, or (c) if the member is a trust, the trust’s entire interest in the LLC is distributed.
Upon the dissociation of a member, the member’s status changes to that of a transferee under which there is a retention of economic rights but loss of rights to participate in management of the LLC or obtain information. Further, a person who is both a member and a manager, and who becomes dissociated, is automatically removed as manager. If it is the intent of the members that no such automatic dissociation or removal occur, then the operating agreement should address this issue.
Additionally, under the Old Act, if a member withdraws, the withdrawing member is not entitled to payment for the member’s interest in the LLC. However, this is not included in the New Act. Thus, if there is a dissociation of a member, and unless the operating agreement provides otherwise, possibly the member may be entitled to payment for the member’s interest. Because the concept of “dissociation” was not covered by the Old Act, existing operating agreements do not address the issue of “dissociation.” Thus, unless the operating agreement is amended, it appears that a member will have the right to dissociate (without the dissociation being considered wrongful) and might be able to request payment for the member’s interest in the LLC.
Under the Old Act, the judgment creditor of a member of an LLC can attach distributions made from the LLC to the debtor-member. This “charging order,” which constitutes a lien on the debtor-member’s transferable interest, is similar to a garnishment of wages or income. It does not give the judgment creditor management rights in the LLC, nor can the creditor interfere in the management of the LLC to which the debtor is a member. While similar to the Old Act, the New Act also permits a judgment creditor, upon a showing that distributions under a charging order will not pay the judgment debt within a reasonable time, to foreclose the lien and order the sale of the transferable interest (i.e., the purchaser at the foreclosure sale obtains only the economic interest and does not become a member).
As noted above, the New Act applies to the acts or transactions by an LLC or by members or managers occurring, or contracts entered into by an LLC or the members or managers, on or after January 1, 2014. Thus, any votes or consents by managers or members made after the effective date are governed by the New Act. The Old Act will continue to apply to all acts and transactions by an LLC or members or managers occurring or contracts entered into by the LLC or members or managers, before January 1, 2014. As noted, it is important to recognize that the New Act could have the effect of significantly altering the rights and intentions of members. Accordingly, we recommend that existing operating agreements be reviewed to determine the impact of the New Act and whether an amendment to the operating agreement is necessary or desirable.
If you wish us to review your existing operating agreement and/or discuss the potential impact of the New Act on your LLC, please contact us.
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This Bulletin is made available for educational purposes and to provide general information on current legal topics, not to provide specific legal advice. The publication of this Bulletin does not create any attorney client relationship, and this Bulletin should not be used as a substitute for competent legal advice from a licensed professional attorney.