California’s new LLC Act becomes effective on January 1, 2014. The new act, the Revised Uniform Limited Liability Company Act (RULLCA), will completely replace the current statute, the Beverly-Killea Limited Liability Company Act (Beverly-Killea).
RULLCA was signed into law by Governor Brown in September 2012. The new law is based in large part on NCCUSL’s Revised Uniform Limited Liability Company Act, which has now been adopted in eight states. The passage of RULLCA brings California’s LLC statute more in line with the LLC laws of other states, which should facilitate interstate transactions.
The substance of RULLCA is generally similar to Beverly-Killea, but there are a number of significant changes. I describe some of those below, but my list is not exhaustive.
Operating Agreement. Beverly-Killea defines an operating agreement as any written or oral agreement between an LLC’s members as to the affairs and the conduct of the LLC. Cal. Corp. Code § 17001(ab). RULLCA goes further by allowing an operating agreement to be written, oral, or implied. § 17701.02(s). The significance here is that, subject to the limits of Section 17701.10, an LLC’s operating agreement can override RULLCA’s default provisions.
Manager-managed. In both the old and the new statutes an LLC is member-managed unless the proper steps are taken to establish it as manager-managed, but RULLCA changes the requirements. Under Beverly-Killea an LLC is member-managed unless the articles of organization contain a statement that the LLC is to be managed by one or more managers. §§ 17051(a)(7), 17150. Under RULLCA an LLC is member-managed unless the LLC’s articles of organization and the operating agreement state that it is manager-managed. § 17704.07.
Shelf LLCs. Under Beverly-Killea an LLC exists when its articles of organization are filed, but it is not formed until the members enter into an operating agreement. § 17050. RULLCA, on the other hand, does not require the admission of members in order for an LLC to be formed: “A limited liability company is formed when the Secretary of State has filed the articles of organization.” § 17702.01(d).
Non-economic Member. Beverly-Killea assumes that members have economic rights. For example, its definition of a membership interest includes the member’s economic interest, such as the right to share in profits, losses, and distributions. RULLCA, in contrast, allows an LLC to include members that have no economic interest and make no capital contributions. § 17704.01(d). The NCCUSL comment on this section indicates that the purpose of this provision is to “accommodate business practices and also because a limited liability company need not have a business purpose.” NCCUSL, Revised Uniform Limited Liability Company Act, § 401(e) cmt.
Fiduciary Duties. RULLCA provides a more detailed description of the fiduciary duties of LLC managers and managing members than does Beverly-Killea, and constrains the ability of the operating agreement to eliminate or limit fiduciary duties.
Beverly-Killea incorporates by reference the fiduciary duties of a partner in a partnership: “The fiduciary duties a manager owes to the limited liability company and to its members are those of a partner to a partnership and to the partners of the partnership.” § 17153. The members may modify those duties, but only in a written operating agreement with the informed consent of the members. § 17005(d).
RULLCA instead sets out the fiduciary duties of managers and managing members in some detail, and limits or “cabins in” the fiduciary duties to the duty of care and the duty of loyalty. The limits are evident in the introductory sentence: “The fiduciary duties that a member owes to a member-managed [LLC] and the other members of the [LLC] are the duties of loyalty and care under subdivisions (b) and (c).” § 17704.09(a). The duty of loyalty is limited to enumerated activities, and the duty of care is limited to refraining from grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law.
RULLCA limits the extent to which the members can modify the managers’ or managing members’ fiduciary duties. Any modification of the fiduciary duties can only be done by a written operating agreement. Neither the duty of care, the duty of loyalty, nor the contractual duty of good faith and fair dealing may be eliminated, and the duty of care may not be unreasonably reduced. § 17701.10.
There is one oddity in RULLCA’s fiduciary duty rules. Section 17704.09 comprehensively defines the fiduciary duties of LLC members and managers and appears to exclude any other fiduciary duties. But Section 17701.10(c)(4) says that an operating agreement may not eliminate “the duty of loyalty, the duty of care, or any other fiduciary duty.” (Emphasis added.) A California court may at some point have to resolve this inconsistency, unless it is first clarified by an amendment to the statute.
Effectiveness. RULLCA’s general rule is that it applies to all LLCs after January 1, 2014: “Except as otherwise specified in this title, this title shall apply to all domestic limited liability companies existing on or after January 1, 2014.” § 17713.04(a).
Sub-paragraph (b) provides that RULLCA applies only to acts or transactions by an LLC or its members or managers occurring, or contracts entered into by the LLC or its members, on or after January 1, 2014. § 17713.04(b). Those acts which take place before that date will be governed by Beverly-Killea. This section appears intended to cover issues such as the authority of a manager, breaches of fiduciary duty, and so on, that relate to actions occurring before RULLCA’s effective date.
There is an unfortunate ambiguity in RULLCA’s transition rules, however. As some commentators have pointed out, (1) sub-paragraph (b) states that Beverly-Killea governs all “contracts entered into by the [LLC] or by the members or managers of the [LLC]” prior to January 1, 2014, and (2) an LLC’s operating agreement is a contract between the members. From this they posit that RULLCA was intended to apply only to operating agreements entered into after January 1, 2014.
That would be a surprising result, given that RULLCA consistently uses the defined term “operating agreement” when it refers to the member agreement that governs an LLC. It would also be a poor result from a public policy standpoint, because then all pre-existing LLCs would continue to be governed indefinitely by Beverly-Killea, unless and until they amend or restate their operating agreement or otherwise opt in to the new statute. That is probably not what the drafters of this section and the legislature intended, but predicting how a California court would resolve the issue is a risky business.
Comment. RULLCA makes a variety of other changes to California’s LLC statute. As the end of the year approaches, California’s business lawyers will be reviewing the new law and attending legal education seminars to bring themselves up to speed on the new Act. I expect many will be alerting their clients about the new law and recommending that they review their operating agreements for consistency with RULLCA.
The Florida legislature recently passed unanimously a new limited liability company statute (the New Act), and Governor Scott is expected to sign the bill shortly. The New Act is based substantially on the Revised Uniform Limited Liability Company Act (RULLCA), but with some variations. RULLCA is a uniform law recommended by the National Conference of Commissioners on Uniform State Laws (NCCUSL).
RULLCA was released by NCCUSL in 2006, but until last September only five states had adopted it: Idaho, Iowa, Nebraska, Utah, and Wyoming. In September 2012 New Jersey and California became the first major commercial states to adopt RULLCA. I described the adoptions by California and New Jersey here.
Upon signing by the Governor, Florida’s New Act will be effective January 1, 2014, and will apply to all LLCs formed thereafter. LLCs formed prior to that date are not subject to the New Act until January 1, 2015, unless they elect to be governed by the New Act during the transition period.
The New Act is a major update to Florida’s LLC law, and the changes are numerous. The Bill Summary, prepared by the Senate’s Judiciary Committee, summarizes many of the most significant changes. Florida lawyers Gregory Marks, here, and Charles Rubin, here, have also provided useful summaries of the many changes made by the New Act.
RULLCA has been criticized by commentators and has not been widely adopted. But with Florida’s adoption (even with some significant deviations from RULLCA) and last year’s passage by California and New Jersey, it appears that momentum among the states is increasing.
The governors of California and New Jersey both signed new LLC statutes into law on September 21, 2012, and both states adopted the Revised Uniform Limited Liability Company Act (RULLCA), with some variations. RULLCA is a uniform law recommended by the National Conference of Commissioners on Uniform State Laws (NCCUSL). RULLCA has been slow to catch on, but its passage by California and New Jersey may encourage other states to seriously consider it.
RULLCA was released by NCCUSL in 2006. It was adopted by Idaho and Iowa in 2008, by Nebraska and Wyoming in 2010, and by Utah in 2011. RULLCA has been criticized by the late Professor Larry Ribstein, which I wrote about when Nebraska and Wyoming passed RULLCA, here. But passage by California and New Jersey, the first major commercial states to adopt RULLCA, should increase momentum for its adoption by other states.
California. As originally introduced in the California legislature, the bill for the new statute authorized series LLCs, although that is not a RULLCA provision. (A series LLC can partition its assets and members into multiple series. Each series can own its own assets, enter into contracts in its own name, and incur its own liabilities, separate from the assets and liabilities of the LLC or any other series.) A later amendment deleted that provision from the bill, and the final version made no provision for series LLCs.
New Jersey. The new statute clarifies that a New Jersey LLC “may have any lawful purpose, regardless of whether for profit.” It establishes the default duration of an LLC as perpetual, unless limited by the operating agreement. And although the current LLC Act only allows a written operating agreement to override the various statutory defaults of the LLC Act, the new statute allows the operating agreement to be oral, written, or implied.
In 2010 I opined that RULLCA’s prognosis for becoming widely adopted looked bleak. With California and New Jersey’s adoption, RULLCA’s future now looks brighter.
The ABA’s Revised Prototype Limited Liability Company Act has been published in the November 2011 Business Lawyer, copies of which were received at my firm last week. The Revised Prototype incorporates a number of welcome changes, and will likely become an even more widely used resource by states considering amendments to their LLC Acts.
Many state LLC Acts were first adopted in the early 1990s. In adopting and amending their LLC Acts, state legislatures have been able to look for guidance to several sources:
- The Uniform Limited Liability Company Act (“ULLCA”) promulgated by the National Conference of Commissioners on Uniform State Laws (“NCCUSL”) in 1994;
- The Prototype Limited Liability Company Act (the “Prototype”) published in 1992 by the ABA’s Committee on LLCs, Partnerships and Unincorporated Entities; and
Both the ULLCA and the Prototype were influential as the states drafted their LLC Acts, but neither fully occupied the field. As a result there is a lot of variation in LLC laws from state to state. According to NCCUSL, the revised ULLCA has been adopted by only the District of Columbia, Idaho, Iowa, Nebraska, Utah, and Wyoming. The Prototype also was used as the basis for several states’ LLC Acts, and has been used as a reference by other states in amending their Acts.
The Revised Prototype is a major revision and modernization of the Prototype. Changes include terminology, organization, and major points of law. The following is a partial list of the major changes.
Terminology. The name of the formation document has been changed from “articles of organization” to “certificate of formation,” and the principal contract that defines an LLC’s structure and the members’ rights has been renamed from “operating agreement” to “limited liability company agreement.” The latter change reflects the more common terminology, although it is cumbersome. E.g., Washington (RCW § 25.15.005), Delaware (DLLCA § 18-101).
Nonwaivable Provisions. Most state LLC statutes provide numerous default provisions that may be modified by an LLC agreement. Often each default rule will be preceded by language such as “except as otherwise provided in a limited liability company agreement.” Usually, however, some provisions of the statute will be nonmodifiable or nonwaivable by an LLC agreement, in which case the “except as otherwise provided …” language is not used to limit the statutory rule. This was the approach used in the 1992 Prototype.
The Revised Prototype instead simply states that the LLC agreement governs the LLC and its members, and that when the LLC agreement is silent the Act will govern, except that certain statutory provisions listed in Section 110 may not be modified by the LLC agreement. This approach eliminates the need to repeat variants of “except as otherwise provided [in an LLC agreement]” throughout the statute, as all of the default rules in the statute are subject to modification in an LLC agreement unless modification is barred by Section 110.
Manager-Managed vs. Member-Managed; Authority. Many state LLC Acts assume that management of the LLC will be vested either in the members or in one or more managers. Typically the statute will also describe the actual and apparent authority of the members or managers. Oregon and Washington both follow this approach, as did the Prototype.
The Revised Prototype instead takes a more flexible approach by eliminating the need to pigeon-hole the LLC as member-managed or manager-managed. The default rule is that the activities of the LLC are under the direction and oversight of its members. Revised Prototype, § 406. That can be changed by the LLC agreement, which may establish managers, officers, or other decision-makers and define their authority.
The Revised Prototype does not define any actual or apparent authority for members or managers. Instead, the actual and apparent authority of the members or of any officers, managers, or other agents, will be established by the LLC agreement, the decisions of the members, any filed statement of authority, or the common law of agency. Revised Prototype, Article 3.
Power. Most if not all state LLC Acts explicitly state that an LLC formed under the Act has adequate power. The statutes typically refer to LLCs having the powers that are “necessary or convenient” for their activities, or to comparable language. E.g. Delaware (DLLCA § 18-106(b), Washington (RCW § 25.15.030(2)), Oregon (ORS 63.077). Entity power is a fundamental attribute. For example, if an entity lacks power to form a contract and purports to do so, the contract will not be enforceable.
The importance of this issue is shown by legal opinion-letter practice. Lawyers for parties in major transactions are often required as a condition of the transaction to provide a legal opinion to the other party covering, among other things, the power of the lawyer’s client to enter into and carry out the transaction. The TriBar Opinion Committee’s 2006 Report on LLC closing opinions states that a lawyer’s opinion that an LLC has the power to enter into and perform its obligations under an agreement means that the LLC “has that power under … the statute under which it was formed.” TriBar Opinion Committee, Third-Party Closing Opinions: Limited Liability Companies, 61 Bus. Law. 679, 687 (2006) (emphasis added).
The Prototype intentionally did not include any language dealing with the LLC’s power to carry out its activities, apparently relying on the contractual aspect of LLCs. See Prototype, § 106, Commentary. The Revised Prototype, however, has included a statement that an LLC will have the powers “necessary or convenient to the conduct, promotion, or attainment of the business, purposes, or activities” of the LLC. Revised Prototype, § 105(b).
The Revised Prototype explicitly recognizes the entity nature of LLCs, defining an LLC as “an entity formed or existing under this Act.” Revised Prototype, § 102(13) (emphasis added). The Prototype, in contrast, defines an LLC as “an organization formed under this Act.” Prototype, § 102(F) (emphasis added).
It seems odd that the summary of major changes in the introduction to the Revised Prototype makes no mention of the addition of a powers clause, which I think most practicing lawyers would consider major, and the comment to Section 105 of the Revised Prototype makes no mention of the change.
Fiduciary Duties. The Revised Prototype does not provide for fiduciary duties and allows broad latitude to the LLC agreement to expand, restrict, or eliminate fiduciary duties. The implied contractual covenant of good faith and fair dealing may not be eliminated. Revised Prototype, § 110. Note that the absence of a default specification of fiduciary duties does not mean that the applicable state’s common law would necessarily hold that managers of LLCs have no fiduciary obligations. See Auriga Capital Corp. v. Gatz Props., LLC, No. C.A. 4390-CS, 2012 WL 294892 (Del. Ch. Jan. 27, 2012), which I wrote about, here.
Charging Orders. The Prototype provided that a court may issue a charging order, which gives an LLC member’s judgment creditor the right to receive any distributions the member would otherwise receive. The Prototype left unclear whether a charging order was a judgment creditor’s exclusive remedy. I wrote about the exclusivity of charging orders last year, here.
The Revised Prototype makes clear that a judgment creditor’s charging order is its exclusive remedy against an LLC member’s interest in the LLC. This change brings desirable clarity, but many would argue that there is a policy issue left unaddressed by the Revised Prototype, i.e. whether the charging order should be exclusive even in the case of a single-member LLC.
The new provision provides additional detail about the exercise of the charging order, and also makes clear that a charging order may be obtained against an assignee’s LLC interest.
Derivative Suits. The Prototype did not provide a default rule for derivative suits, although nothing in the Prototype prevented an LLC agreement from authorizing derivative suits. The Revised Prototype authorizes derivative suits for members as a default rule, although not for assignees (unlike Delaware, which allows members and assignees to bring a derivative suit, DLLCA § 18-1001).
Series LLCs. Series LLC provisions were added to the Revised Prototype. A series LLC is an LLC that is split into separate series, each having its own members and managers, owning its own assets separate from the assets of the LLC or any other series, and incurring obligations enforceable only against its own assets. At least eight states have authorized series LLCs (see my blog post, here).
Evergreen. The Revised Prototype has been published by the ABA’s Committee on LLCs, Partnerships and Unincorporated Entities. The Committee deserves praise for this comprehensive revision and the thoughtful comments.
The Committee stated in the overview to the Revised Prototype that it will be revised on an ongoing basis, to anticipate and respond to legal and business changes affecting LLCs. This will be especially useful if the Committee can make such revisions publicly available on the Internet (once released), with clear delineation of the changes from one version to another and with adequate comments explaining the changes.
Comments. The Committee has encouraged interested parties to submit suggestions and comments on the Revised Prototype. The Committee can be reached through the ABA’s website, here.
The National Conference of Commissioners on Uniform State Laws (NCCUSL) was formed in 1892 to promote uniformity in state laws by providing states with proposed legislation. NCCUSL’s record has been mixed, but it has had notable successes in the area of commercial and business law. Examples include the Uniform Commercial Code (in cooperation with the American Law Institute), the Uniform Partnership Act, and the Uniform Trade Secrets Act.
LLC law has not been one of NCCUSL’s shining successes. NCCUSL released its first Uniform LLC Act (ULLCA) in 1995, after almost all the states had already adopted LLC statutes. ULLCA has since been adopted by only eight states.
In 2006 NCCUSL released a revised version, the Revised Uniform Limited Liability Company Act (RULLCA). In 2008 RULLCA was enacted by Idaho and Iowa.
Earlier this year Nebraska and Wyoming enacted RULLCA, doubling the number of RULLCA states from two to four. Nebraska’s new law was signed by the governor on April 1, 2010. It becomes effective January 1, 2011 and has a two-year transition period. The new Wyoming Act was signed by the governor on March 8, 2010 and became effective July 1, 2010, with a four-year transition period.
There is significant variation among the current state LLC laws, other than those of the eight states that enacted ULLCA, and the four states that have now adopted RULLCA. Many were originally modified versions of the states’ limited partnership laws, while some were copied in part from other states’ laws, from ULLCA, and from the ABA’s 1992 Prototype Limited Liability Company Act.
RULLCA has been criticized. Larry E. Ribstein, An Analysis of the Revised Uniform Limited Liability Company Act, 3 Va. L. & Bus. Rev. 35 (2008). Professor Ribstein has referred to it as “the incredibly misguided Revised Uniform Limited Liability Company Act,” here. His view is that RULLCA “threaten[s] to impose substantial risks and costs on limited liability companies … that there is little reason for states to adopt the Act, and that practitioners should be wary about advising clients to form under it.” Id.
The major criticisms of RULLCA include the following issues. Ribstein, supra, at 78-79.
- Unworkable provisions on shelf registration, i.e., creating an LLC with no initial members
- No provisions for series LLCs
- An overly broad definition of the elements of the operating agreement
- Unclear rules on the agency power of members and managers
- Broader fiduciary duties than the traditional duties of loyalty and care, with uncertain boundaries, and intricate restrictions on operating agreement waivers of fiduciary duties
RULLCA is a valuable resource for states looking to review and revise their LLC statutes, but its prognosis for becoming widely adopted looks bleak.
Given the relatively recent appearance of LLCs on the legal stage, a variety of state approaches may not be such a bad thing. Over time, case law will play out against the statutory backdrops, LLC statutes will be revised based on business needs and the results of litigation, and lawyers and business people can in effect vote with their feet by forming LLCs using whatever states’ laws best fit their needs.