Business and Corporate: MANAGERS, MEMBERS AND ADVISORS BEWARE: California's New Limited Liability Company Law Becomes Effective on January 1, 2014
The California Revised Uniform Limited Liability Company Act ("RULLCA") will repeal and supersede California’s existing limited liability company act (the Beverly-Killea Limited Liability Company Act, "Beverly-Killea"). RULLCA is different from Beverly-Killea in many significant respects.
RULLCA is replete with ambiguities and inconsistencies. Those ambiguities and inconsistencies were created because RULLCA, as enacted in California, did not adopt word-for-word the Revised Uniform Limited Liability Company Act as promulgated by the National Conference of Commissioners on Uniform State Laws (the “National Conference”). RULLCA, as enacted in California, attempted to incorporate provisions from Beverly-Killea because the drafters believed the version adopted by the National Conference is slanted in favor of LLC management. The California version seeks greater protections for the interests of LLC members. The Partnerships and Limited Liability Companies Committee of the State Bar of California, Business Law Section, has proposed a technical corrections act to correct the ambiguities and inconsistencies. However, that technical corrections bill was not taken up by the legislature this year and will not be effective on January 1, 2014, when RULLCA becomes the law of the land. If enacted in 2014, the technical corrections act will eliminate many of the ambiguities and inconsistencies.
REPEALED OR NOT REPEALED?
RULLCA does not provide transition rules whereby the old law would continue to apply to existing LLCs. RULLCA states that the new law applies to acts and transactions of existing LLCs, and their members or managers, and contracts entered into after January 1, 2014. Acts and transactions of existing LLCs and their members or managers and contracts entered into before January 1, 2014, are governed by Beverly-Killea but as of January 1, 2014, Beverly-Killea is repealed. There is uncertainty as to whether existing operating agreements are governed by the old law or the new law as a contract entered into prior to January 1, 2014. If the uncertainty is resolved in favor of existing operating agreements being governed by Beverly-Killea, then there is still uncertainty as to whether an amendment after January 1, 2014, makes the entire operating agreement subject to RULLCA. The technical corrections bill, if enacted, may resolve some of this uncertainty but RULLCA, with all its flaws, will be in effect on January 1, 2014. Because of this uncertainty, members, managers, and advisors of LLCs should consider that the provisions of RULLCA, to the extent different than Beverly-Killea, will operate at all times subsequent to January 1, 2014. Operating agreements of existing LLCs should be reviewed and, if necessary, amended to carry forward the wishes of the appropriate constituents after January 1, 2014.
The following are significant matters that have changed:
• By default, an LLC governed by RULLCA is managed by the “majority of the members.” RULLCA defines a “majority of the members” by default as more than 50 percent of the membership interests of members in current profits. If the managers and the members desire to have a manager-managed LLC, then they must use words specified in the statute. Those provisions must be contained in the articles of organization and the operating agreement in order to effectuate management by a manager. If an existing LLC, intending to be manager-managed, does not have sufficient language in the operating agreement, then it may revert to being member-managed.
• Certain matters in a manager-managed LLC require a unanimous vote of the members. Those matters include sale, exchange or other disposition of all or substantially all of the LLC’s property; a merger or conversion; any other act outside of the ordinary course of the LLC’s business; and amendment of the operating agreement. Under Beverly-Killea, in the absence of the provision in the operating agreement, a majority of the members could amend an operating agreement. If LLC managers, members or advisors desire to amend an operating agreement for an existing LLC that does not specify how the operating agreement is to be amended and if unanimous approval is not possible, then the amendment should be adopted prior to January 1, 2014.
• RULLCA adopts the concept of “dissociation” of a member. Unless otherwise specified in the operating agreement, certain events will cause dissociation of a member. Those events include resignation or withdrawal of a member; death of an individual member; bankruptcy of a member (in a member-managed LLC); appointment of a guardian or conservator for an individual member (in a member-managed LLC); distribution of a transferrable interest by an estate or trust; or dissolution or termination of a legal entity acting as a member. In addition, transfer of a member’s entire transferable interest allows the non-transferring members to expel the transferring member by their unanimous consent. Dissociation causes the dissociated member to lose all management and voting rights and any interest owned by the member or successor in interest is owned by the person merely as a transferee with very limited rights. Dissociation does not ordinarily cause dissolution of the LLC or a buy out of a dissociated member.
• RULLCA has no default allocation of profits and losses.
• RULLCA contains default indemnification provisions that may be modified by an operating agreement. If the constituents of an LLC desire to have different indemnification rights than those in RULLCA, they should specify those indemnification rights in the operating agreement.
• As between members and managers, RULLCA reverses the default rule as to which document governs if there are inconsistent provisions between the articles of organization and the operating agreement. Under RULLCA, the inconsistent provisions of the operating agreement prevail over the provisions of the articles of organization. Under Beverly-Killea the articles of organization control over the operating agreement. If an LLC has significant substantive provisions in its articles of organization, then those provisions should be adopted in the operating agreement by an amendment.
FIDUCIARY DUTIES NOW SPECIFIED
Fiduciary duties of LLC management are now specified by RULLCA. Those fiduciary duties include a strict duty of loyalty that requires, among other things, management to strictly account as a trustee, to provide all opportunities to the LLC and not to compete with the LLC. Fiduciary duties may be changed only by an “informed consent” in writing and may not be completely eliminated. The enumeration of fiduciary duties in RULLCA seems to have caught many practitioners unaware that the fiduciary duties in RULLCA are no different than the fiduciary duties applicable under Beverly-Killea. Beverly-Killea did not enumerate fiduciary duties but referenced that management of an LLC has the same duties as a partner of a partnership. Essentially the enumeration of fiduciary duties set forth in the Uniform Partnership Act of 1994 in effect in California is incorporated by reference in Beverly-Killea. The fiduciary duties in the Uniform Partnership Act of 1994 are substantially the same as the fiduciary duties specified in RULLCA.
There are significant substantive differences between RULLCA and Beverly-Killea. In several instances, the new provisions of RULLCA will not have been considered in connection with drafting an operating agreement effective under Beverly-Killea. Members, managers and advisors should review their existing operating agreements and determine whether amendments or modifications are necessary to prepare for the effectiveness of RULLCA.