California Replaces Its Limited Liability Company Act

On January 1, 2014, the California Revised Uniform Limited Liability Company Act (the New Act) replaced California’s Beverly-Killea Limited Liability Company Act (Beverly-Killea), which was adopted in 1994. The New Act is intended to bring California’s laws more in line with the laws of other states while also clarifying certain issues that existed under Beverly-Killea.

Existing and future California LLCs are subject to the New Act. Thus, it is important that operating agreements drafted prior to 2014 be reviewed, and perhaps amended, in light of the changes in the law.

One of the benefits of choosing to do business as an LLC is the ability to draft a customized operating agreement that governs the business entity and its members and managers. California law only requires a limited number of mandatory provisions. Most provisions in Beverly-Killea and the New Act are default rules that apply only where the operating agreement is silent or otherwise refers back to applicable law.

The following is a summary of some of the key changes in default rules under the New Act.

Member-Management

The New Act provides that LLCs will be member-managed by default. In order to create a manager-managed structure, the LLC must specifically state such structure in both the articles of organization filed with the Secretary of State and the operating agreement.1 LLC managers are encouraged to review these two documents to ensure the designation is clear in both. The requirements for amendment of the articles of organization and operating agreement are discussed below. It is important to note that in the event an existing manager-managed LLC cannot obtain the required consent to amend the articles to include the manager-managed designation, the LLC will be deemed to be member-managed by default.

Member Consent Requirement

Under the New Act, unless otherwise provided in the operating agreement, managers may not take actions “outside the ordinary course of business” without obtaining the unanimous consent of the members.2 As a result, operating agreements that currently rely on applicable law to establish voting rights may need to be amended to allow managers to avoid disputes with minority members.

Fiduciary Duties

The New Act allows LLCs to modify, but not eliminate, fiduciary duties in their operating agreements.3 These duties fall under three categories:

  1. Duty of Loyalty: This includes three sub-duties: (a) the duty to account, (b) the duty to refrain from self-dealing, and (c) the duty to refrain from competing. Members may designate certain acts that do not violate the duty of loyalty so long as the list is not manifestly unreasonable. Operating Agreements may also specify the approval required to authorize or ratify acts that otherwise would violate the duty of loyalty.
  2. Duty of Care: The duty of care may be modified in the operating agreement, provided it is not unreasonably reduced.
  3. Good Faith and Fair Dealing: The standards by which this duty is measured may be modified so long as the new standards are not manifestly unreasonable.

Indemnification

The New Act provides that LLCs must indemnify members of member-managed LLCs and managers of manager-managed LLCs, unless the indemnified manager or member has not complied with its statutory duties.4 Thus, LLCs not intending to provide such indemnification should carefully review the applicable sections of their operating agreement and determine if any clarifying amendments should be made.

Dissociation of Members

The New Act provides a list of events that will result in a member’s dissociation, effectively giving an existing member the legal status of an assignee. These events are: (1) death; (2) the appointment of a guardian or conservator for a member of a member-managed LLC; (3) a judicial order that a member of a member-managed LLC is incapable of performing such member’s duties; (4) in the case of a member that is a trust, the distribution of the trust’s interest in the LLC; and (5) a member of a member-managed LLC becomes a debtor in bankruptcy.5 Additionally, a dissociated manager will be automatically removed as a manager.6 If members or managers do not intend for these events to trigger dissociation or removal as managers, the operating agreement should be amended accordingly.

Expense Reimbursement

The New Act mandates reimbursement of managers and members for expenses incurred on behalf of the LLC provided that the incurrence of those expenses did not constitute a violation of fiduciary duties.7 Beverly-Killea only provided that LLCs were permitted to reimburse for such expenses. As a result, LLCs should review and possibly revise the reimbursement provisions of their operating agreements if they wish to avoid this new mandate or limit it in some way (for example, by requiring pre-approval or receipts for reimbursement).

Additional Members

The New Act provides that newly admitted members of an LLC will be subject to the terms of existing operating agreements. This will be true even if new members do not sign the operating agreement or otherwise consent to it.8 As with the other default rules in the New Act, this rule may be modified in the terms of an operating agreement.

Amending the Articles of Organization and Operating Agreement

In light of the changes discussed above, some existing California LLCs may want to amend or restate their articles of organization. As a default, such amendment or restatement must be executed by at least one manager of a manager-managed LLC or at least one member of a member-managed LLC. However, the operating agreement and/or articles of organization may provide differently, so both documents should be carefully reviewed before filing with the Secretary of State.

The terms of the existing operating agreement will govern its amendment. The provisions regarding amendment should be reviewed carefully and all necessary consents obtained to avoid disputes.

Conclusion

This alert is a summary of the changes in California law applicable to LLCs and does not include every change effected by the New Act. LLCs are encouraged to review their existing operating agreements in light of the New Act and make appropriate changes to reflect the intentions of their members and managers.

Endnotes

1 See new §17704.07.

2 See new §17704.07.

3 See new §17704.09.

4 See new §17704.08.

5 See new §17706.02.

6 See new §17706.03.

7 See new §17704.08.

8 See new §17701.11.

Topics:  Compliance, Fiduciary Duty, LLC, Operating Agreements

Published In: Business Organization Updates, General Business Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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