Ready or Not, the New California LLC Law is Here

by Buchalter
Contact

The California Revised Uniform Limited Liability Company Act was effective January 1, 2014 and is codified as new Title 2.6 of the California Corporations Code starting at Section 17701. The new law incorporates a more robust set of default rules that apply if the LLC operating agreement is silent. It is intended to bring California LLC law more in line with the LLC laws of other states, making it easier for multi-state businesses to operate both inside and outside of California. 

The transition provisions of the new law provide that the old law continues to govern all contracts, including operating agreements, entered into by an LLC, its members or managers prior to January 1, 2014, making it seem as if the new law will not affect existing operating agreements entered into prior to that date. However, the new law also provides that any acts taken by an LLC, its members or managers on or after January 1st, will be governed by the new law rather than the prior law. As such, the new law is seemingly unclear as to which law will apply to operating agreements adopted prior to January 1st, but amended after that date. Would just the amendment be governed by the new law? By virtue of amending the operating agreement, does the entire operating agreement now come under the scope of the new law? The answer is that it is unclear.  This is the crux of many of the criticisms of the new law as business persons and lawyers try to understand and cope with the changes. As a result, LLC members and managers should consult with their corporate counsel to avoid unwanted consequences that may be brought on by the new law.

The following is a summary that highlights several of the noteworthy changes implemented by the new law. 

Operating Agreements Under the new law, if a record filed with the Secretary of State (i.e., Articles or a Statement of Information) conflicts with the operating agreement, the operating agreement controls, with an exception for third parties who rely on the public record. Also, the new law provides that, in addition to an operating agreement being a written and oral agreement, an operating agreement may also be “implied.” Although it is unclear what would be considered “implied,” the significance of this is that an “implied” way of doing things could override the default provisions in the code. 

Management The default rule under the prior law stated that an LLC is member managed, unless the Articles provide otherwise. The new law provides that unless both the Articles and the operating agreement state that the LLC is manager-managed, the default rule is that the LLC will be member managed. 

With respect to manager-managed LLCs, as a default, absent a contrary provision in the operating agreement, managers have equal rights in the management and conduct of the LLC’s activities and that a majority of managers decide matters in the ordinary course of business except that all members must approve: (1) the sale of assets, (2) an act outside the ordinary course, (3) a merger or conversion, and (4) an amendment to the operating agreement.  This is different from the prior law, which provided that as a default all decisions of the manager would be decided by majority vote.

Member Voting Absent a contrary provision in the operating agreement, matters outside the ordinary course of the LLC require the approval of all of the members. So unless a particular action is set forth in the agreement, or unless the agreement expressly disclaims any additional voting rights, a member who does not approve of an action undertaken by a manager could contest that action, claiming it was “outside the ordinary course of business,” and that the member did not consent to it. Accordingly, the operating agreement should specifically list enumerated items for which less than unanimous consent is required, and disclaim all other voting rights with respect to such actions outside the ordinary course actions of the manager.  The Code does not define what is meant by outside the ordinary course, so this has the potential to produce disputes between managers and members.

Fiduciary Duties The prior law does not specify the fiduciary duties owed by member-manager or managers, instead stating that they are the same as those of a general partner in a partnership. The new law changes this by providing detailed provisions regarding fiduciary duties. They include the duty of loyalty, the duty of care and the duty of good faith and fair dealing. The new law also provides that, to a certain extent, some of these duties may be varied only by a written operating agreement. The duty of loyalty is limited to enumerated activities as follows:

  1. to account to and hold as trustee for the LLC any property or benefit, including the appropriation of a company opportunity,
  2. to refrain from dealing with the LLC as or on behalf of a party having an interest adverse to the LLC, and,
  3. to refrain from competing with the LLC. 

 The duty of loyalty may not be eliminated, but the operating agreement may do any of the following:

  1. Identify specific types or categories of activities that do not violate the duty of loyalty, if not manifestly unreasonable, and/or,
  2. Specify the number or percentage of members that may authorize or ratify, after full disclosure to all members of all material facts, a specific act or transaction that otherwise would violate the duty of loyalty. 

The duty of care is limited to refraining from grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law. However, the duty of care may be reduced so long as it is not unreasonably reduced.  The contractual duty of good faith and fair dealing may not be eliminated.

Capital Contributions The prior law provided that capital contributions can take the form of “money, property or services rendered, or a promissory note or other binding obligation to contribute money or property or to render services.” The new law now adds “any benefit” provided by a person to the LLC, which could present a valuation problem.

Tax Allocations Under the prior law, the default rule for tax allocations was that profits and losses were in proportion to the contributions of each member. The new law is silent on the allocation of profits and losses among LLC members for tax purposes. So the operating agreement should specify the method by which profits and losses are to be allocated as the new law does not provide a default rule.  

Indemnification The prior default rule provided that an operating agreement may, but is not required to, provide for the indemnification of any person acting on behalf of the LLC. The default rule under the new law is that the LLC must indemnify managing members and managers, so long as they have complied with their statutory duties. If members do not want indemnification to be mandatory, they should amend their operating agreement to override this default rule. 

Similarly, the new law also has a default rule requiring an LLC to reimburse members of member-managed LLCs, and managers of manager-managed LLCs, for payments made by them in the course of their activities on behalf of the LLC, provided they have complied with their statutory duties. If members prefer that reimbursement not be mandatory, or that certain conditions be satisfied for members or managers to be eligible for reimbursement (for instance, that the expenses are preapproved or do not exceed certain amounts), they should provide so in the operating agreement to override this default rule.

Disassociation The events described below under the new law are deemed to be member dissociation events, which leave the member with only a “transferee/assignee” status. Dissociated members cannot conduct operations and have no access to records or other information other than the right to an accounting from the date of the LLCs dissolution. 

  1. Death of member who is an individual;
  2. If member managed, the appointment of a guardian or conservator for an individual member;
  3. If member managed, a judicial order that the member is incapable of performing his duties;
  4. If member managed, a member becomes a debtor-in-bankruptcy.

If members do not want these events to cause disassociation, the operating agreement should so provide. 

There are several noteworthy provisions that have remained unchanged by the new law as follows:

  1. A California LLC may not perform a professional service that requires a license, registration or certification under the California Business and Professions Code (such as a legal or medical practice);
  2. California LLCs will continue to be subject to a gross receipts tax on income from all California sources (S corps are not subject to this tax); and
  3. Laws on mergers and conversions are the same for the most part (with the default rule that unanimous member consent must approve a merger).

In light of the notable changes discussed here, members and managers of LLCs should evaluate how the new framework will impact their interests and modify their LLC agreements accordingly.

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.

© Buchalter | Attorney Advertising

Written by:

Buchalter
Contact
more
less

Buchalter on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.