New Law Will Change the Way Limited Liability Companies Form and Operate

by Best Best & Krieger LLP

BB&K's George Reyes Examines How the California Law Will Impact Existing and Future Businesses

OCTOBER 9, 2013 - The Press-Enterprise

The rules that govern businesses formed as limited liability companies, or LLCs, in California are about to get their first major overhaul in 20 years with a new law that takes effect on Jan. 1.

Known as the California Revised Uniform Limited Liability Company Act, the new law significantly changes the way such companies form and operate. LLCs, popular with small businesses, are legally structured hybrid business entities that share certain characteristics of both a corporation and a partnership. Like a corporation, an LLC provides limited liability to the owners who are referred to as “members,” but it also offers the tax efficiencies and operational flexibility of a partnership.

The new law will completely replace the current Beverly-Killea Limited Liability Company Act, which has governed LLCs in California since 1994, when limited liability companies were first permitted in the state. It will regulate new LLCs formed on or after Jan. 1 and applies to all actions taken by existing LLCs on or after that date. Beverly-Killea will continue to govern LLCs operating agreements entered into prior to Jan. 1. However, there is uncertainty whether amending a portion of an existing operating agreement will make the entire operating agreement subject to the new law.

Here are some of the key changes with the new law:

Operating agreements: LLCs are commonly subject to a written operating agreement among the members regarding items such as member voting, division of profits and transferability of membership interests. The new law does not require a written agreement; it only requires a record, or even an implication of an agreement. This broad definition highlights the need to create a well-drafted operating agreement that limits the agreement solely to the written document. Otherwise, emails among the members, phone calls and even perceptions may find their way into what the court considers the agreement made among the parties.

New Members: Under the new law, any newly admitted member of the LLC will be bound by the terms of the operating agreement, even if the new member did not actually sign or otherwise consent to the agreement.

Profits and Losses: While Beverly-Killea divided profits and losses in proportion to the contributions of each member, unless it was specified otherwise in the operating agreement, the new law does not appear to have a default allocation of profits and losses. This makes it all the more important to determine and state the allocation agreed upon by the members in a written operating agreement.

Fiduciary Duties: Under Beverly-Killea, the duty of loyalty a manager or managing member owes to the LLC and to the members of the LLC is the same open-ended list of duties a partner owes to the partnership and to the other partners. The new law, however, limits the duties to those expressly listed in the statute and allows members, through an operating agreement, to both specify certain activities that will not violate fiduciary duties and set standards to determine good faith — as long as they are not unreasonable.

Default Rules: Under the new law, an LLC will be managed by the members unless a company’s articles of organization and operating agreement expressly state that management is by one or more managers. If a limited liability company is relying on a statement in its articles of organization that it is managed by a manager but does not have a formal operating agreement or its operating agreement is silent on the matter, it may unintentionally become a member-managed entity, and vest management obligations, rights and fiduciary duties in the members.

Mergers: The new law includes a default provision that an LLC managed by a manager requires unanimous member consent to approve a merger. This may be modified through an operating agreement, but if not expressly addressed, then unanimous consent is required.

In light of these notable changes, members of limited liability companies should evaluate how the new framework will impact their interests and the interests of their clients before the new law takes effect at the beginning of next year.

* This column was first published in The Press-Enterprise on Sunday, Oct. 5, 2013. Republished with permission.

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