Business and Corporate Section Monthly Article


Updating Your LLC Operating Agreement

As of January 1, 2014, the California Revised Uniform Limited Liability Company Act (“RULLCA”) [Corp Code 17701.01 et seq] will take effect and automatically apply to all existing and newly formed limited liability companies (“LLCs”).  All acts, contracts or transactions of a new or existing LLC that take place or are entered into on or after January 1, 2014 will be governed by RULLCA.  Any acts, contracts or transactions of an existing LLC that occurred prior to January 1, 2014 will still be controlled by the Beverly-Killea Limited Liability Company Act.  Articles of Organization (“Articles”) for existing LLCs do not need to be amended or refiled in order for RULLCA to apply.  Under the new Act, there are some significant changes from Beverly-Killea that should be noted, and modifications that should be made to all operating agreements drafted for new LLCs.  This article highlights some of those changes.

Operating Agreements

Under RULLCA an LLC may be created for any lawful purpose, (whether for profit or not) unless it is created for banking, insurance, trust companies, or rendering professional services as defined in Corp Code §13401 or 13401.3. Operating agreements can now be oral, implied or in writing.  For all operating agreements drafted on or after January 1, 2014, if a conflict arises between the Articles and the agreement, the agreement will prevail.  However, the Articles will still prevail for third parties if third parties reasonably relied on the Articles.  All members of the LLC are deemed to assent to, and be bound by, the terms of the operating agreement regardless of whether or not they sign the operating agreement.  If the operating agreement is silent on an issue, RULLCA statutory provisions will control.

RULLCA permits the modification of certain statutory provisions through a written operating agreement.  The statutory provisions that can be modified include: (a) relations between the members and the LLC; (b) rights and duties of a Manager as that term is defined under the Act; (c) activities and conduct of the LLC; (d) amendments to the operating agreement; (e) limiting fiduciary duties (but not eliminating them); (f) eliminating or limiting the indemnification or personal liability of a member or Manager to the LLC for money damages (unless the damages are due to any acts listed under §17701.10(g)).

Although RULLCA provides for some flexibility in overriding the statute, the following provisions cannot be modified by the operating agreement: (a) varying an LLC’s capacity to sue and be sued in its own name; (b) California choice of law; (c) varying the powers of a court under RULLCA; (d) eliminating fiduciary duties (but can be limited); (e) eliminating the contractual obligation of good faith and fair dealing;  (f) unreasonably restricting the rights of members to receive information and inspect LLC records; (g) varying the power of a court to decree dissolution; (h) varying any provision related to mergers and conversions (Article 10) or class provisions (Article 12); (i) unreasonably restricting a member’s right to maintain a class action on behalf of all members or class of members; (j) restricting a member’s right to vote on dissolution or merger; (k) restricting the rights of a third party (other than member or manager), (l) varying the agency relationship of members in a manager-managed LLC; and (m) modifying any of the defined terms under RULLCA.

Member Contributions

As a default rule, LLCs will have a perpetual duration, unless sooner terminated as provided for in the operating agreement. (§17701.04)  Contributions by members may consist of tangible or intangible property, or other benefit to the LLC (including money, services performed, promissory notes, other agreements to contribute money/property, and contracts for services to be performed).  (§17704.02, 17704.03)  Under these new rules, a person can become a member without acquiring an economic interest in the LLC.  RULLCA does not list any penalties for a member’s failure to make a contribution, but does state that a member is not excused from making a contribution because of a person’s death, disability or other inability to perform personally.  It is recommended that operating agreements set forth penalties for a member’s failure to make a contribution, and that members cannot be excused from making a contribution for any reason. 

Manager-Managed vs. Member-Managed

A significant change in the new law was made to Manager-Managed LLCs and member-managed LLCs for purposes of defining the scope of a member’s agency, imposing fiduciary duties on members and Managers in control of the LLC, and permitting the establishment of member classes.

Under RULLCA, a “Manager” is defined as “a person that under the operating agreement of a manager-managed limited liability company is responsible, alone or in concert with others, for performing the management functions stated in subdivision (c) of 17704.07.”  Managers can be individuals, partnerships, trusts, corporations, LLCs, associations, or other entities, and are not required to be members.  In order to be deemed a manager-managed LLC, (i) the Articles must specify the LLC is manager-managed, and (ii) the operating agreement must contain language expressly providing that the LLC is manager-managed.  Without satisfying both requirements, the LLC will be deemed to be member-managed by default.  It is important to note that RULLCA’s rules regarding Managers do not apply to any manager under a member-managed LLC, regardless of their title.       

In a Manager-Managed LLC, all activities of the LLC are decided exclusively by the Managers, and each Manager has equal rights in the management and conduct of the LLC.  No member in a Manager-Managed LLC will be deemed an agent of the LLC, or have the authority to bind the LLC.  By default the consent of a majority of the members in a Manager-Managed LLC will be required for any sale, lease or exchange of all or substantially all of the LLCs property outside the ordinary course of the company’s activities; for approval of a merger or conversion; for approval of a dissolution; to change the nature of the principal business of the LLC; to undertake any act outside the ordinary course of the LLC activities; to amend the operating agreement; or to remove the Manager.  (§17704.07)  Member consent for these activities may be modified by the operating agreement.

In contrast, in a member-managed LLC, the members will control the management and conduct of business. Every member in a member-managed LLC is an agent of the LLC for the purpose of conducting its business or affairs.  The act of any member which is performed in the ordinary business of the company, will bind the LLC.  All members are deemed to have equal rights in the management of the LLC, and equal voting rights, unless such voting rights are altered through the establishment of member classes in the operating agreement.  Ordinary LLC activities will be decided by a majority vote of the members (more than 50%), while matters outside the ordinary course of business require unanimous member consent. 

Members in a member-managed LLC, and Managers in a Manager-Managed LLC owe the members and the LLC the duty of loyalty and care, and the obligation of good faith and fair dealing.  These duties cannot be eliminated, but may be limited by the operating agreement.  (§17704.09) 

Distributions

If a Manager in a Manager-Managed LLC, or a member in a member-managed LLC consents to an improper distribution made in violation of section 17704.05, the Manager of the Manager-Managed LLC, and consenting members of a member-managed LLC, will be personally liable to the LLC for any excess distributions made beyond what would have been permissible.  The liability of the Manager or members for consenting to excess distributions cannot be eliminated or limited by the operating agreement.  If a member does not have authority to consent to the distribution, the member will not be personally liable for any improper distributions. 

Disassociation & Dissolution

RULLCA provides specific instances which result in a member’s disassociation from the LLC.  These provisions can be modified by the operating agreement.  Upon a member’s disassociation, all rights of the member to participate in the management and conduct of the LLC ceases, but the disassociated member will still be liable for any debt, obligation or liability incurred as a member of the LLC.  A disassociated member of a member-managed LLC will not owe any fiduciary duties to the LLC after the date of dissolution.  Under the new rules, if a member transfers all of his “transferrable interest” (as that term is defined under the Act), other than for security purposes or charging order that has not been foreclosed, the transferring member can be disassociated by the unanimous consent of the other members. (§17706.02) It is a good practice pointer to specify the terms of member disassociation in the operating agreement if these statutory rules are not desirable. 

Although a majority of the rules regulating LLCs remain unchanged under RULLCA, operating agreements will need to be updated to reflect the substantive changes that will go into effect January 1, 2014.  This article highlights some of the significant changes from Beverly-Killea, but is not intended to be an exhaustive list, thus practitioners are advised to review the Act to determine which default provisions should be varied through the operating agreement.

-- Ashley M. Peterson, Peterson & Price, APC

**This article is intended for informational purposes only and does not constitute legal advice. Any views expressed are those of the author only and not of the SDCBA or its Business & Corporate Law Section.**