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A Snapshot of Recent California Revised Uniform Limited Liability Company "Clean-Up" Legislation

The California Revised Uniform Limited Liability Company Act ("RULLCA") became effective on January 1, 2014. Nearly two years later on October 11, 2015, AB 506 was filed with the California Secretary of State and is long awaited RULLCA "clean up" legislation. The amendments to RULLCA became effective January 1, 2016.

Attached is a summary (the "Summary") of the key AB 506 changes to RULLCA, which was provided in a Special Alert contained in the 2015 Supplement to the California Limited Liability Company Forms and Practice Manual, authored by Gerald V. Niesar, Benjamin Berk and Elen Kaye Fleishhacker (who are all practicing attorneys in San Francisco), and which is published by Data Trace Publishing Company.

The Summary does a good job providing an overview of the key changes to RULLCA. However, as the Summary notes, the California legislature left continuing uncertainty concerning which law governs a pre January 1, 2014 operating agreement, which is amended in some fashion on or after January 1, 2014.

In at least one recently reported case, cited in the Summary, a California appellate court dealt with the issue of which of the two laws applied with respect to an action for the involuntary dissolution of a limited liability company organized under the Beverly Killea Act governing LLCs formed prior to January 1, 2014 (the "Prior Law").  The action had been commenced by the plaintiff prior to January  1, 2014 (the effective date of RULLCA and date the Prior Law was repealed by RULLCA).   The plaintiff dismissed its action with prejudice within a few months following January  1, 2014.

At issue in the case was whether the dismissal of the involuntary dissolution action cut off the defendant's right to compel a buyout of the plaintiff's interest in the LLC.  Dismissal of an action for involuntary dissolution of an LLC under the Prior Law cuts off any buyout right by the non­ moving party, the defendant in this case.  Under RULLCA, the dismissal of such an action does not cut off the buy-out right of a non-moving party, such as the defendant.

After engaging in extensive statutory interpretation related to the legislative history of RULLCA and significance of its effective date related to LLCs formed under the Prior Law, the court held in favor of the plaintiff dismissing its involuntary dissolution case., holding there was no buy-out right. Specifically the court emphasized that since the suit was commenced by the plaintiff prior to the effective/operative  date of RULLCA, and since RULLCA specifically provides in section 17713.02 that RULLCA does not "affect an action commenced . . . before this title(i.e.RULLCA) takes effect," the Prior Law, which was in effect when the suit commenced, applied.

For practitioners, however, neither the case nor AB 506 answers the question of which law applies to a California LLC, formed prior to January 1, 2014, where the operating agreement is amended after that date.  Do the provisions of RULLCA pertaining to the amendment of a Prior Law LLC operating agreement override the provisions contained in the operating agreement of the Prior Law LLC?  Does the Prior Law LLC become  100% subject to RULLCA by virtue of an amendment to the Prior Law LLC's operating agreement after January  1, 2014?  Does the amendment have to be "material" or will any amendment of the operating agreement of a Prior Law LLC trigger RULLCA coverage?

Until the question is squarely answered by the courts or California legislature, careful analysis and consideration should be given to the consequences of amending the operating agreement of an LLC formed under the Prior Law.

-- By Robert Copeland

This article is for information purposes and does not contain or convey legal advice. The information herein should not be relied upon in regard to any particular facts or circumstances without first consulting with a lawyer.

CALIFORNIA LLC ACT CLEAN-UP LEGISLATION ADOPTED, EFFECTIVE JANUARY 1, 2016

On October 11, 2015, AB 506 was filed with the California Secretary of State.  This new law, which will become effective on January 1, 2016, is "clean-up" legislation, intended to correct some of the problems that existed with the California Revised Uniform Limited Liability Company Act (CRULLCA). In most cases, the amendments to CRULLCA will not require any changes to existing LLC Operating Agreements as the amendments are primarily intended to clarify ambiguities and disconnects in the legislation.  However, in some cases it may be wise to consider an amendment to the Operating Agreement for purposes of clarification and avoiding unnecessary disputes in later years. Additionally, in some cases the amendment may provide flexibility that Members of an LLC will desire to work into their Operating Agreement.  In this regard, see in particular the discussion in points 4 through 8 below.

Summary of Key Changes: The following is a summary of what the authors believe to be the most important changes effected by AB 506.

  1. 1. 17701.02(v): The word "Person" has been amended to provide that a trustee is a Person. The change to 17701.02(v) is a useful recognition that trustees, rather than the trusts for which they serve, can (and in our opinion, should) be members of LLCs.
  2. 17701.10: This Sub-section,  which provides rules as to what an Operating Agreement may and may not do, has seen several amendments that are primarily technical tweaks.  Many of the changes merely reposition provisions to other Sub-sections. Others correct oversights in the CRULLCA; for instance, subparagraph {e) makes clear that its requirements as to modification of fiduciary duties apply to the duties of Members of a Member-managed LLC, as well as the Managers of a Manager­ managed LLC.
  3. 17704.0l(e): This is a new Sub-section, which reinserts into CRULLCA the exemptions from Labor Code Sections 406 and 407 for the issuance of LLC interests to an employee, a welcome correction of what seems to have been an oversite in the original CRULLCA. The Prior Act had provided these exemptions.
  4. 17704.04(e): This is also a new Sub-section.  It provides that if the Operating Agreement does not specify how profits and losses are to be allocated, the allocation shall be in proportion to the value of the contributions the LLC has received from each Member.   It is unlikely that written Operating Agreements do not specify how profits and losses are to be allocated.  But for those LLCs that exist  under an oral, instead of written, Operating Agreement, this can create a significant litigation issue in the event there is an understanding that profits get allocated on a percentage or other basis that is different from what this new statutory provision provides.
  5. 17704.07{c)(4)(B):  This Sub-section has been deleted.  It provided that in a Manager­ managed LLC approval of a merger or conversion required unanimous consent by all the Members. That requirement could have been varied, but only by a written Operating Agreement.  Effective January 1, 2016, any LLC merger will need to be approved by a Majority of the Members unless the Operating Agreement specifies a greater percentage.  {Amended Sections 17710.12(a) and 17710.03(b){1), respectively.)
  6. 17704.07(C){4}{d}: This Sub-section has been deleted. It had prohibited amendment of a Manager-managed Operating Agreement with less than unanimous approval.
  7. 17704.0S(b): This Sub-section has been added (and the prior (b) was made (c)). The new (b) expands the permissible reimbursements and indemnifications to include Persons other than Managers.
  8. 17704.0S(d): This Sub-section has been added. It provides basically the same level of mandatory indemnification for an agent of the LLC as is provided for agents of California corporations. To qualify for mandatory indemnification the agent must have been successful on the merits in defense or settlement of the claim or other matter that was the subject of the dispute at issue.  Presumably this indemnification obligation may not be eliminated by the Operating Agreement; see Sub-section 17701.lO(g) which allows modification or elimination of permissive indemnification in Sub-section 17704.0S(aL but does not refer to Sub-section 17704.08((d).
  9. 17707.06(a): This Sub-section has been amended to provide that an LLC that has filed a certificate of cancellation nevertheless continues to exist for purposes of winding up.  This has been a problem for cancelled LLCs involved in litigation, or needing to be brought into litigation, for example where a post-cancellation lawsuit involves former Managers who might be able to assert an LLC claim as an offset.
  10. 17713.04(b): This Sub-section has been amended to make clear that an Operating Agreement or other contract entered into before January 1, 2014 is not governed by the CRULLCA but apparently appears to be governed by the Prior Act (which has been repealed).  It is not clear which act will apply to an Operating Agreement entered into prior to January 1, 2014, but amended in some regard after that date.   On this issue of application of the new or old act generally, see Kennedy v. Kennedy, 235 Cal. App. 4th 1474, 2d Dist. 2015 where the Court of Appeal, finding it a close call, nevertheless decided that the Prior Act should govern whether withdrawal of an involuntary dissolution cuts off the right of the non-moving party to compel a buyout of the moving party's interest; CRULLCA affords the moving party that right, but the Prior Act did not.
  11. 17713.04(c):  This Sub-section has been amended to provide that any vote or consent prior to January 1, 2014 is governed by the Prior Act.   It seems to open up for dispute whether a vote taken post January 1, 2014 that may be permitted or prohibited by the Prior Act, but is prohibited or permitted under CRULLCA, will be governed by the pre-CRULLCA Operating Agreement, or by CRULLCA.

This Summary is based upon the Special Alert in the 2015 Supplement to California Limited Liability Company Forms and Practice Manual Gerald V. Niesar, Niesar & Vestal LLP, San Francisco, Benjamin Berk and Ellen Kaye Fleishhacker, Arnold Porter LLP, San Francisco Published by Data Trace Publishing Company
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