While not quite as exciting as the NCAA Tournament (I’m sure many of you are watching on your computer today), California’s limited liability company statute was recently updated by the California Revised Uniform Limited Liability Company Act (the “Act”). The Act, which took effect on January 1, 2014, was intended to update existing California law to reflect developments in this area over the past twenty years, include more detailed rules governing issues not covered by the company’s operating agreement, and to bring California law in line with the laws of other states. (CEB Law Alert, October 1, 2013). The Act also provides more specifics concerning when the Act cannot be overridden by the members.
Although most of the substance of the Act is similar to existing law, there are a number of provisions that will impact the use of LLCs. Some of the more relevant issues are discussed below. Not all of the concepts are changes to the law, but serve as reminders about important issues.
The Act retains the right of the LLC to be managed either by the members or a manager (or multiple managers). If the articles of organization and the company’s operating agreement do not specify that the LLC will be managed by a manager, then the LLC will be deemed to be member managed, and all of the members will be agents of the Company. This is a change from existing law where only the articles of organization needed to specify the structure.
Member Approvals Of Major Decisions
The company’s operating agreement usually addresses what percentage of the members must approve a major issue, like merger, sale of the Company’s assets, or amendment of the operating agreement. Previously, if these issues were not addressed, a majority vote was required. Under the Act, the members must unanimously approve such decisions. The operating agreement should clearly state the members’ intentions.
Becoming a Member
The Act allows a person to become a member without acquiring an interest in the profits of the company or making a contribution to the company. Previous law did not provide for this. The reason for the change was twofold – to accommodate common business practices and recognizing that an LLC does not necessarily need to have a specific business purpose.
Distributions of Profits
Unless stated in the operating agreement, distributions of profits will be made to the members based on the value of the contributions from each member. It is critical to specify the members’ intentions in the operating agreement. In most cases, some members are intended to receive distributions for reasons that are not based on the amount of cash contributed.
Failure to Make Contributions May Result in Personal Liability to Third Parties
One of the most important protections of an LLC is to avoid personal liability to the owners/members. The Act now includes an important exception. If creditors of the LLC extend credit or act in reliance on a member’s obligation to make a contribution to the company, then that creditor may enforce the obligation personally against the member. An example of this is where a lender agrees to make a loan to the company based on the member’s commitment to contribute capital at a later date.
Non-Cash Distributions May Be Made
The Act now allows a LLC to make distributions in kind (property, not cash) if the asset is fungible and each member receives a percentage equal in value to the member’s share of distributions. This means that the property must have a value that is easily calculated. However, a member may not demand a distribution in kind unless permitted by the operating agreement. In some residential developments, members wish to receive condo units instead of cash distributions. This can only be enforced if permitted by the operating agreement or elected by the vote of the members or managers, as applicable.
Duties of Care and Loyalty
In a member managed LLC, the members owe each other a duty of loyalty and care. However, this standard of care is essentially one of gross negligence, unless otherwise provided for in the operating agreement. In a manager managed LLC, the managers owe the members a duty of loyalty and care. In all instances, the members and managers are bound by the covenant of good faith and fair dealing.
Limitations on Freedom of Contract
Although the Act recognizes the right to freedom of contract in creating an LLC structure, there are limits. Here are some of the important limitations on what provisions may not be changed by the operating agreement:
Elimination of the duty of loyalty and care and the contractual obligation of good faith and fair dealing. However, the operating agreement may specify categories of activities that do not violate the duty of loyalty and good faith and fair dealing;
- Any unreasonable restriction on the rights of members to receive documents relating to the company’s business;
- Change to the statutory restrictions on distributions (for example, prohibition of distributions if the company cannot pay its debts);
- Any provision that would eliminate liability for money damages for (i) receipt of a benefit to which the member or manager is not entitled, (ii) liability for excess distributions, (iii) intentional infliction of harm, and (iv) violation of criminal law.
The above is a limited summary of the changes to LLC laws. Consultation with counsel is always a good idea when forming a new LLC.
The issues discussed in this update are not intended to be legal advice and no attorney-client relationship is established with the recipient. Readers should consult with legal counsel before relying on any of the information contained herein. Reuben, Junius & Rose LLP is a full service real estate law firm. We specialize in land use, development and entitlement law. We also provide a wide range of transactional services, including leasing, acquisitions and sales, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.