Top Five Considerations for California LLCs Under RULLCA

Top Five Considerations for California LLCs Under RULLCA

On January 1, 2014, the Revised Uniform Limited Liability Company ACT ("RULCCA") went into effect in California and made many substantive changes with respect to the management and ownership of California LLC's. 

The attorneys in Selman Breitman's Business Transactions Group frequently advise clients on the formation and governance of LLCs.  In our experience, the following five issues have been of paramount importance for our clients since the enactment of RULCCA.  Do note, this article deals with LLCs formed after January 1, 2014.  If your LLC was formed prior to that date, contact us today to discuss how RULLCA may affect your business.

1. Governance – The Operating Agreement. 

An operating agreement is a contract executed by the members of an LLC to govern how the LLC will operate.  Big picture, the operating agreements dictate the rights and responsibilities of LLC members. 

RULLCA expands the definition to mean any agreement between the members, "whether oral, in a record, implied, or in any combination thereof" that governs the following:

(1) Relations among members and between members and the LLC;

(2) The rights and duties of a manager;

(3) Activities/conduct of the LLC; and

(4) The method for amending the operating agreement.

For LLCs being formed under RULLCA, a written operating agreement is crucial. Otherwise, members are at risk of creating an "implied" operating agreement that could hamstring management and confound daily operations. To avoid unintended consequences, it is best to consult an experienced business attorney before preparing any operating agreement.

2. Management.

There are two management structures for LLCs: member-managed and manager-managed.  In a member-managed LLC, members generally have equal rights with respect to the management and conduct of LLC affairs.  In a manager-managed LLC, a manager or managers is/are vested with the exclusive right to make decisions relating to LLC activities.

Many attorneys and commentators have said that RULLCA requires an LLC to be designated manager-managed in both the articles of organization and the operating agreement.  In fact, section 17704.07 of the Corporations Code provides:

(a)  A limited liability company is a member-managed limited liability company unless the articles of organization and the operating agreement do either of the following:

(1)  Expressly provide that:

(A) The limited liability company is or will be “manager-managed.”

(B) The limited liability company is or will be “managed by managers.”

(C) Management of the limited liability company is or will be “vested in managers.”

(2)  Include words of similar import.

When advising clients forming new LLCs, we recommend that LLCs wishing to be manager-managed say so in the articles and operating agreement. 

3. Voting Rights.

RULLCA changed many of default rules that would apply if a particular issue was not addressed by the operating agreement. Unless the operating agreement states otherwise, unanimous consent is required to:

(1)Amend the operating agreement;

(2)Sell, lease, exchange or otherwise dispose of all, or substantially all, of the LLC's property;[1]

(3)Merge the LLC with another entity;

(4)Convert the LLC to another type of entity; or

(5)Undertake any other act outside the ordinary course of business.

Whenever unanimous consent is required, there is the threat of a holdout.  Thus, it is imperative that LLCs formed under RULLCA have a comprehensive operating agreement prepared where issues such as voting right are vetted by the members and agreed upon at the onset. 

4. Fiduciary Duties. 

Under RULLCA, the members and/or managers of an LLC owe fiduciary duties to the LLC and the other members.  Section 17704.09 of the California Corporations Code describes the applicable fiduciary duties as the duty of loyalty, the duty of care, and the duty of good faith and fair dealing. 

The members of an LLC may modify the applicable fiduciary duties in a written operating agreement.  They may not eliminate the fiduciary duties altogether.  Further, the ability to modify the fiduciary duties is subject to various limitations, including a catch-all that such modification cannot be "manifestly unreasonable."

Perhaps the most important development in that regard is found in section 17701.10 of the Corporations Code.  It requires that any modification of the applicable fiduciary duties be made with the "informed consent of the members."  However, "[a]ssenting to the operating agreement … shall not constitute informed consent."  In other words, while the operating agreement can limit or modify these fiduciary duties, the modification will only be effective if the members actually understand what it does. 

The fiduciary duties required by RULLCA can potentially expose members and/or managers to liability for LLC-related conduct.  Again, it is essential that members execute a written operating agreement with the advice of an experienced attorney.

5. Indemnification.

The prior statute governing LLC's allowed LLC's to include a provision in the articles of organization or operating agreement to indemnify members/managers for LLC-related debts/liabilities. Under RULLCA, the default rule requires indemnification unless the member/manager fails to adhere to the applicable fiduciary duties. 

The LLC may modify or even eliminate the indemnification requirement in a written operating agreement.  If you were not already convinced of the importance of a well-crafted, written operating agreement, this should do it. 

To discuss how these and many other changes to California LLC law might affect your business, contact Selman Breitman today.

 

[1] NOTE: This only applies if the sale/lease/etc. is "outside the ordinary course of the limited liability company's activities.  For instance, an LLC formed for the sole purpose of purchasing a property, developing it, and reselling it for profit would not require unanimous consent for the sale.