On January 1, 2014, the California Revised Uniform Limited Liability Company Act (RULLCA) took effect and applies to all existing California limited liability companies (LLCs). RULLCA makes significant changes in the rights and responsibilities of members and managers of LLCs. Most importantly, RULLCA has a strong set of default rules that automatically apply if the operating agreement is silent, contains insufficient specificity, or refers back to “applicable law,” meaning California’s previous LLC law, the Beverly-Killea Act. With the passage of RULLCA, LLC managers and members should consult with legal counsel to determine whether to amend their Operating Agreements and Articles of Organization to avoid unintended consequences of RULLCA’s default rules.
An LLC’s appeal as a business entity stems from the entity’s protection of the business owners’ personal liability for LLC actions and its pass-through tax treatment. Additionally, an LLC gives owners the flexibility to draft a customized Operating Agreement that governs the LLC, its members, and its managers. LLC members can negotiate their percentage of ownership interests, their allocation of profits and losses, and their rights and responsibilities. Even with the passage of RULLCA, LLC members continue to enjoy the freedom to negotiate terms of the Operating Agreement. If an existing Operating Agreement adopts rules for operation different from RULLCA’s default rules, the terms of the Operating Agreement generally override the default rules.
With the passage of RULLCA, LLC managers and members should examine whether some of RULLCA’s default rules should be modified in their written Operating Agreement. Here are some examples.
Member-Management
RULLCA provides that LLCs will be member-managed by default. To create a manager-managed structure, the LLC must specifically state such structure in both the Articles of Organization filed with the Secretary of State and the Operating Agreement. LLC managers and members should review these two documents to ensure the designation is clear in both documents.
Conflicts between Operating Agreement and Articles of Organization
RULLCA provides that in the event of conflicting provisions between the Operating Agreement and its Articles of Organization, the terms of the Operating Agreement govern. The previous LLC law, however, gave priority to the Articles of Organization. LLCs should thus closely examine both their Operating Agreement and Articles of Organization to eliminate any conflicting provisions.
Unanimous Member Consent Required
Also, under RULLCA, if the LLC is managed by a manager (rather than its members), then the manager may not take any action “outside the ordinary course of business” without the unanimous consent of the members. If the LLC wants to allow its manager to take actions with majority consent, the LLC should review its Operating Agreement’s section on voting rights and consider whether amendment is necessary.
Fiduciary Duties
Under RULLCA, LLC members and managers owe the LLC and the other members a duty of care, a duty of loyalty, and a duty of good faith and fair dealing. RULLCA allows LLCs to modify, but not eliminate, fiduciary duties in their Operating Agreements. A written Operating Agreement should address any modifications desired in these fiduciary duties, and RULLCA requires the consent of members for these changes. For example, LLC members may wish to include exceptions to the prohibition on competition for existing businesses or investments of the members. The LLC members may also wish to authorize specific transactions or relationships between the LLC and other businesses controlled by a member or manager. LLC members may even wish to increase the duty of care required of a manager to similar to the duty owed by a director of a corporation. Such revisions should be made clear in an LLC’s Operating Agremeent.
Indemnification
Unlike prior law, RULLCA provides that LLCs must indemnify members and managers of an LLC, unless the indemnified manager or member has not complied with her statutory duties. Thus, if the parties do not want mandatory indemnification, the Operating Agreement should be amended to reflect the parties’ intentions. If the existing Operating Agreement does not address indemnification, then LLCs should consider the benefits and liabilities of RULLCA’s indemnification policies and amend its Operating Agreement accordingly.
Dissociation of Members
RULLCA provides a list of events, not included in the previous law that results in a member’s dissociation, effectively giving an existing member the legal status of an assignee, such as death, the appointment of a guardian or conservator, or a judicial order that a member is incapacitated. If members or managers do not intend for these events to trigger dissociation or removal as managers, the Operating Agreement should be amended accordingly.
Amending the Articles of Organization and Operating Agreement
In light of RULLCA’s changes, California LLCs should seek legal advice to determine whether amendments to the LLC documents are necessary to reflect the intent of the managers or members. Proper review and amendment of the LLC documents can help to avoid costly misunderstandings, potential internal conflict and unintended effects down the road. Contact Punzalan Law to help you review your Articles of Organization and Operating Agreement in light of RULLCA.