On January 1, 2014, the previous law governing California limited liability companies (LLCs) was replaced by a new law, called the Revised Uniform Limited Liability Company Act (RULLCA). There is no “opt in” or “grandfather” clause; all California LLCs are now governed by RULLCA, whether they like it or not.
RULLCA’s general approach is to allow the parties to an LLC to describe how that LLC will be governed in their Operating Agreement. However, RULLCA contains some provisions that cannot be waived or altered by the Operating Agreement. More importantly, RULLCA contains some “default” provisions that apply, unless your Operating Agreement provides otherwise. It is important to know what those provisions are and, if you don’t like them, make sure your Operating Agreement provides otherwise. If it does not, you’ll need to amend your agreement.
Following is a brief summary of RULLCA default provisions that apply, unless your operating agreement provides otherwise.
- Actions Requiring Unanimous Consent of Members
If your LLC is managed by a manager (as opposed to the members), the unanimous consent of all members is required for the manager to do any of the following:
- Sell all, or substantially all, of the LLC’s assets outside the ordinary course of business.
- Merge the LLC with another company or convert it to a different type of entity (e.g. a corporation).
- Undertake any other act outside the ordinary course of the LLC’s business.
- Amend the operating agreement.
If you are the manager, you probably don’t want to have to get the consent of all your members to take the above actions. If your Operating Agreement states that the above actions require majority consent (or two-thirds or other percentage), then you are okay because your agreement provides otherwise. If your agreement is silent on this issue, then RULLCA applies and you need unanimous consent. In that case you might want to amend your Operating Agreement to require the consent of a majority or some other percentage of the members (with the possible exception of amending the agreement, where it’s fairly common to require unanimous consent).
- Mandatory Indemnification
RULLCA’s default is to require the LLC to indemnify the manager and members against any liability they may occur while acting as a manager or member, provided they complied with the fiduciary duties described in RULLCA. This means there is no opportunity for the manager or the other members to review the facts and circumstances of each case and decide if indemnification is warranted. If your Operating Agreement states that the LLC “may” (not “shall”) indemnify the manager or members, then you are covered. However, if your Operating Agreement does not address this issue, then RULLCA governs. In that case you may wish to amend your Operating Agreement to state that the LLC may indemnify the manager/members in certain instances (and set forth the standard and procedure for indemnification). Of course, if you are the manager, you may prefer RULLCA’s default position.
- Voting Rights
Unless the Operating Agreement provides otherwise, members vote in proportion to their allocated share of the LLC’s profits. If you want a different voting scheme (e.g., by capital contributions, or one vote per member regardless of ownership interest), your Operating Agreement needs to say that. Also, under RULLCA, any amendment to the Articles of Organization or the Operating Agreement requires unanimous consent. If you want a lower percentage (say, two-thirds or a majority), your Operating Agreement needs to say so. All other matters require majority consent. If you want a higher percentage for certain matters (say, two-thirds consent to approve a merger or conversion or the dissolution of the LLC), you need to say that in your Operating Agreement (remember that a sale of assets requires unanimous consent, unless you specify a lower percentage).
Other Considerations: Advantageous Provisions
The converse of the default provisions that apply unless your Operating Agreement provides otherwise, are certain potentially beneficial provisions of RULLCA that apply only if they are included in your Operating Agreement:
- Modify Duty of Loyalty
Although the Operating Agreement cannot eliminate the duty of loyalty of the manager and/or members to each other and the LLC, it can partially reduce that duty by (i) specifying types or categories of activities that do not breach that duty, and/or (ii) specifying a number or percentage of members that can approve an act that would otherwise breach that duty. For example, the Operating Agreement can state that the manager and/or members have other business activities that they engage in, and they can continue to engage in those activities even if they compete with the LLC. Many Operating Agreements already contain such provisions. If yours does not, you may want to amend it to take advantage of this.
Note that any reduction of the duty of loyalty may be made only with the informed written consent of the members. Therefore, you probably need to inform them what the “default” standard is under RULLCA, and that any proposed amendment is a reduction or modification of that standard.
- Limitation of Liability
The Operating Agreement may eliminate or limit the manager’s and/or the members’ liability to the LLC and the members for money damages, except for the following:
- Breach of the duty of loyalty;
- A financial benefit received by the member or manager to which the member or manager is not entitled;
- A member’s liability for excess distributions;
- Intentional infliction of harm on the LLC or a member; or
- An intentional violation of criminal law.
Most Operating Agreements do not contain a provision implementing the above, because it was not in the prior LLC law. Therefore, you may want to consider adding such a provision to your Operating Agreement.
- Adapt Terminology
If you are going to amend your Operating Agreement, you should change some of the terminology to dovetail with RULLCA. Your Operating Agreement probably contains a definition of “the Act” that identifies the prior law. You should change that definition so that “the Act” means RULLCA. Also, the previous terms “economic interest” and “withdrawal” have been changed to “transferable interest” and “dissociation”, respectively. If you are going to amend your Operating Agreement anyway, you should update the terminology to match RULLCA. If you have no other reason to amend the agreement, however, it’s not essential to do this.
If your business operates in the LLC format, you may want to take a look at your Operating Agreement and consider amending it to take full advantage of RULLCA (and avoid any provisions of RULLCA you don’t like). If you do consider amending your Operating Agreement, be sure to review the section regarding amendments. You must comply with those requirements (including the consent of a certain percentage of members) to amend the agreement.
For a general summary of the changes implemented by RULLCA, click here.
If you have any questions about the new law or how it may affect your LLC, please give us a call.
This article is not intended and should not be relied upon as legal or tax advice pertaining to any specific matter. You are encouraged to seek competent legal and tax counsel before proceeding with any transaction involving any of the matters discussed above.