CALIFORNIA’S NEW LIMITED LIABILITY COMPANY ACT IMPACTS LLCS, OLD AND NEW AUTHOR: MARGARET S. NG

On January 1, 2014, a new limited liability company act becomes law in California. The new act, the California Revised Uniform Limited Liability Act (the “new law”), replaces the current law known as the Beverly-Killea Act (the “prior law”). While the new law leaves most of the prior law substantially intact, this article discusses the key changes that the new law will impose.

As of January 1, 2014, the new law will generally apply to all limited liability companies (“LLCs”) organized or registered in California.  However, there are a couple of noteworthy exceptions from the new law’s general applicability.  First, the new law provides that the laws of the state in which a foreign LLC is organized govern that LLC’s organization and internal affairs, the authority of its members and managers and the liability of its members and managers for its debts, obligations and other liabilities.  Second, the new law provides that the prior law governs contracts entered into by an LLC, its members and/or its managers prior to January 1, 2014.  Given that an LLC’s operating agreement is both the LLC’s governing document and a contract among an LLC’s members and/or managers, it is uncertain whether operating agreements entered into prior to January 1, 2014 are governed by the new law or by the prior law.  It would appear contrary to the intent of the new law to exempt certain operating agreements because doing so would impose two sets of laws on some LLCs – i.e., the prior law with respect to its operating agreement and the new law with respect to all other LLC matters.  In light of the likelihood that the new law applies to all operating agreements (even those entered into prior to January 1, 2014), it is important for members and managers to have their counsel review the new law’s implications on their operating agreements and matters of general LLC governance.

Contrary to the prior law, the new law provides that if there is a conflict between the terms of an LLC’s operating agreement and its articles of organization, the operating agreement will control.  However, to the extent a third party reasonably relies on the articles of organization (presumably without knowledge of any inconsistency with the operating agreement), the new law provides that the articles of organization will control over the operating agreement with respect to such third parties.  Further, if an LLC is to be manager-managed, both the articles of organization and the operating agreement must expressly provide that the LLC is manager-managed.  Accordingly, members and managers should review their operating agreement to verify that it meets the new law’s requirements for the intended management structure.

Unless expressly provided otherwise in the LLC’s operating agreement, the new law requires the unanimous consent of the members to carry out any of the following acts: (i) selling, leasing, exchanging, or otherwise disposing of all, or substantially all, of the LLC’s property outside the ordinary course of business, (ii) entering into a merger or conversion, (iii) undertaking any act outside the ordinary course of the LLC’s activities and (iv) amending the operating agreement for the LLC.  Under the prior law, absent a lower voting threshold established in the LLC’s articles of organization or operating agreement, unanimous member approval was required only for amendments to the articles of organization and the operating agreement.  Under the new law, if such decisions and actions are to require only the approval of the manager(s) or fewer than all of the members, the operating agreement must expressly so provide.  Therefore, to the extent practicable, parties dealing with an LLC should request to review the LLC’s operating agreement to confirm that the person, whether a member or manager, representing the LLC has proper authority under the new law to enter into the contemplated transaction.

While the prior law only provides that the fiduciary duties of a manager to the LLC and its members are those of a partner to a partnership, the new law clarifies, and perhaps broadens, a manager’s fiduciary duties to include the duties of loyalty and care.  Under the new law, the duties of loyalty and care and any other fiduciary duty of a manager cannot be eliminated but may be modified to some extent.  For example, the members can identify in an operating agreement specific activities that do not violate the duty of loyalty if doing so is not “manifestly unreasonable.”  The new law also implies that the duty of care may be modified in an operating agreement, provided that such modification does not unreasonably reduce the duty of care.

Note, that any modification of the manager’s fiduciary duties under both the prior law and the new law requires the informed consent of the members.  Under certain circumstances, members may be deemed to have accepted an LLC’s operating agreement even if such member has not signed the LLC’s operating agreement.  For example, in cases where a member becomes a member of an LLC by way of a conversion or merger of the LLC, he or she may be deemed to have accepted the operating agreement of the surviving LLC.  However, the new law provides that a member’s deemed acceptance of an operating agreement is not a member’s informed consent to the modification of a manager’s fiduciary duties in such operating agreement.  The practical take away is that managers and members of an LLC should require all new members to acknowledge in writing their consent to any modification of the manager’s fiduciary duties upon their admission into the LLC, including admission in connection with the conversion or merger of an LLC.

Unless the operating agreement provides otherwise, the new law requires the LLC to indemnify members of a member-managed LLC and managers of a manager-managed LLC as long as the person being indemnified has complied with his or her duties under the new law.  The prior law permitted the LLC to indemnify any person but did not go as far as the new law to mandate indemnification.  Accordingly, managers and members should consider, and consult with their counsel, whether any limitations or requirements should be placed on the mandatory indemnification under the new law.

While the prior law addresses the limitation of liability to third parties, it does not expressly address the limitation of a member or manager’s liability to the LLC or the other members.  The new law clarifies that members and managers cannot eliminate their liability to the LLC and the other members for money damages for the following acts: a breach of the duty of loyalty, the receipt of a financial benefit to which the recipient was not entitled, excess distributions, intentional inflictions of harm to a person or the LLC or intentional violations of criminal law.  However, under the new law, an operating agreement may eliminate or limit a member or manager’s liability to the LLC and the other members under other circumstances.

In light of the new law’s enactment, managers and members of LLCs should revisit their operating agreements and, with appropriate advice from counsel, make necessary amendments to conform their operating agreements to the new law.  Likewise, parties transacting business with LLCs should be wary of how the new law affects the LLC’s governing documents and the authority of persons acting on behalf of such LLCs.