THE NEW LIMITED LIABILITY COMPANY LAW IN CALIFORNIA
There’s a new statute in town governing limited liability companies (“LLC’s”)*. Effective since Jan 1, 2014, it automatically applies to all California LLC’s (and possibly some out of state ones) regardless of when formed. You can’t opt out.
Some of the key changes made by the new statute are: first, there are several “default” rules that apply unless your operating agreement expressly changes them; second, new rules govern fiduciary obligations; and third, a clarification of the duty of loyalty.
A. Default Rules. The main ones are:
• Under the old law, in order not to be deemed “member managed”, all you had to do was to check the appropriate box in the LLC-1. But under the new law, that’s not enough – you have to check one of the other boxes and the operating agreement must provide for different management.
• Under the old law, provisions in the operating agreement would typically grant managers broad rights of management so as to give them the maximum amount of control over business decisions, without expressly stating that these might be outside the ordinary course of business. Now, unless the operating agreement expressly states otherwise, managers will be required to obtain the unanimous consent of the members before performing an act outside the ordinary course of business. Because the new law doesn’t define “the ordinary course of business,” there’s no magic language that will necessarily work to override this new default rule; accordingly, operating agreements should define that term as broadly as the members wish. In particular, a sale, lease or exchange of all or substantially all of the assets of the LLC need to be addressed, as these actions are expressly covered by the new law as requiring unanimous consent.
• Under the old law, managers and members were entitled to reimbursement of expenses incurred on behalf of the LLC only if the operating agreement expressly so provided. Now, under the new law such reimbursement is permitted automatically unless a breach of fiduciary duty is involved. Members and managers of LLC’s should therefore consider putting appropriate limitations or requirements (such as pre-approval) into their operating agreements.
• Similarly, under the old law those acting on behalf of the LLC were merely permitted to indemnification (i.e. would have it only if the operating agreement provided it). Now, it’s automatic unless a breach of fiduciary duty is involved. Again, members and managers of LLC’s should consider the issue of mandatory indemnification if they want to limit or restrict it.
• The new law provides that the default rule for amendments to the operating agreement is unanimous consent (the old rule being only majority consent). This means that each member – even members with small LLC interests – will have veto power over the will of the majority.
B. Fiduciary Obligations. The new law provides greaterflexibility with regard to fiduciary duties, both of managers of manager-managed LLCs and of members of member-managed LLCs. The new law prohibits an operating agreement from eliminating the fiduciary duties of a manager or a member, it clarifies these duties and permits their modification.
C. Duty of Loyalty. The New Law specifically limits the duty of loyalty to three duties:
(i) the duty to account;
(ii) the duty to refrain from self-dealing; and
(iii) the duty to refrain from competing.
The new law permits an operating agreement to designate certain acts as expressly not violating the duty of loyalty, provided that the list is not “manifestly unreasonable.” While this may be somewhat vague, the new law does permit the operating agreement to specify the number or percentage of members required to authorize or ratify specific acts that would otherwise violate the duty of loyalty, after full disclosure.
* The new law is California Revised Uniform Limited Liability Company Act (Corp. Code§§17701.01-17713.13). It replaces the Beverly-Killea Limited Liability Company Act, Corp Code §§17000-17656.