Solana Beach Lawyers - New Law Affecting California Limited Liability Companies

NEW LAWS AFFECTING CALIFORNIA LIMITED LIABILITY COMPANIES - by Blumberg

The laws regulating California’s limited liability companies were changed, effective January 1, 2014, are known as the California Revised Uniform Limited Liability Company Act(“CRULLCA”) and codified in Title 2.6, starting at Section 17701 of our Corporations Code.What seems to be the most prominent of general changes are the rules that will apply to themanagement of the LLC where the operating agreement was deficient. Apparently, the goal wasto try to make California’s laws more like those of other states which should make inter-statebusiness transactions easier to navigate.

There is some uncertainty whether the CRULLCA governs operating agreements entered into before January 1, 2014 which indicates the prior law applies to contracts entered into by theLLC prior to January 1, 2014. This would appear that the CRULLCA does not affect operatingagreements entered into before January 1, 2014. The CRULLCA also provides, however, thatLLC operations on or after January 1, 2014 are governed by the CRULLCA rather than the priorlaw. The confusion, then, is when an operating agreement, prepared before January 1, 2014 isamended after implementation of the CRULLCA. How are the members of an LLC to knowwhat part of he operating agreement is governed by the CRULLCA or the prior law? This is aquestion that has yet to be fully addressed or resolved.

The CRULLCA has made a number of changes to prior law. The following are a few of the highlights:

1. Operating Agreements: Two of the many provisions may impact small businessmanagement: 1) Under the CRULLCA, if something filed with the CaliforniaSecretary of State conflicts with the operating agreement, the operating agreementgenerally controls. One exception to this applies to third-parties who might relyon the Secretary of State filing; and 2) the CRULLCA added “implied” to“written” and “oral” as acceptable forms of operating agreements. The problemhere is obvious: What is defined as “implied?”

2. Management and the Default Rule: Under the prior law the default rule was anLLC is member managed, unless the Articles of Organization state to the contrary.The CRULLCA now provides unless both the Articles of Organization AND theoperating agreement state the LLC is manager-managed, member management isthe default rule.

3. Manager-Managed LLCs: The prior law defaulted to require decisions of themanager to be ratified by a majority vote. Now, with the CRULLCA, absent acontrary provision in the operating agreement, managers have equal rights in themanagement and conduct of the LLC’s activities and that a majority of managersdecide matters in the “ordinary course of business” except that all members mustapprove: a) the sale of assets, b) an act outside the ordinary course, c) a merger orconversion, and d) an amendment to the operating agreement.

4. Member Voting: Absent a contrary provision in the operating agreement, mattersoutside the ordinary course of the LLC require the approval of all of the members.So unless stated otherwise in the operating agreement a member who does notapprove of an action undertaken by a manager could raise an objection claiming itwas “outside the ordinary course of business.” As such, it would be prudent toinclude matters in the operating agreement the members want to be decided bysomething other than by unanimity. The question will still remain what is actuallydeemed “outside the ordinary course,” which is not adequately addressed in theCRULLCA.

5. Fiduciary Duties: The prior law does not define “fiduciary duties” themembers/managers have to one another other than to make them similar to that ofa general partner to the individual partners. The CRULLCA changes this byspecifying certain fiduciary duties, including: 1) the duty of loyalty; 2) the duty ofcare; and 3) the duty of good faith and fair dealing. The new law also allowscertain of these duties to be altered only in a written operating agreement.

6. Capital Contributions: The prior law allowed capital contributions in the formof “money, property or services rendered, or a promissory note or other bindingobligation to contribute money or property or to render services.” The CRULLCA now includes “any benefit” provided to the LLC. Members should be cognizantthat this could lead to conflict over “valuation.”

7. Tax Allocations: Under prior law, the default rule for tax allocations was thatprofits and losses were in proportion to the contributions of each member. Thenew law is silent on the allocation of profits and losses among LLC members fortax purposes. Because of this, operating agreements should specify the method bywhich profits and losses are to be allocated.

8. Indemnification: The prior default rule was that the operating agreement could,but was not required to, provide indemnification of any person acting on behalf ofthe LLC. The default rule under the CRULLCA is that the LLC MUST indemnifymanaging members and managers (so long as they have complied with theirstatutory duties). Because of this, if members do not want the LLC to indemnifythe managers the operating agreement should reflect this.

9. Reimbursement: The CRULLCA requires the LLC to reimburse members ofmember-managed LLCs, and managers of manager-managed LLCs, for paymentsthey make on behalf of the LLC (provided they have complied with their statutoryduties). If members prefer reimbursement not be mandatory the operatingagreement should reflect this deviation from the default rule.

The CRULLCA remains unchanged the following important provisions:

1. A California LLC may not perform a professional service that requires a license,registration or certification under the California Business and Professions Code;

2. A California LLC will continue to be subject to a gross receipts tax on incomefrom all California sources (S corps are not subject to this tax); and

3. Mergers and conversions are subject to virtually the same laws, with the defaultrule that unanimous member consent must approve a merger).The key take-away with the CRULLCA is members/managers of California LLCs shouldconsider how the new law may impact operations. If the LLC does not have a written operatingagreement, one should be considered. If the LLC does have an operating agreement it should beevaluated in light of the CRULLCA to ensure the new default rules comport with the membersintentions.

For further information contact Ron Blumberg, Managing Partner of Blumberg LawGroup LLP, rhb@blumberglawgroup.com. Blumberg Law Group LLP is a boutique law firm inSolana Beach, California specializing is small business counseling, transactions and litigation.

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