California’s New LLC Law and You
by: Daniel E Gwozdz
Daniel E Gwozdz is a 2012 graduate of Gonzaga School of Law and the newest attorney at Bay Oak Law.
If the title above grabbed your attention, chances are that you are either a member of an Limited Liability Company or are interested in forming one. Limited Liability Companies, or LLCs, are a relatively new form of hybrid business entity that provide limited liability protection and a great deal of a flexibility to the owners, called members. The most important benefit that an LLC provides is limited liability. When set up properly, limited liability protects the LLC’s members from being personally responsible for the contractual debts and obligations of the LLC – including court judgments – other than the members’ personal investment into the business. (If a member personally participates in tortious wrongdoing, then the member can still be liable.)
Before LLCs, limited liability could only be established, in most cases, by incorporating a business or by forming a limited partnership in which certain owners, called limited partners, have an ownership interest in the business but lose their limited liability protection if they engage in the management of day-to-day operations. Another advantage of an LLC is that it provides greater flexibility in structuring the business and requires fewer mandatory formalities than a corporation. California LLCs also provide their members with federal passthrough taxation – meaning, the income of the LLC is only taxed once when it passed on to its members whereas corporations pay taxes on their income and this income is taxed again when it is distributed to its shareholders. For LLCs organized in California, however, there is a yearly franchise fee imposed on the LLC ranging from $800 to $11,790 depending on the LLC’s income.
On January 1, 2014, the California Revised Uniform Limited Liability Company Act, or RULLCA goes into effect, replacing the Beverly-Killea Act which established LLCs in California in 1996. New and existing LLCs will automatically be subject to the new law beginning January 1, 2014. While many of current LLC provisions will be carried over to the new law and it is unlikely that new law will have a major impact on the day-to-day operations of most LLCs, it is still a good idea to be familiar with the new law and how it may affect your business. Some of the important changes and provisions of the new LLC law include:
• Operating Agreement: The new law heightens the importance of an LLC’s operating agreement. Under the previous law, in the event of a conflict between the provisions of the Articles of Organization and the Operating Agreement, the Articles prevailed. Under RULLCA, the Operating Agreement takes precedence unless the disagreement over the terms of the documents involves a 3rd party that reasonable relies on the Articles. In addition, LLC members are bound by the Operating Agreement even if they did not sign it. Transfers of an interest in the LLC are ineffective as to any person with notice of the restriction at the time of transfer. So, if you are an LLC member or are about to become one, it is in your best interest to carefully review your LLC’s Operating Agreement.
• Non-Economic Members: The new laws allow a person to have some of the rights of members, such as voting rights, without requiring or obligating the person to make a contribution to the LLC and without giving the person a transferable interest in the LLC. Since a non-economic member does not have a transferable interest, that member is not a “partner” for tax purposes. A full member may transfer his economic interest in the LLC while maintaining his voting rights. A well drafted Operating Agreement should address whether non-economic members are allowed and what rights they have.
• Fiduciary Duties: Under the old law, it was unclear as to whether the LLCs members owed a duty to each other. Under RULLCA, if the LLC is manager managed; only the manager owes the duty of loyalty and the duty of care to the members. All members owe a duty of good faith and fair dealing to each other.
• Indemnification: Under the new law, the LLC must indemnify any member of a member-managed LLC or manager of a manager-managed LLC who complies with his duties outlined in the new law. The new law, however, often allows the Operating Agreement to alter or eliminate the indemnification requirement. In addition, the new law allows the operating agreement to alter or eliminate a member or manager’s liability to the LLC and other members except with respect to: breaches of the duty of loyalty; excess distributions; intentional infliction of harm; or criminal conduct.
• Dissociation: The new law introduces the term dissociation to describe an event that terminates membership status providing consistency among business entities (a dissociation was referred to as a withdrawal under the old law). While the events triggering a dissociation remain largely the same, under the new law, a judicial order may be used to remove a member – currently, the entire LLC needs to be dissolved, if the majority of members want to remove a member who will not voluntarily withdraw.
• Death of a Sole Member: The new law clarifies what happens if the sole member of an LLC dies. Typically an LLC with no members is automatically dissolved. Under the new law, if the sole member of an LLC dies, his heirs may admitted as substitute members.
It is important to remember that many of the provisions in RULLCA are default rules and can be modified or eliminated in the Operating Agreement. If you would like additional information regarding RULLCA or assistance reviewing or drafting new or existing LLC agreements, please contact Bay Oak Law, ‘Your Consigliere.’
Photo by Coolcaesar, from Wikipedia Commons.