The California legislature “Killea-d” the Beverly-Killea Limited Liability Company Act ten years after its passage. On January 1, 2014, the California Revised Uniform Limited Liability Company Act (RULLCA) will replace the Beverly-Killea Limited Liability Company Act as the governing law for LLCs in California. The RULLCA differs in several aspects from the Beverly-Killea Limited Liability Company Act, and LLC members and managers should become familiar with these changes.

The RULLCA’s implementation will not be smooth.  As many commentators have pointed out, the RULLCA contains several sections that contradict each other. For instance, Section 17713.04(a) states that the RULLCA will apply to all domestic and foreign registered LLCs beginning January 1, 2014. [1] This section seems to indicate that the RULLCA applies to any LLC in California after January 1, 2014. However, another section provides that “The prior law governs all acts or transactions … or contracts entered into by the limited liability company or by the members or managers of the limited liability company, prior to [January 1, 2014.]”[2] Since an operating agreement is a contract, an LLC with an operating agreement dated January 1, 2013 may or may not be governed by the new RULLCA.

Commentators have also noted that the RULLCA provisions governing foreign LLCs registered in California are in conflict with each other.[3] Currently, legislature is considering a technical correction bill to clarify these provisions, but it remains to be seen which provision will control.

The RULLCA will go into effect on January 1, 2014, whether or not legislature clarifies the conflicting sections. Consequently, many of the default LLC laws will change. A brief summary of some of the changes follows.

New default rules for LLCs

The RULLCA contains a new set of default rules for LLCs. These default rules apply if the operating agreement is silent on the issue. Thus, an LLC may be stuck with default rules that are contrary to its purpose if the operating agreement does not specify otherwise.

A few of the new default rules for LLCs include:

  • An LLC is a member-managed LLC unless the “articles of organization and the operating agreement” expressly provide otherwise.[4] This means that even if the articles of organization state the LLC is manager-managed, the operating agreement must specifically state it is manager-managed as well.
  • Requiring the consent of all members to sell, lease, exchange or otherwise dispose of all or substantially all of the LLC’s property, approve a merger or conversion, undertake any other act outside the ordinary course of the LLC’s activities, or amend the operating agreement.[5] Thus, an LLC that is manager-managed may still have to obtain the consent of all members for such activities if the operating agreement does not specify otherwise.
  • Automatic dissociation when (1) a member dies (2) if member-managed, the appointment of a guardian for a member (3) if member-managed, if a judge declares a member incapable of performing his or her duties as a member (4) if member-managed, the member declares bankruptcy. [6]  If the LLC does not want a member to be dissociated by any of these activities, the operating agreement must provide otherwise. Once a member becomes dissociated, he or she only has rights as a transferee. [7] This means that the dissociated member cannot participate in the management or conduct of the LLC. [8]
  • Automatic removal of the manager if the manager becomes dissociated, unless the operating agreement states otherwise. [9]
  • Mandatory indemnification for an LLC member or manager that complies with the RULLCA. [10] However, section 17701.10(g) provides that the operating agreement may alter or eliminate indemnification for a member or manager.

Fiduciary Duties

The new RULLCA also clarifies that managers of an LLC owe a fiduciary duty of loyalty and care to the LLC and its members.

The duty of loyalty and duty of care cannot be eliminated by an operating agreement. [11] However, an operating agreement may identify types of activities that do not violate the duty of loyalty and duty of care, as long as these activities are not unreasonable. [12] This opens the door for debates on what is a “reasonable” activity.

In short, operating agreements that give managers freedom to engage in competing businesses may need to be revised.

Priority of the Operating Agreement Over the Articles of Organization

17701.12(d) states that if the articles of organization conflict with the operating agreement, the operating agreement prevails unless a third party (not a member, dissociated member, transferee, or manager of the LLC) reasonably relies on them. This is a significant change from the previous Beverly-Killea Limited Liability Act, which provided that the articles of organization were controlling in the event of a conflict with the operating agreement.

Limiting Liability of Members or Managers

On a final note, it is important to know that the RULLCA allows the operating agreement to limit or eliminate a member or manager’s liability to the LLC for money damages. The operating agreement cannot eliminate liability for breach of the duty of loyalty, intentional infliction of harm, liability for excess distributions, receipt of a financial benefit a member/manager is not entitled to, and intentional violations of criminal law.[13]

The RULLCA significantly changes California LLC law. Its implementation will certainly be interesting to monitor.

 

 


[1] RULLCA 17713.04(a)

[2] RULLCA 17713.04(b)

[3] See Potential Challenges Associated with California’s Revised ULLCA, available at http://www.martindale.com/corporate-law/article_Sheppard-Mullin-Richter-Hampton-LLP_1940244.htm

[4] RULLCA 17704.07(a) (emphasis added)

[5] RULLCA 17704.07(c)(4)

[6] RULLCA 17706.01(b)(2)

[7] RULLCA 17706.03(a)(3)

[8] RULLCA 17705.02(a)(3)

[9] RULLCA 17706.03(a)(1)

[10] RULLCA 17704.08(a)

[11] RULLCA 17701.10(c)(4)

[12] RULLCA 17701.10(c)(14)-(15)

[13] RULLCA 17701.10(g)