California LLC Owners: Changes to Law May Require an Update to Your Operating Agreements

We assist many clients with the formation of their businesses, including choosing the right business form, preparing the operating agreements that govern so much of how an entity's business is run and that delineate the powers and responsibilities of the members, shareholders, officers and directors of the company. For our limited liability company clients, and our California LLC owners in particular, changes in California's LLC law that took effect earlier this year should prompt a review of your company's LLC operating agreement. The revisions to the law may void certain provisions in your existing agreement or result in alterations to the members' relationship that are contrary to what the members intended.

The new law, which took effect January 1, 2014, applies to all California LLC, including ones formed before that date, and governs every act taken by a California LLC or its members on or after that date. Like the old LLC law, the revised law provides LLCs with certain default rules to be applied in disputes when the entity's operating agreement is silent on the subject. To the extent that parties relied on the default rules when drafting their operating agreements, this can lead to unwanted surprises down the road.

Some of the more important new default rules include:

Designation of Manager-Managed LLCs. Under the old LLC law, establishing a manager-managed LLC could be accomplished simply by including a statement to that effect in the articles of organization; without such a statement, the LLC would be considered member-managed by default. Now, however, both the articles of organization and the written operating agreement must designate the LLC as managed-managed. Accordingly, manager-managed LLCs that currently do not have such language in their operating agreements should amend them or risk being deemed member-managed by default.

Manager Powers and Member Consent. Under the new law's default rules, an LLC manager must get the unanimous consent of the members before taking any actions outside of the ordinary course of business, including the sale lease or exchange of all or substantially all of the assets of the company. This effectively means that in the absence of specific language to the contrary in the operating agreement, a single minority member could veto any such actions against the clear will of the majority of members. Operating agreements should be reviewed to ensure that the managers have the amount of control over business decisions that the members desire, that they will not be authorized to do things for which the members expect unanimous consent, and that they will not be hampered by having restricted authority that was never intended or desired.

Mandatory Reimbursement and Indemnification. The new LLC law mandates that members or managers be reimbursed for expenses incurred on behalf of the LLC and be indemnified for liabilities incurred on behalf of the LLC, provided that neither the expenses nor the acts constitute violations of fiduciary duties.

Fiduciary Duty Changes. One of the more significant changes under California's new LLC law involves clarifying the duties owed by members and managers. It specifically defines the "duty of loyalty" as being limited to 1) the duty to account, 2) the duty to refrain from self-dealing and 3) the duty to refrain from competing. However, the parties can modify and further define the duty of loyalty as well as the duty of care and the duty of good faith and fair dealing within certain limits.

We recommend that all LLC owners take a look at their operating agreements and consult with an experienced California business attorney to determine whether any modifications are necessary in light of the changes to California's LLC law.

Meyer & Yee: Sacramento and Roseville Area Business Lawyers

At Meyer & Yee, your business is our business. We partner with our business clients to provide them counsel they can rely on so they can focus on growing their business. The business world is fraught with challenges; your business lawyers should be ready to face those challenges with you head-on. If your business needs reliable, accessible, and personalized counsel, we welcome the opportunity to see how we can help. Please give us a call at (916) 599-7297. We look forward to the privilege of being your attorneys.

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