Posted by: Pierson W. Backes | Posted on: April 15th, 2014 | 0 Comments
There are some dramatic changes to the way LLC agreements are interpreted and enforced under the Revised Uniform Limited Liability Company Act (the “Revised Act”), which became effective in March 2013 for newly formed New Jersey LLCs and will apply to all New Jersey LLCs as of March 2014. N.J.S.A. 42:2C-91. A few highlights are provided below.
The Revised Act may “change the deal” among members even in existing LLCs, especially if there is no written operating agreement in place. For example, an LLC is presumed to be member-managed, and every member has equal rights in management unless the operating agreement provides otherwise.
It would be fair to say that one of the reasons LLCs have become so popular for small businesses is that they require fewer of the formalities required for corporations – shareholder meetings, elections of directors, and so on. On the other hand, lack of formalities and the very flexibility allowed by the Revised Act could make any disagreements among members more difficult and expensive to sort out. The Revised Act includes default provisions that make all members “equal” regardless of what percentage of capital they contributed to the company.
Oral and Implied Terms of Operating Agreements
As noted in other posts, the operating agreement among the members is the key governing document of an LLC. Until adoption of the Revised Act, “operating agreement” meant a written agreement. Now, it means “the agreement, whether oral, in a record, implied, or in any combination thereof.”
There are good practical reasons for the traditional requirement for agreements to be in writing, and to interpret a written agreement as expressing the final terms of agreement – replacing negotiations, prior incomplete drafts and so forth. Otherwise, the terms of an agreement might have to be reconstructed from many different records (visualize paying an attorney to pore over all of the e-mails between the parties), testimony, and whatever evidence would show an “implied” agreement (such as a pattern of conduct between the parties). It would seem that proving the terms of an agreement could be far more complicated now, especially with the “combination” language in the Revised Act, unless the agreement includes an express “merger” clause stating that it represents the final and complete agreement of the parties and only can be amended in writing signed by all parties. (This is an example of language that non-lawyers would not necessarily recognize as important.)
Member-Managed LLCs Have “Equal Rights” in Management Regardless of Ownership Percentage
A key section of the Revised Act is “Management of Limited Liability Company” (N.J.S.A. 42:2C-37). LLCs are presumed to be managed by the members – and every member has “equal rights in management”, per capita rather than by percentage ownership. In the former statute, members had the right to participate in management according to their percentage interest in the company. If you contributed 75% of the capital, you would be entitled to 75% vote on decisions and 75% of the distributions of profits.
Other language in the same section of the law may have been intended to clarify things by stating: “A difference arising among members as to a matter in the ordinary course of the company’s activities may be decided by a majority of the members.” Note, this does NOT say a majority of capital contributed. If you have an even number of members – say, two – even if you contributed different percentages, there will not necessarily be a “majority of members” to resolve disagreements.
Unanimous Agreement Required for Decisions Outside Ordinary Course of Business
Under the Revised Act, unanimous agreement by members is needed for decisions “outside the ordinary course of business,” again regardless of ownership percentage (in comparison, if certain decisions had to be approved by the shareholders of by a New Jersey business corporation, the presumption is that a majority of shares would decide the vote unless the Certificate or By-Laws expressly provide otherwise.)
Members have Equal Rights to Distributions Regardless of Percentage of Ownership
The Revised Act also changed the presumptions about sharing of profit distributions, if no written operating agreement is in place. Distributions are to be made equally to members, regardless of their capital contributions.
Review and Clarification of Operating Agreements is Strongly Advised
The items noted above are only a portion of the changes put into effect under the Revised Act. We strongly recommend that clients have their LLC agreements put into writing – or, if there is already a written agreement, have the agreement reviewed in light of the Revised Act.