REVISED UNIFORM LIMITED LIABILITY COMPANY ACT

PREFATORY NOTE

Background to this Act:

Developments since the Conference Considered and Approved the Original

Uniform Limited Liability Company Act (ULLCA)

The Uniform Limited Liability Company Act (“ULLCA”) was conceived in 1992 and first adopted by the Conference in 1994. By that time nearly every state had adopted an LLC statute, and those statutes varied considerably in both form and substance. Many of those early statutes were based on the first version of the ABA Model Prototype LLC Act.

ULLCA’s drafting relied substantially on the then recently adopted Revised Uniform Partnership Act (“RUPA”), and this reliance was especially heavy with regard to member-managed LLCs. ULLCA’s provisions for manager-managed LLCs comprised an amalgam fashioned from the 1985 Revised Uniform Limited Partnership Act (“RULPA”) and the Model Business Corporation Act (“MBCA”). ULLCA’s provisions were also significantly influenced by the then-applicable federal tax classification regulations, which classified an unincorporated organization as a corporation if the organization more nearly resembled a corporation than a partnership. Those same regulations also made the tax classification of single-member LLCs problematic.

Much has changed. All states and the District of Columbia have adopted LLC statutes, and many LLC statutes have been substantially amended several times. LLC filings are significant in every U.S. jurisdiction, and in many states new LLC filings approach or even outnumber new corporate filings on an annual basis. Manager-managed LLCs have become a significant factor in non-publicly-traded capital markets, and increasing numbers of states provide for mergers and conversions involving LLCs and other unincorporated entities.

In 1997, the tax classification context changed radically, when the IRS’ “check-the-box” regulations became effective. Under these regulations, an “unincorporated” business entity is taxed either as a partnership or disregarded entity (depending upon the number of owners) unless it elects to be taxed as a corporation. Exceptions exist (e.g., entities whose interests are publicly-traded), but, in general, tax classification concerns no longer constrain the structure of LLCs and the content of LLC statutes. Single-member LLCs, once suspect because novel and of uncertain tax status, are now popular both for sole proprietorships and as corporate subsidiaries.

In 1995, the Conference amended RUPA to add “full-shield” LLP provisions, and today every state has some form of LLP legislation (either through a RUPA adoption or shield-related revisions to a UPA-based statute). While some states still provide only a “partial shield” for LLPs, many states have adopted “full shield” LLP provisions. In full-shield jurisdictions, LLPs and member-managed LLCs offer entrepreneurs very similar attributes and, in the case of professional service organizations, LLPs may dominate the field.

ULLCA was revised in 1996 in anticipation of the “check the box” regulations and has been adopted in a number of states. In many non-ULLCA states, the LLC statute includes RUPA-like provisions. However, state LLC laws are far from uniform.

Eighteen years have passed since the IRS issued its gate-opening Revenue Ruling 88-76, declaring that a Wyoming LLC would be taxed as a partnership despite the entity’s corporate-like liability shield. More than eight years have passed since the IRS opened the gate still further with the “check the box” regulations. It is an opportune moment to identify the best elements of the myriad “first generation” LLC statutes and to infuse those elements into a new, “second generation” uniform act.

Noteworthy Provisions of the New Act

The Revised Uniform Limited Company Act is drafted to replace a state’s current LLC statute, whether or not that statute is based on ULLCA. The new Act’s noteworthy provisions concern:

the operating agreement
fiduciary duty
the ability to “pre-file” a certificate of organization without having a member at the time of the filing
the power of a member or manager to bind the limited liability company
default rules on management structure
charging orders
a remedy for oppressive conduct
derivative claims and special litigation committees
organic transactions – mergers, conversions, and domestications

The Operating Agreement: Like the partnership agreement in a general or limited partnership, an LLC’s operating agreement serves as the foundational contract among the entity’s owners. RUPA pioneered the notion of centralizing all statutory provisions pertaining to the foundational contract, and – like ULLCA and ULPA (2001) – the new Act continues that approach. However, because an operating agreement raises issues too numerous and complex to include easily in a single section, the new Act uses three related sections to address the operating agreement:

o Section 110 – scope, function, and limitations;

o Section 111 – effect on limited liability company and persons becoming members; preformation agreement; and

o Section 112 – effect on third parties and relationship to records effective on behalf of limited liability company.

The new Act also contains a number of substantive innovations concerning the operating agreement, including:

better delineating the extent to which the operating agreement can define, alter, or even eliminate aspects of fiduciary duty;
expressly authorizing the operating agreement to relieve members and managers from liability for money damages arising from breach of duty, subject to specific limitations; and
stating specific rules for applying the statutory phrase “manifestly unreasonable” and thereby providing clear guidance for courts considering whether to invalidate operating agreement provisions that address fiduciary duty and other sensitive matters.

Fiduciary Duty: RUPA also pioneered the idea of codifying partners’ fiduciary duties in order to protect the partnership agreement from judicial second-guessing. This approach – to “cabin in” (or corral) fiduciary duty – was followed in ULLCA and ULPA (2001). In contrast, the new Act recognizes that, at least in the realm of limited liability companies:

the “cabin in” approach creates more problems than it solves (e.g.. by putting inordinate pressure on the concept of “good faith and fair dealing”); and
the better way to protect the operating agreement from judicial second-guessing is to:

* increase and clarify the power of the operating agreement to define or re-shape fiduciary duties (including the power to eliminate aspects of fiduciary duties); and

* provide some guidance to courts when a person seeks to escape an agreement by claiming its provisions are “manifestly unreasonable.”

Accordingly, the new Act codifies major fiduciary duties but does not purport to do so exhaustively. See Section 409.

The Ability to “Pre-File” a Certificate of Organization: The Comments to Section 201 explain in detail how the new Act resolves the difficult question of the “shelf LLC” – i.e., an LLC formed without having at least one member upon formation. In short, the Act: (i) permits an organizer to file a certificate of organization without a person “waiting in the wings” to become a member upon formation; but (ii) provides that the LLC is not formed until and unless at least one person becomes a member and the organizer makes a second filing stating that the LLC has at least one member.

The Power of a Member or Manager to Bind the Limited Liability Company: In 1914, the original Uniform Partnership Act codified a particular type of apparent authority by position, providing that “[t]he act of every partner ... for apparently carrying on in the usual way the business of the partnership binds the partnership . . . .” This concept of “statutory apparent authority” applies by linkage in the 1916 Uniform Limited Partnership Act and the 1976/85 Revised Uniform Limited Partnership Act and appears in RUPA, ULLCA, ULPA (2001), and almost every LLC statute in the United States.

The concept makes good sense for general and limited partnerships. A third party dealing with either type of partnership can know by the formal name of the entity and by a person’s status as general or limited partner whether the person has the power to bind the entity.

The concept does not make sense for modern LLC law, because: (i) an LLC’s status as member-managed or manager-managed is not apparent from the LLC’s name (creating traps for unwary third parties); and (ii) although most LLC statutes provide templates for member-management and manager-management, variability of management structure is a key strength of the LLC as a form of business organization.

The new Act recognizes that “statutory apparent authority” is an attribute of partnership formality that does not belong in an LLC statute. Section 301(a) provides that “a member is not an agent of the limited liability company solely by reason of being a member.” Other law – most especially the law of agency – will handle power-to-bind questions.

Although conceptually innovative, this approach will not significantly alter the commercial reality that exists between limited liability companies and third parties, because:

1. The vast majority of interactions between limited liability companies and “third parties” are quotidian and transpire without agency law issues being recognized by the parties, let alone disputed.

2. When a limited liability company enters into a major transaction with a sophisticated third party, the third party never relies on statutory apparent authority to determine that the person purporting to act for the limited liability company has the authority to do so.

3. Most LLCs use employees to carry out most of the LLC’s dealings with third parties. In that context, the agency power of members and managers is usually irrelevant. (If an employee’s authority is contested and the employee “reports to” a member or manager, the member or manager’s authority will be relevant to determining the employee’s authority. However, in that situation, agency law principles will suffice to delineate the manager or member’s supervisory authority.)

4. Very few current LLC statutes contain rules for attributing to an LLC the wrongful acts of the LLC’s members or managers. Compare RUPA § 305. In this realm, this Act merely acknowledges pre-existing reality.

5. As explained in detail in the Comments to section 301 and 407(c), agency law principles are well-suited to the tasks resulting from the “de-codification” of apparent authority by position.

The moment is opportune for this reform. The newly-issued Restatement (Third) of Agency gives substantial attention to the power of an enterprise’s participants to bind the enterprise. In addition, the new Act has “souped up” RUPA’s statement of authority to permit an LLC to publicly file a statement of authority for a position (not merely a particular person). Statements of authority will enable LLCs to provide reliable documentation of authority to enter into transactions without having to disclose to third parties the entirety of the operating agreement. (The new Act also has eliminated prolix provisions that sought to restate agency law rules on notice and knowledge.)

Default Rules on Management Structure: The new Act retains the manager-managed and member-managed constructs as options for members to use in configuring their inter se relationship, and the operating agreement is the vehicle by which the members make and state their choice of management structure. Given the elimination of statutory apparent authority, it is unnecessary and could be confusing to require the articles of organization to state the members’ determination on this point.

Charging Orders: The charging order mechanism: (i) dates back to the 1914 Uniform Partnership Act and the English Partnership Act of 1890; and (ii) is an essential part of the “pick your partner” approach that is fundamental to the law of unincorporated businesses. The new Act continues the charging order mechanism, but modernizes the statutory language so that the language (and its protections against outside interference in an LLC’s activities) can be readily understood.

A Remedy for Oppressive Conduct: Reflecting case law developments around the country, the new Act permits a member (but not a transferee) to seek a court order “dissolving the company on the grounds that the managers or those members in control of the company … have acted or are acting in a manner that is oppressive and was, is, or will be directly harmful to the [member].” Section 701(5)(B). This provision is necessary given the perpetual duration of an LLC formed under this Act, Section 104(c), and this Act’s elimination of the “put right” provided by ULLCA, § 701.

Derivative Claims and Special Litigation Committees: The new Act contains modern provisions addressing derivative litigation, including a provision authorizing special litigation committees and subjecting their composition and conduct to judicial review.

Organic Transactions – Mergers, Conversions, and Domestications: The new Act has comprehensive, self-contained provisions for these transactions, including “inter-species” transactions.

No Provision for “Series” LLCs

The new Act also has a very noteworthy omission; it does not authorize “series LLCs.” Under a series approach, a single limited liability company may establish and contain within itself separate series. Each series is treated as an enterprise separate from each other and from the LLC itself. Each series has associated with it specified members, assets, and obligations, and – due to what have been called “internal shields” – the obligations of one series are not the obligation of any other series or of the LLC.

Delaware pioneered the series concept, and the concept has apparently been quite useful in structuring certain types of investment funds and in arranging complex financing. Other states have followed Delaware’s lead, but a number of difficult and substantial questions remain unanswered, including:

conceptual – How can a series be – and expect to be treated as – a separate legal person for liability and other purposes if the series is defined as part of another legal person?
bankruptcy – Bankruptcy law has not recognized the series as a separate legal person. If a series becomes insolvent, will the entire LLC and the other series become part of the bankruptcy proceedings? Will a bankruptcy court consolidate the assets and liabilities of the separate series?
efficacy of the internal shields in the courts of other states – Will the internal shields be respected in the courts of states whose LLC statutes do not recognize series? Most LLC statutes provide that “foreign law governs” the liability of members of a foreign LLC. However, those provisions do not apply to the series question, because those provisions pertain to the liability of a member for the obligations of the LLC. For a series LLC, the pivotal question is entirely different – namely, whether some assets of an LLC should be immune from some of the creditors of the LLC.
tax treatment – Will the IRS and the states treat each series separately? Will separate returns be filed? May one series “check the box” for corporate tax classification and the others not?
securities law – Given the panoply of unanswered questions, what types of disclosures must be made when a membership interest is subject to securities law?

The Drafting Committee considered a series proposal at its February 2006 meeting, but, after serious discussion, no one was willing to urge adoption of the proposal, even for the limited purposes of further discussion. Given the availability of well-established alternate structures (e.g., multiple single member LLCs, an LLC “holding company” with LLC subsidiaries), it made no sense for the Act to endorse the complexities and risks of a series approach.

REVISED UNIFORM LIMITED LIABILITY COMPANY ACT

[ARTICLE] 1

GENERAL PROVISIONS

SECTION 101. SHORT TITLE. This [act] may be cited as the Revised Uniform Limited Liability Company Act.

Comment

This Act is drafted to replace a state’s current LLC statute, whether or not that statute is based on the original Uniform Limited Liability Company Act. Section 1104 contains transition provisions.

SECTION 102. DEFINITIONS. In this [act]:

(1) “Certificate of organization” means the certificate required by Section 201. The term includes the certificate as amended or restated.

(2) “Contribution” means any benefit provided by a person to a limited liability company:

(A) in order to become a member upon formation of the company and in accordance with an agreement between or among the persons that have agreed to become the initial members of the company;

(B) in order to become a member after formation of the company and in accordance with an agreement between the person and the company; or

(C) in the person’s capacity as a member and in accordance with the operating agreement or an agreement between the member and the company.

(3) “Debtor in bankruptcy” means a person that is the subject of:

(A) an order for relief under Title 11 of the United States Code or a successor statute of general application; or

(B) a comparable order under federal, state, or foreign law governing insolvency.

(4) “Designated office” means:

(A) the office that a limited liability company is required to designate and maintain under Section 113; or

(B) the principal office of a foreign limited liability company.

(5) “Distribution”, except as otherwise provided in Section 405(g), means a transfer of money or other property from a limited liability company to another person on account of a transferable interest.

(6) “Effective”, with respect to a record required or permitted to be delivered to the [Secretary of State] for filing under this [act], means effective under Section 205(c).

(7) “Foreign limited liability company” means an unincorporated entity formed under the law of a jurisdiction other than this state and denominated by that law as a limited liability company.

(8) “Limited liability company”, except in the phrase “foreign limited liability company”, means an entity formed under this [act].

(9) “Manager” means a person that under the operating agreement of a manager-managed limited liability company is responsible, alone or in concert with others, for performing the management functions stated in Section 407(c).

(10) “Manager-managed limited liability company” means a limited liability company that qualifies under Section 407(a).

(11) “Member” means a person that has become a member of a limited liability company under Section 401 and has not dissociated under Section 602.

(12) “Member-managed limited liability company” means a limited liability company that is not a manager-managed limited liability company.

(13) “Operating agreement” means the agreement, whether or not referred to as an operating agreement and whether oral, in a record, implied, or in any combination thereof, of all the members of a limited liability company, including a sole member, concerning the matters described in Section 110(a). The term includes the agreement as amended or restated.

(14) “Organizer” means a person that acts under Section 201 to form a limited liability company.

(15) “Person” means an individual, corporation, business trust, estate, trust, partnership, limited liability company, association, joint venture, public corporation, government or governmental subdivision, agency, or instrumentality, or any other legal or commercial entity.

(16) “Principal office” means the principal executive office of a limited liability company or foreign limited liability company, whether or not the office is located in this state.

(17) “Record” means information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form.

(18) “Sign” means, with the present intent to authenticate or adopt a record:

(A) to execute or adopt a tangible symbol; or

(B) to attach to or logically associate with the record an electronic symbol, sound, or process.

(19) “State” means a state of the United States, the District of Columbia, Puerto Rico, the United States Virgin Islands, or any territory or insular possession subject to the jurisdiction of the United States.

(20) “Transfer” includes an assignment, conveyance, deed, bill of sale, lease, mortgage, security interest, encumbrance, gift, and transfer by operation of law.

(21) “Transferable interest” means the right, as originally associated with a person’s capacity as a member, to receive distributions from a limited liability company in accordance with the operating agreement, whether or not the person remains a member or continues to own any part of the right.

(22) “Transferee” means a person to which all or part of a transferable interest has been transferred, whether or not the transferor is a member.

Comment

This Section contains definitions for terms used throughout the Act, while Section 1001 contains definitions specific to Article 10’s provisions on mergers, conversions and domestications. Section 405(g) contains an exception to the definition of “distribution,” which is specific to Section 405.

Paragraph (1) [Certificate of organization] – The original ULLCA and most other LLC statutes use “articles of organization” rather than “certificate of organization.” This Act purposely uses the latter term to signal that: (i) the certificate merely reflects the existence of an LLC (rather than being the locus for important governance rules); and (ii) this document is significantly different from articles of incorporation, which have a substantially greater power to affect inter se rules for the corporate entity and its owners. For the relationship between the certificate of organization and the operating agreement, see Section 112(d).

Paragraph (2) [Contribution] – This definition serves to distinguish capital contributions from other circumstances under which a member or would-be member might provide benefits to a limited liability company (e.g., providing services to the LLC as an employee or independent contractor, leasing property to the LLC). The definition contemplates three typical situations in which contributions are made, and for each situation establishes two “markers” to identify capital contributions – the purpose for which the contributor makes the contribution and the agreement that contemplates the contribution:

circumstance	purpose/cause of providing benefits	the relevant agreement
pre-formation deal among would-be initial members [Paragraph 2(A)]	in order to become initial member(s)	agreement among would-be initial members
deal between an existing LLC and would-be member [Paragraph 2(B)]	in order to become a member	agreement between the LLC and the would-be member
member contribution [Paragraph 2(C)]	in member’s capacity as a member	operating agreement or an agreement between the member and the LLC

This definition does not encompass capital raised from transferees, which is sometimes provided for in operating agreements. In such circumstances, the default rules for liquidating distributions should be altered accordingly. See Section 708(b)(1) (“referring to contributions made by a member and not previously returned”).

Paragraph (7) [Foreign limited liability company] – Some statutes have elaborate definitions addressing the question of whether a non-U.S. entity is a “foreign limited liability company.” The NY statute, for example, defines a “foreign limited liability company” as:

an unincorporated organization formed under the laws of any jurisdiction, including any foreign country, other than the laws of this state (i) that is not authorized to do business in this state under any other law of this state and (ii) of which some or all of the persons who are entitled (A) to receive a distribution of the assets thereof upon the dissolution of the organization or otherwise or (B) to exercise voting rights with respect to an interest in the organization have, or are entitled or authorized to have, under the laws of such other jurisdiction, limited liability for the contractual obligations or other liabilities of the organization.

N.Y. Limit Liab Co. LAW § 102(k) (McKinney 2006). ULLCA § 101(8) takes a similar but less complex approach (“an unincorporated entity organized under laws other than the laws of this State which afford limited liability to its owners comparable to the liability under Section 303 and is not required to obtain a certificate of authority to transact business under any law of this State other than this [Act]”). This Act follows Delaware’s still simpler approach. DEL. CODE ANN. tit. 6, § 18-101(4) (2006) (“denominated as such”).

Paragraph (8) [Limited liability company] – This definition makes no reference to a limited liability company having members upon formation, but Section 201 does. For a detailed discussion of the “shelf LLC” issue, see the Comment to Section 201.

Paragraph (9) [Manager] – The Act uses the word “manager” as a term of art, whose applicability is confined to manager-managed LLCs. The phrase “manager-managed” is itself a term of art, referring only to an LLC whose operating agreement refers to the LLC as such. Paragraph 10 (defining “manager-managed limited liability company”). Thus, for purposes of this Act, if the members of a member-managed LLC delegate plenipotentiary management authority to one person (whether or not a member), this Act’s references to “manager” do not apply to that person.

This approach does have the potential for confusion, but confusion around the term “manager” is common to almost all LLC statutes. The confusion stems from the choice to define “manager” as a term of art in a way that can be at odds with other, common usages of the word. For example, a member-managed LLC might well have an “office manager” or a “property manager.” Moreover, in a manager-managed LLC, the “property manager” is not likely to be a manager as the term is used in many LLC statutes. See, e.g., Brown v. MR Group, LLC, 278 Wis.2d 760, 768-9, 693 N.W.2d 138, 143 (Wis.App. 2005) (rejecting a party’s urging to use the dictionary definition of “manager” in determining coverage of a policy applicable to a limited liability company and its “managers” and relying instead on the meaning of the term under the Wisconsin LLC act).

Under this Act, the category of “person” is not limited to individuals. Therefore, a “manager” need not be a natural person. After a person ceases to be a manager, the term “manager” continues to apply to the person’s conduct while a manager. See Section 407(c)(7).

Paragraph (10) [Manager-managed] – This Act departs from most LLC statutes (including the original ULLCA) by authorizing a private agreement (the operating agreement) rather than a public document (certificate or articles of organization) to establish an LLC’s status as a manager-managed limited liability company. Using the operating agreement makes sense, because under this Act managerial structure creates no statutory power to bind the entity. See Section 301 (eliminating statutory apparent authority). The only direct consequences of manager-managed status are inter se – principally the triggering of a set of rules concerning management structure, fiduciary duty, and information rights. Sections 407 – 410. The management structure rules are entirely default provisions – subject to change in whole or in part by the operating agreement. The operating agreement can also significantly affect the duty and rights provisions. Section 110.

For pre-existing limited liability companies that eventually become subject to this Act, Section 1104(c) provides that “language in the limited liability company’s articles of organization designating the company’s management structure will operate as if that language were in the operating agreement.” For limited liability companies formed under this Act, the typical method to select manager-managed status will be an explicit provision of the operating agreement. However, a reference in the certificate of organization to manager-management might be evidence of the contents of the operating agreement. See Comment to Section 112(b).

An LLC that is “manager-managed” under this definition does not cease to be so simply because the members fail to designate anyone to act as a manager. In that situation, absent additional facts, the LLC is manager-managed and the manager position is vacant. Non-manager members who exercise managerial functions during the vacancy (or at any other time) will have duties as determined by other law, most particularly the law of agency.

Paragraph 10(A) and (B) – In these paragraphs, the phrases “manager-managed” and “managed by managers” are “magic words” – i.e., for either subparagraph to apply, the operating agreement must include precisely the required language. However, the word “expressly” does not mean “in writing” or “in a record.” This Act permits operating agreements to be oral (in whole or in part), and an oral provision of an operating agreement could contain the magic words. This Act also recognizes that provisions of an operating agreement may be reflected in patterns of conduct.

Oral and implied agreements invite memory problems and “swearing matches.” Section 110(a)(4) empowers the operating agreement to determine “the means and conditions for the amending the operating agreement.”

Paragraph 10(C) – In contrast to Paragraphs 10(A) and (B), this provision does not contain “magic words” and considers instead all terms of the operating agreement that expressly refer to management by managers.

Paragraph 11 [Member] – After a person has been dissociated as a member, Section 602, the term “member” continues to apply to the person’s conduct while a member. See Section 603(b).

Paragraph 12 [Member-managed limited liability company] – A limited liability company that does not effectively designate itself a manager-member limited liability company will operate, subject to any contrary provisions in the operating agreement, under statutory rules providing for management by the members. Section 407(a). For a discussion of potential confusion relating to the term “manager”, see the Comment to Paragraph 9 (Manager).

Paragraph (13) [Operating Agreement] – This definition must be read in conjunction with Sections 110 through 112, which further describe the operating agreement. An operating agreement is a contract, and therefore all statutory language pertaining to the operating agreement must be understood in the context of the law of contracts.

The definition in Paragraph 13 is very broad and recognizes a wide scope of authority for the operating agreement: “the matters described in Section 110(a).” Those matters include not only all relations inter se the members and the limited liability company but also all “activities of the company and the conduct of those activities.” Section 110(a)(3). Moreover, the definition puts no limits on the form of the operating agreement. To the contrary, the definition contains the phrase “whether oral, in a record, implied, or in any combination thereof”.

This Act states no rule as to whether the statute of frauds applies to an oral operating agreement. Case law suggests that an oral agreement to form a partnership or joint venture with a term exceeding one year is within the statute. E.g. Abbott v. Hurst, 643 So.2d 589, 592 (Ala. 1994) (“Partnership agreements, like other contracts, are subject to the Statute of Frauds. A contract of partnership for a term exceeding one year is within the Statute of Frauds and is void unless it is in writing; however, a contract establishing a partnership terminable at the will of any partner is generally held to be capable of performance by its terms within one year of its making and, therefore, to be outside the Statute of Frauds.”) (citations omitted); Pemberton v. Ladue Realty & Const. Co., 362 Mo. 768, 770-71, 244 S.W.2d 62, 64 (Mo. 1951) (rejecting plaintiff’s contention that mere part performance sufficed to take the oral agreement outside the statute and holding that partnership was therefore at will); Ebker v. Tan Jay Int'l, Ltd., 739 F.2d 812, 827-28 (2d Cir.1984) (same analysis with regard to a joint venture). However, it is not possible to form an LLC without someone signing and delivering to the filing officer a certificate of organization in record form, Section 201(a), and the Act itself then establishes the LLC’s duration. Subject to the operating agreement, that duration is perpetual. Section 104(c). An oral provision of an operating agreement calling for performance that extends beyond a year might be within the one-year provision – e.g., an oral agreement that a particular member will serve (and be permitted to serve) as manager for three years.

An oral provision of an operating agreement which involves the transfer of land, whether by or to the LLC, might come within the land provision of the statute of frauds. Froiseth v. Nowlin, 156 Wash. 314, 316, 287 P. 55. 56 (Wash. 1930) (“[The land provision] applies to an oral contract to transfer or convey partnership real property, and the interest of the other partners therein, to one partner as an individual, as well as to a parol contract by one of the parties to convey certain land owned by him individually to the partnership, or to another partner, or to put it into the partnership stock.”) (quoting 27 CORPUS JURIS 220).”).

In contrast, the fact that a limited liability company owns or deals in real property does not bring within the land provision agreements pertaining to the LLC’s membership interests. Interests in a limited liability company are personal property and reflect no direct interest in the entity’s assets. Re-ULLCA §§ 501 & 102(21). Thus, the real property issues pertaining to the LLC’s ownership of land do not “flow through” to the members and membership interests. See, e.g., Wooten v. Marshall, 153 F. Supp. 759, 763-764 (S.D. N.Y. 1957) (involving an “oral agreement for a joint venture concerning the purchase, exploitation and eventual disposition of this 160 acre tract” and stating “[t]he real property acquired and dealt with by the venturers takes on the character of personal property as between the partners in the enterprise, and hence is not covered by [the Statute of Frauds].”

The operating agreement may comprise a number of separate documents (or records), however denominated, unless the operating agreement itself provides otherwise. Section 110(a)(4). Absent a contrary provision in the operating agreement, a threshold qualification for status as part of the “operating agreement” is the assent of all the persons then members. An agreement among less than all of the members might well be enforceable among those members as parties, but would not be part of the operating agreement.

An agreement to form an LLC is not itself an operating agreement. The term “operating agreement” presupposes the existence of members, and a person cannot have “member” status until the LLC exists. However, the Act’s very broad definition of “operating agreement” means that, as soon as a limited liability company has any members, the limited liability company has an operating agreement. For example, suppose: (i) two persons orally and informally agree to join their activities in some way through the mechanism of an LLC, (ii) they form the LLC or cause it to be formed, and (iii) without further ado or agreement, they become the LLC’s initial members. The LLC has an operating agreement. “[A]ll the members” have agreed on who the members are, and that agreement – no matter how informal or rudimentary – is an agreement “concerning the matters described in Section 110(a).” (To the extent the agreement does not provide the inter se “rules of the game,” this Act “fills in the gaps.” Section 110(b).)

The same result follows when a person becomes the sole initial member of an LLC. It is not plausible that the person would lack any understanding or intention with regard to the LLC. That understanding or intention constitutes an “agreement of all the members of the limited liability company, including a sole member.”

It may seem oxymoronic to refer an “agreement of . . . a sole member,” but this approach is common in LLC statutes. See, e.g., ARIZ. REV. STAT. ANN. § 29-601 (14)(b) (2006) (defining operating agreement to mean “in the case of a limited liability company that has a single member, any written or oral statement of the member made in good faith”); Colo. Rev. Stat. Ann. § 7-80-102 (11)(b)(I) (West 2006) (defining operating agreement to include, in the case of a single member LLC “[a]ny writing, without regard to whether such writing otherwise constitutes an agreement … signed by the sole member”; N.H. Rev. Stat. Ann. § 304-c:1 (VI) (2006) (defining limited liability company agreement to include “a document adopted by the sole member”); Or. Rev. Stat. Ann. § 63.431(2) (2005) (vesting the “power to adopt, alter, amend or repeal an operating agreement of … a single member limited liability company, in the sole member of the limited liability company”); R.I. Gen. Laws § 7-16-2 (19) (2005) (stating that the term operating agreement “includes a document adopted by the sole member of a limited liability company that has only one member”); and Wash. Rev. Code Ann. § 25.15.005 (5) (West 2006): (defining limited liability company agreement to include “any written statement of the sole member”).

This re-definition of “agreement” is a function of “path dependence.” By the time single-member LLCs became widely accepted, almost all LLC statutes were premised on the LLC’s key organic document being the operating agreement. Because a key function of the operating agreement is to override statutory default rules, it was necessary to make clear that a sole member could make an operating agreement. Such an agreement may also be of interest to third parties, because the operating agreement binds the LLC. Section 111(a).

In light of Paragraph 13’s broad definition, it is possible to argue that any activity involving unanimous consent of the members becomes part of the operating agreement. For example, if pursuant to an operating agreement all the members consent to the redemption of one-half of the managing-member’s transferable interest, does that action constitute an addition to the agreement?

Typically, such questions will turn on the practical issue of whether the unanimous consent pertained solely to a single event (now past) or also to future circumstances (now in controversy) rather than on the semantic question of whether the operating agreement has been amended. Occasionally, however, the amendment vel non question could have practical import. For example, if the operating agreement entitles a non-member to approve (or veto) amendments, see Section 112(a), the members and the non-member might see the matter quite differently.

Careful drafting of veto provisions can help avoid controversy – e.g., by defining with specificity the type of decisions subject to the veto. On the question of how far a written (or “in a record”) operating agreement can go to prevent oral or implied-in-fact terms, see Section 110(a)(4).

If it is necessary for a court to decide whether the contents of a matter approved by unanimous consent have become part of the operating agreement, the court should rely on principles of contract interpretation and look:

· first, at the manifestations of the members, including:

o the manifestations made to give the unanimous consent; and

o any terms of the operating agreement (e.g., terms specifying how matters become part of the operating agreement); and

· second, at whether, viewed from the perspective of a reasonable person in the position of the members giving consent, the consent was intended to incorporate the matter into the ongoing “rules of the game” or merely take some particular action as already permitted by those rules.

Of course, if all the members have the same understanding, the reasonableness vel non of that understanding is irrelevant and the shared meaning governs. See Restatement (Second) of Contracts, § 201(1) (1981).

Paragraph (14) [Organizer] – If an LLC is to have one or more members when the filing officer files the certificate of organization, the organizer: (i) acts on behalf of the person or persons who will become the LLC’s initial members, Section 401(a) and (b); and (ii) has no function other than to compose, sign, and deliver to the filing officer for filing the certificate of organization. Section 201(a). If an LLC is to have its first member sometime after the filing officer files the certificate of organization, the organizer has the power to admit the initial member or members, Section 401(c), and to sign and deliver for filing the notice of initial membership described in Section 201(e)(1). Whether in this latter category of circumstances the organizer acts on behalf of the initial member or members is determined under ordinary principles of agency law and depends on the facts of each situation.

Paragraph (20) [Transfer] –The reference to “transfer by operation of law” is significant in connection with Section 502 (Transfer of Transferable Interest). That section severely restricts a transferee’s rights (absent the consent of the members), and this definition makes those restrictions applicable, for example, to transfers ordered by a family court as part of a divorce proceeding and transfers resulting from the death of a member. The restrictions also apply to transfers in the context of a member’s bankruptcy, except to the extent that bankruptcy law supersedes this Act.

Paragraph (21) [Transferee] – “Transferee” has displaced “assignee” as the Conference’s term of art.

SECTION 103. KNOWLEDGE; NOTICE.

(a) A person knows a fact when the person:

(1) has actual knowledge of it; or

(2) is deemed to know it under subsection (d)(1) or law other than this [act].

(b) A person has notice of a fact when the person:

(1) has reason to know the fact from all of the facts known to the person at the time in question; or

(2) is deemed to have notice of the fact under subsection (d)(2);

(c) A person notifies another of a fact by taking steps reasonably required to inform the other person in ordinary course, whether or not the other person knows the fact.

(d) A person that is not a member is deemed:

(1) to know of a limitation on authority to transfer real property as provided in Section 302(g); and

(2) to have notice of a limited liability company’s:

(A) dissolution, 90 days after a statement of dissolution under Section 702(b)(2)(A) becomes effective;

(B) termination, 90 days after a statement of termination Section 702(b)(2)(F) becomes effective; and

(C) merger, conversion, or domestication, 90 days after articles of merger, conversion, or domestication under [Article] 10 become effective.

Comment

This section is substantially slimmer than the corresponding provisions of previous uniform acts pertaining to business organizations (RUPA, ULLCA, and ULPA (2001)). Each of those acts borrowed heavily from the comparable UCC provisions. For the most part, this Act relies instead on generally applicable principles of agency law, and therefore this section is mostly confined to rules specifically tailored to this Act.

Several facets of this section warrant particular note. First, and most fundamentally, because this Act does not provide for “statutory apparent authority,” see Section 301, this section contains no special rules for attributing to an LLC information possessed, communicated to, or communicated by a member or manager.

Second, the section contains no generally applicable provisions determining when an organization is charged with knowledge or notice, because those imputation rules: (i) comprise core topics within the law of agency; (ii) are very complicated; (iii) should not have any different content under this Act than in other circumstances; and (iv) are the subject of considerable attention in the new Restatement (Third) of Agency.

Third, this Act does not define “notice” to include “knowledge.” Although conceptualizing the latter as giving the former makes logical sense and has a long pedigree, that conceptualization is counter-intuitive for the non-aficionado. In ordinary usage, notice has a meaning separate from knowledge. This Act follows ordinary usage and therefore contains some references to “knowledge or notice.”

Subsection (a)(2) – In this context, the most important source of “law other than this [act]” is the common law of agency.

Subsection (b)(1) – The “facts known to the person at the time in question” include facts the person is deemed to know under subsection (a)(2).

Subsection (d)(2) – Under this Act, the power to bind a limited liability company to a third party is primarily a matter of agency law. Section 301, Comment. The constructive notice provided under this paragraph will be relevant if a third party makes a claim under agency law that someone who purported to act on behalf of a limited liability company had the apparent authority to do so.

SECTION 104. NATURE, PURPOSE, AND DURATION OF LIMITED LIABILITY COMPANY.

(a) A limited liability company is an entity distinct from its members.

(b) A limited liability company may have any lawful purpose, regardless of whether for profit.

Legislative Note: This state should consider whether to amend statutes protecting the public interest in organizations formed for charitable or similar purposes.

Comment

Subsection (a) – The “separate entity” characteristic is fundamental to a limited liability company and is inextricably connected to both the liability shield, Section 304, and the charging order provision, Section 503.

Subsection (b) – The phrase “any lawful purpose, regardless of whether for profit” means that: (i) a limited liability company need not have any business purpose; and (ii) the issue of profit vel non is irrelevant to the question of whether a limited liability company has been validly formed. Although some LLC statutes continue to require a business purpose, this Act follows the current trend and takes a more expansive approach.

The expansive approach comports both with the original ULLCA and with ULPA (2001). See ULLCA §§ 112(a) (captioned with reference to “Nature of Business” and permitting “any lawful purpose, subject to any law of this State governing or regulating business”) and 101(3) (defining “Business” as including “every trade, occupation, profession, and other lawful purpose, whether or not carried on for profit”); ULPA (2001) § 104(b) (permitting a limited partnership to be organized for any “lawful” purpose). Compare UPA § 6 (defining a general partnership as organized for profit), RUPA § 101(6) (same), and RULPA (1976/85) § 106 (delineating the “Nature of [a limited partnership’s] Business” by linking back to “any business that a partnership without limited partners may carry on”).

The subsection does not bar a limited liability company from being organized to carry on charitable activities, and this act does not include any protective provisions pertaining to charitable purposes. Those protections must be (and typically are) found in other law, although sometimes that “other law” appears within a state’s non-profit corporation statute. See, e.g., Minn. Stat. § 317A.811 (2006) (providing restrictions on charitable organizations that seek to “dissolve, merge, or consolidate, or to transfer all or substantially all of their assets” but imposing those restrictions only on “corporations,” which are elsewhere defined as corporations incorporated under the non-profit corporation act).

Subsection (c) – In this context, the word “perpetual” is a misnomer, albeit one commonplace in LLC statutes. Like all current LLC statutes, this Act provides several consent-based avenues to override perpetuity: a term specified in the operating agreement; an event specified in the operating agreement; member consent. Section 701 (events causing dissolution). In this context, “perpetuity” actually means that the Act does not require a definite term and creates no nexus between the dissociation of a member and the dissolution of the entity. (The dissociation of an LLC’s last remaining member does threaten dissolution. Section 701(a)(3) (stating, as a default rule, that a limited liability company dissolves “upon . . . the passage of 90 consecutive days during which the limited liability company has no members”).

An operating agreement is not a publicly-filed document, which means that the public record pertaining to a limited liability company will not necessarily reveal whether a limited liability company actually has a perpetual duration. Accord ULPA (2001) § 104, comment to subsection (c) (“The partnership agreement has the power to vary this subsection [which provides for perpetual duration], either by stating a definite term or by specifying an event or events which cause dissolution. . . . . [The limited partnership act] also recognizes several other occurrences that cause dissolution. Thus, the public record pertaining to a limited partnership will not necessarily reveal whether the limited partnership actually has a perpetual duration.”)

SECTION 105. POWERS. A limited liability company has the capacity to sue and be sued in its own name and the power to do all things necessary or convenient to carry on its activities.

Comment

Following ULPA (2001), § 105, this Act omits as unnecessary any detailed list of specific powers. Compare ULLCA § 112 (containing a detailed list).

The capacity to sue and be sued is mentioned specifically so that Section 110(c)(1) can prohibit the operating agreement from varying that capacity. An LLC’s standing to enforce the operating agreement is a separate matter, which is covered by Section 111(a) (stating, as a default rule, that the limited liability company “may enforce the operating agreement”).

SECTION 106. GOVERNING LAW. The law of this state governs:

(1) the internal affairs of a limited liability company; and

(2) the liability of a member as member and a manager as manager for the debts, obligations, or other liabilities of a limited liability company.

Comment

Paragraph (1) – Like any other legal concept, “internal affairs” may be indeterminate at its edges. However, the concept certainly includes interpretation and enforcement of the operating agreement, relations among the members as members; relations between the limited liability company and a member as a member, relations between a manager-managed limited liability company and a manager, and relations between a manager of a manager-managed limited liability company and the members as members. Compare Restatement (Second) of Conflict of Laws § 302, cmt. a (defining “internal affairs” with reference to a corporation as “the relations inter se of the corporation, its shareholders, directors, officers or agents”).

The operating agreement cannot alter this provision. Section 110(c)(2). However, an operating agreement may lawfully incorporate by reference the provisions of another state’s LLC statute. If done correctly, this incorporation makes the foreign statutory language part of the operating agreement, and the incorporated terms (together with the rest of the operating agreement) then govern the members (and those claiming through the members) to the extent not prohibited by this Act. See Section 110. This approach does not switch the limited liability company’s governing law to that of another state, but instead takes the provisions of another state’s law and incorporates them by reference into the contract among the members.

Paragraph (2) – This paragraph certainly encompasses Section 304 (the liability shield) but does not necessarily encompass a claim that a member or manager is liable to a third party for (i) having purported to bind a limited liability company to the third party; or (ii) having committed a tort against the third party while acting on the limited liability company’s behalf or in the course of the company’s business. That liability is not by status (i.e., not “as member . . . [or] as manager”) but rather results from function or conduct. Contrast Section 301(b) (stating that, although this Act does not make a member as member the agent of a limited liability company, other law may make an LLC liable for the conduct of a member).

This paragraph is stated separately from Paragraph (1), because it can be argued that the liability of members and managers to third parties is not an internal affair. See, e.g., Restatement (Second) of Conflict of Laws, § 307 (treating shareholders’ liability separately from the internal affairs doctrine). A few cases subsume owner/manager liability into internal affairs, but many do not. See, e.g., Kalb, Voorhis & Co. v. American Fin. Corp., 8 F.3d 130, 132 (2nd Cir. 1993). In any event, the rule stated in this paragraph is correct. All sensible authorities agree that, except in extraordinary circumstances, “shield-related” issues should be determined according to the law of the state of organization.

SECTION 107. SUPPLEMENTAL PRINCIPLES OF LAW. Unless displaced by particular provisions of this [act], the principles of law and equity supplement this [act].

SECTION 108. NAME.

(a) The name of a limited liability company must contain the words “limited liability company” or “limited company” or the abbreviation “L.L.C.”, “LLC”, “L.C.”, or “LC”. “Limited” may be abbreviated as “Ltd.”, and “company” may be abbreviated as “Co.”.

(b) Unless authorized by subsection (c), the name of a limited liability company must be distinguishable in the records of the [Secretary of State] from:

(1) the name of each person that is not an individual and that is incorporated, organized, or authorized to transact business in this state;

(2) the limited liability company name stated in each certificate of organization that contains the statement as provided in Section 201(b)(3) and that has not lapsed; and

(3) each name reserved under Section 109 and [cite other state laws allowing the reservation or registration of business names, including fictitious or assumed name statutes].

(c) A limited liability company may apply to the [Secretary of State] for authorization to use a name that does not comply with subsection (b). The [Secretary of State] shall authorize use of the name applied for if, as to each noncomplying name:

(1) the present user, registrant, or owner of the noncomplying name consents in a signed record to the use and submits an undertaking in a form satisfactory to the [Secretary of State] to change the noncomplying name to a name that complies with subsection (b) and is distinguishable in the records of the [Secretary of State] from the name applied for; or

(2) the applicant delivers to the [Secretary of State] a certified copy of the final judgment of a court establishing the applicant’s right to use in this state the name applied for.

(d) Subject to Section 805, this section applies to a foreign limited liability company transacting business in this state which has a certificate of authority to transact business in this state or which has applied for a certificate of authority.

Comment

Subsection (a) is taken verbatim from ULLCA § 105(a). Except for subsection (b)(2), the rest of the section is taken from ULPA (2001) § 108.

Subsection (b)(2) – This language is necessary to protect a name contained in a filed certificate of organization that has not become effective because there are no members. If a statement of membership is not thereafter timely filed, “the certificate lapses and is void,” thereby freeing the name. Section 201(e)(1).

SECTION 109. RESERVATION OF NAME.

(a) A person may reserve the exclusive use of the name of a limited liability company, including a fictitious or assumed name for a foreign limited liability company whose name is not available, by delivering an application to the [Secretary of State] for filing. The application must state the name and address of the applicant and the name proposed to be reserved. If the [Secretary of State] finds that the name applied for is available, it must be reserved for the applicant’s exclusive use for a 120-day period.

(b) The owner of a name reserved for a limited liability company may transfer the reservation to another person by delivering to the [Secretary of State] for filing a signed notice of the transfer which states the name and address of the transferee.

Comment

Source: ULLCA, § 106.

Subsection (a) – Although 120-day reservation period is non-renewable, this subsection does not prevent a person from seeking successive 120-day periods of reservation.

SECTION 110. OPERATING AGREEMENT; SCOPE, FUNCTION, AND LIMITATIONS.

(a) Except as otherwise provided in subsections (b) and (c), the operating agreement governs:

(1) relations among the members as members and between the members and the limited liability company;

(2) the rights and duties under this [act] of a person in the capacity of manager;

(3) the activities of the company and the conduct of those activities; and

(4) the means and conditions for amending the operating agreement.

(b) To the extent the operating agreement does not otherwise provide for a matter described in subsection (a), this [act] governs the matter.

(1) vary a limited liability company’s capacity under Section 105 to sue and be sued in its own name;

(2) vary the law applicable under Section 106;

(3) vary the power of the court under Section 204;

(4) subject to subsections (d) through (g), eliminate the duty of loyalty, the duty of care, or any other fiduciary duty;

(5) subject to subsections (d) through (g), eliminate the contractual obligation of good faith and fair dealing under Section 409(d);

(6) unreasonably restrict the duties and rights stated in Section 410;

(7) vary the power of a court to decree dissolution in the circumstances specified in Section 701(a)(4) and (5);

(8) vary the requirement to wind up a limited liability company’s business as specified in Section 702(a) and (b)(1);

(9) unreasonably restrict the right of a member to maintain an action under [Article] 9;

(10) restrict the right to approve a merger, conversion, or domestication under Section 1014 to a member that will have personal liability with respect to a surviving, converted, or domesticated organization; or

(11) except as otherwise provided in Section 112(b), restrict the rights under this [act] of a person other than a member or manager.

(d) If not manifestly unreasonable, the operating agreement may:

(1) restrict or eliminate the duty:

(A) as required in Section 409(b)(1) and (g), to account to the limited liability company and to hold as trustee for it any property, profit, or benefit derived by the member in the conduct or winding up of the company’s business, from a use by the member of the company’s property, or from the appropriation of a limited liability company opportunity;

(B) as required in Section 409(b)(2) and (g), to refrain from dealing with the company in the conduct or winding up of the company’s business as or on behalf of a party having an interest adverse to the company; and

(C) as required by Section 409(b)(3) and (g), to refrain from competing with the company in the conduct of the company’s business before the dissolution of the company;

(2) identify specific types or categories of activities that do not violate the duty of loyalty;

(3) alter the duty of care, except to authorize intentional misconduct or knowing violation of law;

(4) alter any other fiduciary duty, including eliminating particular aspects of that duty; and

(5) prescribe the standards by which to measure the performance of the contractual obligation of good faith and fair dealing under Section 409(d).

(e) The operating agreement may specify the method by which a specific act or transaction that would otherwise violate the duty of loyalty may be authorized or ratified by one or more disinterested and independent persons after full disclosure of all material facts.

(f) To the extent the operating agreement of a member-managed limited liability company expressly relieves a member of a responsibility that the member would otherwise have under this [act] and imposes the responsibility on one or more other members, the operating agreement may, to the benefit of the member that the operating agreement relieves of the responsibility, also eliminate or limit any fiduciary duty that would have pertained to the responsibility.

(g) The operating agreement may alter or eliminate the indemnification for a member or manager provided by Section 408(a) and may eliminate or limit a member or manager’s liability to the limited liability company and members for money damages, except for:

(1) breach of the duty of loyalty;

(2) a financial benefit received by the member or manager to which the member or manager is not entitled;

(3) a breach of a duty under Section 406;

(4) intentional infliction of harm on the company or a member; or

(5) an intentional violation of criminal law.

(h) The court shall decide any claim under subsection (d) that a term of an operating agreement is manifestly unreasonable. The court:

(1) shall make its determination as of the time the challenged term became part of the operating agreement and by considering only circumstances existing at that time; and

(2) may invalidate the term only if, in light of the purposes and activities of the limited liability company, it is readily apparent that:

(A) the objective of the term is unreasonable; or

(B) the term is an unreasonable means to achieve the provision’s objective.

Comment

The operating agreement is pivotal to a limited liability company, and Sections 110 through 112 are pivotal to this Act. They must be read together, along with Section 102(13) (defining the operating agreement).

One of the most complex questions in the law of unincorporated business organizations is the extent to which an agreement among the organization’s owners can affect the law of fiduciary duty. This section gives special attention to that question and is organized as follows:

Subsection (a)

grants broad, general authority to the operating agreement

Subsection (b)

establishes this Act as comprising the “default rules” (“gap fillers”) for matters within the purview of the operating agreement but not addressed by the operating agreement

Subsection (c)

states restrictions on the power of the operating agreement, especially but not exclusively with regard to fiduciary duties and the contractual obligation of good faith

Subsection (d)

contains specific grants of authority for the operating agreement with regard to fiduciary duty and the contractual obligation of good faith; expressed so as to state restrictions on those specific grants – including the “if not manifestly unreasonable” standard

Subsection (e)

specifically grants the operating agreement the power to provide mechanisms for approving or ratifying conduct that would otherwise violate the duty of loyalty; expressed so as to state restrictions on those mechanism – full disclosure and disinterested and independent

decision makers

Subsection (f)

specifically authorizes the operating agreement to divest a member of fiduciary duty with regard to a matter if the operating agreement is also divesting the person of responsibility for the matter (and imposing that responsibility on one or more other members)

Subsection (g)

contains specific grants of authority for the operating agreement with regard to indemnification and exculpatory provisions; expressed so as to state restrictions on those specific grants

Subsection (h)

provides rules for applying the “not manifestly unreasonable” standard established by subsection (d)

A limited liability company is as much a creature of contract as of statute, and Section 102(13) delineates a very broad scope for “operating agreement.” As a result, once an LLC comes into existence and has a member, the LLC necessarily has an operating agreement. See Comment to Section 102(13). Accordingly, this Act refers to “the operating agreement” rather than “an operating agreement.”

This phrasing should not, however, be read to require a limited liability company or its members to take any formal action to adopt an operating agreement. Compare Cal. Corp. Code § 17050(a) (West 2006) (“In order to form a limited liability company, one or more persons shall execute and file articles of organization with, and on a form prescribed by, the Secretary of State and, either before or after the filing of articles of organization, the members shall have entered into an operating agreement.”)

The operating agreement is the exclusive consensual process for modifying this Act’s various default rules pertaining to relationships inter se the members and between the members and the limited liability company. Section 110(b). The operating agreement also has power over “the rights and duties under this [act] of a person in the capacity of manager,” subsection (a)(2), and “the obligations of a limited liability company and its members to a person in the person’s capacity as a transferee or dissociated member.” Section 112(b).

Subsection (a) – This section describes the very broad scope of a limited liability company’s operating agreement, which includes all matters constituting “internal affairs.” Compare Section 106(1) (using the phrase “internal affairs” in stating a choice of law rule). This broad grant of authority is subject to the restrictions stated in subsection (c), including the broad restriction stated in paragraph (c)(11) (concerning the rights under this Act of third parties).

Subsection (a)(1) – Under this Act, a limited liability company is emphatically an entity, and the members lack the power to alter that characteristic.

Subsection (a)(2) – Under this paragraph, the operating agreement has the power to affect the rights and duties of managers (including non-member managers). Because the term “[o]perating agreement . . . . includes the agreement as amended or restated,” Section 102(13), this paragraph gives the members the ongoing power to define the role of an LLC’s managers. Power is not the same as right, however, and exercising the power provided by this paragraph might constitute a breach of a separate contract between the LLC and the manager. A non-member manager might also have rights under Section 112(a).

Subsection (a)(4) – If the operating agreement does not address this matter, under subsection (b) this Act provides the rule. The rule appears in Section 407(b)(5) and 407(c)(4)(D) (unanimous consent).

This Act does not specially authorize the operating agreement to limit the sources in which terms of the operating agreement might be found or limit amendments to specified modes (e.g., prohibiting modifications except when consented to in writing). Compare UCC § 2-209(2) (authorizing such prohibitions in a “signed agreement” for the sale of goods). However, this Paragraph (a)(4) could be read to encompass such authorization. Also, under Section 107 the parol evidence rule will apply to a written operating agreement containing an appropriate merger provision.

Subsection (c) – If a person claims that a term of the operating agreement violates this subsection, as a matter of ordinary procedural law the burden is on the person making the claim.

Subsection (c)(4) – This limitation is less powerful than might first appear, because subsections (d) through (g) specifically authorize significantly alterations to fiduciary duty. The reference to “or any other fiduciary duty” is necessary because the Act has “un-cabined” fiduciary duty. See Comment to Section 409.

Subsection (c)(9) – Arbitration and forum selection provisions are commonplace in business agreements, and this paragraph’s restrictions do not reflect any special hostility to or skepticism of such provisions.

Subsection (c)(10) – Under Section 1014:

§ each member is protected from being merged, converted, or domesticated “into” the status of an unshielded general partner (or comparable position) without the member having directly consented to either:

o the merger, conversion, or domestication; or

o an operating agreement provision that permits such transactions to occur with less than unanimous consent of the members; and

§ merely consenting to an operating agreement provision that permits amendment of the operating agreement with less than unanimous consent of the members does not qualify as the requisite direct consent.

The sole function of subsection (c)(10) is to protect Section 1014 by denying the operating agreement the power to restrict or otherwise undercut the protections of Section 1014.

Subsection (c)(11) – This limitation pertains only to “the rights under this[act] of” third parties. The extent to which an operating agreement can affect other rights of third parties is a question for other law, particularly the law of contracts.

Subsection (d) – Delaware recently amended its LLC statute to permit an operating agreement to fully “eliminate” fiduciary duty within an LLC. This Act rejects the ultra-contractarian notion that fiduciary duty within a business organization is merely a set of default rule and seeks instead to balance the virtues of “freedom of contract” against the dangers that inescapably exist when some have power over the interests of others. As one source has explained:

The open-ended nature of fiduciary duty reflects the law’s long-standing recognition that devious people can smell a loophole a mile away. For centuries, the law has assumed that (1) power creates opportunities for abuse and (2) the devious creativity of those in power may outstrip the prescience of those trying, through ex ante contract drafting, to constrain that combination of power and creativity.

Carter G. Bishop and Daniel S. Kleinberger, Limited Liability Companies: Tax and Business Law, ¶ 14.05[4][a][ii]

Subsection (h) contains rules for applying the “not manifestly unreasonable” standard.

Subsection (d)(1) – Subject to the “not manifestly unreasonable” standard, this paragraph empowers the operating agreement to eliminate all aspects of the duty of loyalty listed in Section 409. The contractual obligation of good faith would remain, see subsections(c)(5) and (d)(5), as would any other, uncodified aspects of the duty of loyalty. See Comment to Section 409 (explaining the decision to “un-cabin” fiduciary duty). See also subsection (d)(4) (empowering the operating agreement to “alter any other fiduciary duty, including eliminating particular aspects of that duty”).

Subsection (d)(3) – The operating agreement’s power to affect this Act’s duty of care both parallels and differs from the agreement’s power to affect this Act’s duty of loyalty as well as any other fiduciary duties not codified in the statute. With regard to all fiduciary duties, the operating agreement is subject to the “manifestly unreasonable” standard. The differences concern: (i) the extent of the operating agreement’s power to restrict the duty; and (ii) the power of the operating agreement to provide indemnity or exculpation for persons subject to the duty.

duty	extent of operating agreement’s power to restrict the duty (subject to the “manifestly unreasonable” standard) Section 110(d)(1), (3) and (4)	power of the operating agreement to provide indemnity or exculpation w/r/t breach of the duty Section 110(g)
loyalty	restrict or completely eliminate	none
care	alter, but not eliminate; specifically may not authorize intentional misconduct or knowing violation of law	complete
other fiduciary duties, not codified in the statute	restrict or completely eliminate Section 110(4)	complete

Subsection (e) – Section 409(f) states the Act’s default rule for authorization or ratification – unanimous consent. This subsection specifically empowers the operating agreement to provide alternate mechanisms but, in doing so, imposes significant restrictions – namely, any alternate mechanism must involve full disclosure to, and the disinterestedness and independence of, the decision makers. These restrictions are consonant with ordinary notions of authorization and ratification.

This Act provides four separate methods through which those with management power in a limited liability company can proceed with conduct that would otherwise violate the duty of loyalty:

Method	Statutory Authority
The operating agreement might eliminate the duty or otherwise permit the conduct, without need for further authorization or ratification.	Section 110(d)(1) and (2)
The conduct might be authorized or ratified by all the members after full disclosure.	Section 409(f)
The operating agreement might establish a mechanism other than the informed consent for authorizing or ratifying the conduct.	Section 110(e)
In the case of self-dealing the conduct might be successfully defended as being or having been fair to the limited liability company.	Section 409(e)

Subsection (f) – This subsection is intended to make clear that – regardless of the strictures stated elsewhere in this section – in the specified circumstances the operating agreement can entirely strip away the pertinent fiduciary duties.

Subsection (g) – This subsection specifically empowers the operating agreement to address matters of indemnification and exculpation but subjects that power to stated limitations. Those limitations are drawn from the raft of exculpatory provisions that sprung up in corporate statutes in response to Smith v. Van Gorkum, 488 A.2d 858 (Del. 1985). Delaware led the response with Del. Code Ann. tit. 8, § 102(b)(7) (2006), and a number of LLC statutes have similar provisions. E.g. Ga. Code Ann. § 14-11-305(4)(A) (West 2006); Idaho Code Ann. § 53-624(1) (2006). For an extreme example, see Va. Code Ann. § 13.1-1025 (West 2006) (establishing limits of monetary liability as the default rule).

The restrictions stated in paragraphs (1) through (5) apply both to indemnification and exculpation. The power to “alter or eliminate the indemnification provided by Section 408(a)” includes the power to expand or reduce that indemnification.

Subsection (g)(4) – Due to this paragraph, an exculpatory provision cannot shield against a member’s claim of oppression. See Section 701(a)(5)(B) and (b).

Subsection (h) – The “not manifestly unreasonable standard” became part of uniform business entity statutes when RUPA imported the concept from the Uniform Commercial Code. This subsection provides rules for applying that standard, which are necessary because:

· Determining unreasonableness inter se owners of an organization is a different task than doing so in a commercial context, where concepts like “usages of trade” are available to inform the analysis. Each business organization must be understood in its own terms and context.

· If loosely applied, the standard would permit a court to rewrite the members’ agreement, which would destroy the balance this Act seeks to establish between freedom of contract and fiduciary duty.

· Case law research indicates that courts have tended to disregard the significance of the word “manifestly.”

· Some decisions have considered reasonableness as of the time of the complaint, which means that a prospectively reasonable allocation of risk could be overturned because it functioned as agreed.

If a person claims that a term of the operating agreement in manifestly unreasonable under subsections (d) and (h), as a matter of ordinary procedural law the burden is on the person making the claim.

Subsection (h)(1) – The significance of the phrase “as of the time the term as challenged became part of the operating agreement” is best shown by example.

EXAMPLE: An LLC’s operating agreement as initially adopted includes a provision subjecting a matter to “the manager’s sole, reasonable discretion.” A year later, the agreement is amended to delete the word “reasonable.” Later, a member claims that, without the word “reasonable,” the provision is manifestly unreasonable. The relevant time under subsection (h)(1) is when the agreement was amended, not when the agreement was initially adopted.

EXAMPLE: When a particular manager-managed LLC comes into existence, its business plan is quite unusual and its success depends on the willingness of a particular individual to serve as the LLC’s sole manager. This individual has a rare combination of skills, experiences, and contacts, which are particularly appropriate for the LLC’s start-up. In order to induce the individual to accept the position of sole manager, the members are willing to have the operating agreement significantly limit the manager’s fiduciary duties. Several years later, when the LLC’s operations have turned prosaic and the manager’s talents and background are not nearly so crucial, a member challenges the fiduciary duty limitations as manifestly unreasonable. The relevant time under subsection (h)(1) is when the LLC began. Subsequent developments are not relevant, except as they might inferentially bear on the circumstances in existence at the relevant time.

SECTION 111. OPERATING AGREEMENT; EFFECT ON LIMITED LIABILITY COMPANY AND PERSONS BECOMING MEMBERS; PREFORMATION AGREEMENT.

(a) A limited liability company is bound by and may enforce the operating agreement, whether or not the company has itself manifested assent to the operating agreement.

(b) A person that becomes a member of a limited liability company is deemed to assent to the operating agreement.

(c) Two or more persons intending to become the initial members of a limited liability company may make an agreement providing that upon the formation of the company the agreement will become the operating agreement. One person intending to become the initial member of a limited liability company may assent to terms providing that upon the formation of the company the terms will become the operating agreement.

Comment

Subsection (a) – This subsection does not consider whether a limited liability company is an indispensable party to a suit concerning the operating agreement. That is a question of procedural law, which can determine whether federal diversity jurisdiction exists.

Subsection (b) – Given the possibility of oral and implied-in-fact components to the operating agreement, see Comment to Section 110(a)(4), a person becoming a member of an existing limited liability company should take precautions to ascertain fully the contents of the operating agreement.

Subsection (c) – The second sentence refers to “assent to terms” rather than “make an agreement” because, under venerable principles of contract law, an agreement presupposes at least two parties. This Act specifically defines the operating agreement to include a sole member, Section 102(13), but a preformation arrangement is not an operating agreement. An operating agreement is among “members,” and, under this Act, the earliest a person can become a member is upon the formation of the limited liability company. Section 401.

SECTION 112. OPERATING AGREEMENT; EFFECT ON THIRD PARTIES AND RELATIONSHIP TO RECORDS EFFECTIVE ON BEHALF OF LIMITED LIABILITY COMPANY.

(a) An operating agreement may specify that its amendment requires the approval of a person that is not a party to the operating agreement or the satisfaction of a condition. An amendment is ineffective if its adoption does not include the required approval or satisfy the specified condition.

(b) The obligations of a limited liability company and its members to a person in the person’s capacity as a transferee or dissociated member are governed by the operating agreement. Subject only to any court order issued under Section 503(b)(2) to effectuate a charging order, an amendment to the operating agreement made after a person becomes a transferee or dissociated member is effective with regard to any debt, obligation, or other liability of the limited liability company or its members to the person in the person’s capacity as a transferee or dissociated member.

(c) If a record that has been delivered by a limited liability company to the [Secretary of State] for filing and has become effective under this [act] contains a provision that would be ineffective under Section 110(c) if contained in the operating agreement, the provision is likewise ineffective in the record.

(d) Subject to subsection (c), if a record that has been delivered by a limited liability company to the [Secretary of State] for filing and has become effective under this [act] conflicts with a provision of the operating agreement:

(1) the operating agreement prevails as to members, dissociated members, transferees, and managers; and

(2) the record prevails as to other persons to the extent they reasonably rely on the record.

Comment

Subsection (a) – This subsection, derived from Del. Code Ann. tit. 6, § 18-302(e), permits a non-member to have veto rights over amendments to the operating agreement. Such veto rights are likely to be sought by lenders but may also be attractive to non-member managers.

EXAMPLE: A non-member manager enters into a management contract with the LLC, and that agreement provides in part that the LLC may remove the manager without cause only with the consent of members holding 2/3 of the profits interests. The operating agreement contains a parallel provision, but the non-member manager is not a party to the operating agreement. Later the LLC members amend the operating agreement to change the quantum to a simple majority and thereafter purport to remove the manager without cause. Although the LLC has undoubtedly breached its contract with the manager and subjected itself to a damage claim, the LLC has the power under Section 110(a)(2) to effect the removal – unless the operating agreement provided the non-member manager a veto right over changes in the quantum provision.

The subsection does not refer to member veto rights because, unless otherwise provided in the operating agreement, the consent of each member is necessary to effect an amendment. Section 407(b)(5) and (c)(4)(D).

Subsection (b) – The law of unincorporated business organizations is only beginning to grapple in a modern way with the tension between the rights of an organization’s owners to carry on their activities as they see fit (or have agreed) and the rights of transferees of the organization’s economic interests. (Such transferees can include the heirs of business founders as well as former owners who are “locked in” as transferees of their own interests. See Section 603(a)(3).).

If the law categorically favors the owners, there is a serious risk of expropriation and other abuse. On the other hand, if the law grants former owners and other transferees the right to seek judicial protection, that specter can “freeze the deal” as of the moment an owner leaves the enterprise or a third party obtains an economic interest.

Bauer v. Blomfield Co./Holden Joint Venture, 849 P2d 1365 (Alaska 1993) illustrates this point nicely. The case arose after all the partners had approved a commission arrangement with a third party and the arrangement dried up all the partnership profits. When an assignee of a partnership interest objected, the court majority flatly rejected not only the claim but also the assignee’s right to assert the claim. A mere assignee “was not entitled to complain about a decision made with the consent of all the partners.” Id. at 1367. A footnote explained, “We are unwilling to hold that partners owe a duty of good faith and fair dealing to assignees of a partner's interest.” Id. at 1367, n. 2.

The dissent, invoking the law of contracts, asserted that the majority had turned the statutory protection of the partners’ management prerogatives into an instrument for abuse of assignees:

It is a well-settled principle of contract law that an assignee steps into the shoes of an assignor as to the rights assigned. Today, the court summarily dismisses this principle in a footnote and leaves the assignee barefoot….

As interpreted by the court, the [partnership] statute now allows partners to deprive an assignee of profits to which he is entitled by law for whatever outrageous motive or reason. The court's opinion essentially leaves the assignee of a partnership interest without remedy to enforce his right.

Id. at 1367-8 (Matthews, J., dissenting).

The Bauer majority is consistent with the limited but long-standing case law in this area (all of it pertaining to partnerships rather than LLCs). This subsection follows the Bauer majority and other cases by expressly subjecting transferees and dissociated members to operating agreement amendments made after the transfer or dissociation. Compare UPA § 32(2) (permitting an assignee to seek judicial dissolution of an at-will general partnership at any time and of a partnership for a term or undertaking if partnership continues in existence after the completion of the term or undertaking); RUPA § 801(6) (same except adding the requirement that the court determine that dissolution is equitable); ULLCA, § 801(5) (same as RUPA); ULLCA, § 801(4) (permitting a dissociated member to seek dissolution on the grounds inter alia of oppressive conduct). See also UCC §§ 9-405(a) and (b) and Restatement (Second) of Contracts § 338 (1981) (recognizing a duty of good faith applicable to the modification of a contract when an assignment of contract is in effect).

The issue of whether, in extreme and sufficiently harsh circumstances, transferees might be able to claim some type of duty or obligation to protect against expropriation, is a question for other law.

Subsection (d) – A limited liability company is a creature of contract as well as a creature of statute. It will be possible, albeit improvident, for the operating agreement to be inconsistent with the certificate of organization or other public filings pertaining to the limited liability company. For those circumstances, this subsection provides rules for determining which source of information prevails.

For members, managers and transferees, the operating agreement is paramount. For third parties seeking to invoke the public record, actual knowledge of that record is necessary and notice, deemed notice, and deemed knowledge under Section 103 are irrelevant. A third party wishing to enforce the public record over the operating agreement must show reasonable reliance on the public record, and reliance presupposes knowledge.

The mere fact that a term is present in a publicly-filed record and not in the operating agreement, or vice versa, does not automatically establish a conflict. This subsection does not expressly cover a situation in which (i) one of the specified filed records contains information in addition to, but not inconsistent with, the operating agreement, and (ii) a person, other than a member or transferee, reasonably relies on the additional information. However, the policy reflected in this subsection seems equally applicable to that situation.

Section 110(a)(4) might also be relevant to the subject matter of this subsection. Absent a contrary provision in the operating agreement, language in an LLC’s certificate of organization might be evidence of the members’ agreement and might thereby constitute or at least imply a term of the operating agreement.

This subsection does not apply to records delivered to the [Secretary of State] for filing on behalf of persons other than a limited liability company.

SECTION 113. OFFICE AND AGENT FOR SERVICE OF PROCESS.

(a) A limited liability company shall designate and continuously maintain in this state:

(1) an office, which need not be a place of its activity in this state; and

(2) an agent for service of process.

(b) A foreign limited liability company that has a certificate of authority under Section 802 shall designate and continuously maintain in this state an agent for service of process.

(c) An agent for service of process of a limited liability company or foreign limited liability company must be an individual who is a resident of this state or other person with authority to transact business in this state.

Comment

Source: ULPA (2001), § 114.

SECTION 114. CHANGE OF DESIGNATED OFFICE OR AGENT FOR SERVICE OF PROCESS.

(a) A limited liability company or foreign limited liability company may change its designated office, its agent for service of process, or the address of its agent for service of process by delivering to the [Secretary of State] for filing a statement of change containing:

(1) the name of the company;

(2) the street and mailing addresses of its current designated office;

(3) if the current designated office is to be changed, the street and mailing addresses of the new designated office;

(4) the name and street and mailing addresses of its current agent for service of process; and

(5) if the current agent for service of process or an address of the agent is to be changed, the new information.

(b) Subject to Section 205(c), a statement of change is effective when filed by the [Secretary of State].

Comment

Source – ULPA (2001) § 115, which is based on ULLCA § 109.

Subsection (a) – This subsection uses “may” rather than “shall” because other avenues exist. A limited liability company may also change the information by amending its certificate of organization, Section 202, or through its annual report. Section 209(e). A foreign limited liability company may use its annual report. Section 209(e). However, neither a limited liability company nor a foreign limited liability company may wait for the annual report if the information described in the public record becomes inaccurate. See Sections 207 (imposing liability for false information in record) and 116(b) (providing for substitute service).

SECTION 115. RESIGNATION OF AGENT FOR SERVICE OF PROCESS.

(a) To resign as an agent for service of process of a limited liability company or foreign limited liability company, the agent must deliver to the [Secretary of State] for filing a statement of resignation containing the company name and stating that the agent is resigning.

(b) The [Secretary of State] shall file a statement of resignation delivered under subsection (a) and mail or otherwise provide or deliver a copy to the designated office of the limited liability company or foreign limited liability company and another copy to the principal office of the company if the mailing addresses of the principal office appears in the records of the [Secretary of State] and is different from the mailing address of the designated office.

(1) the 31st day after the [Secretary of State] files the statement of resignation; (2) when a record designating a new agent for service of process is delivered to the [Secretary of State] for filing on behalf of the limited liability company and becomes effective.

Comment

Source – ULPA (2001) § 116, which is based on ULLCA §110.

SECTION 116. SERVICE OF PROCESS.

(a) An agent for service of process appointed by a limited liability company or foreign limited liability company is an agent of the company for service of any process, notice, or demand required or permitted by law to be served on the company.

(b) If a limited liability company or foreign limited liability company does not appoint or maintain an agent for service of process in this state or the agent for service of process cannot with reasonable diligence be found at the agent’s street address, the [Secretary of State] is an agent of the company upon whom process, notice, or demand may be served.

(c) Service of any process, notice, or demand on the [Secretary of State] as agent for a limited liability company or foreig