In November 2012, the New Jersey Legislature enacted what is referred to as a “second generation” LLC statute, known formally as the Revised Uniform Limited Liability Act (“RULLA”). The Act affects all new LLCs created as of March 18, 2013, and will thereafter apply to all existing LLCs beginning in March 2014. There are default provisions to the RULLA that you should be aware of if you have an interest in an LLC, and especially if the LLC has more than one member. Any LLC operating agreement (which should include buy-sell and non-compete provisions) pre-dating the RULLA may be impacted, thus causing potential disruption or uncertainty among the members.
The LLC entity was created by the New Jersey Legislature in 1994. The Act “entitles members and managers of these entities to take advantage of both the limited liability afforded to shareholders and directors of corporations and the pass through tax advantages available to partnerships.” (Senate Commerce Committee Statement). Therefore, the policy behind the adoption of the LLC was to provide businesses the flexibility of a partnership in terms of tax benefits, yet still provide protection from liability impacting the personal assets of the members. In effect, partnerships and corporations were legally blended. Since 1994, a majority of new businesses in New Jersey and Hunterdon County have utilized the LLC as their preferred legal entity.
Over the last nineteen years, legal issues have arisen concerning the implementation of LLCs, which led to a drive to amend the LLC statutes.
The RULLA impacts LLCs in the following manner (be advised that this is not intended to identify all differences in the original statutes and RULLA; therefore, you are cautioned to read the act [P.L. 2012, Chapter 50, approved September 19, 2012] and seek the advice of an attorney concerning the impact of this legislation on your interest in the LLC).
Indemnification and Limited Exculpation
*A LLC may indemnify any member or manager (hereafter “MM”) or other person against claims and demands against that individual in the course of its activities on behalf of the company.
*The LLC must indemnify the member or manager (hereafter “MM”), as well as officers, employees and other agents of the company against expenses — to the extent that such party has successfully defending any law suit prosecuted against that person by reason of their serving as Company agent.
The Operating Agreement shall not indemnify for the following:
-breach of loyalty;
-receipt of unentitled financial benefit;
-intentional infliction of harm to LLC or member; or
-intentional violation of law.
Rights of Dissociated Members
A member who resigns or dissociates is entitled to Fair Value of his/her interest as of the date of dissociation/resignation, LESS applicable valuation discounts, unless the Operating Agreement provides otherwise.
A member is not entitled to Fair Value of his/her interest.
The dissociated member is effected as follows:
-no further participation in management and activities.
-If “member managed,” fiduciary duties cease as to subsequent LLC activity.
-Retains an economic interest in the LLC.
How are the dissociated member’s interests preserved? Through buy-out provisions in the Operating Agreement.
However, the agreement may (and should) address the members’ ability to dissociate.
Liability for Distributions at Time of Insolvency
If a member knew at the time of distribution that the LLC was insolvent, then he/she is liable to the LLC for the amount of the distribution.
Managers were not expressly liable for distributions.
A member receiving a distribution, ‘knowing that the distribution to that person was made in violation of section 35…is personally liable to the limited liability company but only to the extent that the distribution received by the person exceeded the amount that could have been properly paid…”
The manager is liable to LLC relative to a distribution issued during time of insolvency, if he/she consented to the act, and whether or not the manager was aware the company was insolvent.
Remedies for Deadlock and Oppression
An oppressed member had a right to petition the Court for dissolution of the company, so long as it was deemed “not reasonably practicable” to continue the business under its Operating Agreement terms.
This language was vague and caused problems for oppressed members, and provided the Court just one tool to fix the problem: dissolution.
Remedies provided by the NJ Oppressed Minority Shareholders Act were not available to LLC members.
Now, a member may apply for a decree of dissolution on the following grounds:
–MMs acted illegally or fraudulently;
–MMs acting in an oppressive manner, which was, is or will be harmful to the oppressed member.
–Not reasonably practicable to continue the business in conformity with the Operating Agreement or certificate of formation.
The Court now has additional tools to address these grievances other than just dissolution:
–Appoint custodian or provisional manager.
–Order sale of all interests held by any member who is a party in the law suit, so long as the Court finds that this is fair and equitable to the parties.
Profits, Losses and Distributions
If not addressed in the Operating Agreement, profits and losses are allocated and distributed based on agreed value of members’ capital contributions.
Distributions are now shared equally among all members and dissociated members on a per capita basis. Members’ capital contribution values are not a factor.
Therefore, each member is entitled to an equal portion of the profits and losses, regardless of whether the members have different ownership percentages or made different capital contributions.
Remember, dissociated members will continue to hold their economic interest in the company and are entitled to distributions.
Decisions were determined by a vote of members having more than 50% of the interests in the company profits.
”Ordinary-course” decisions in member-managed LLCs are determined by a vote of the majority of members. The percentage of the members’ interests in the company is not a factor.
If the decision is outside the ordinary-course, such as a merger or amendments to the Operating Agreement, then there must be unanimous consent of the members.
Other Points to Consider Regarding the RULLA:
*A statement of authority may be filed setting forth the authority, or limitations on authority, of the LLC’s representatives, such as their ability to transfer land rights, or enter transactions which bind the company. (Consider: Include in a due diligence checklist a search for a filed statement.)
*Operating Agreements need not be in writing to be enforced. There may be an oral or implied agreement enforced by the Court. Of course, if there is no written agreement, then a court will be required to apply any relevant default provisions from the RULLA.
*LLCs are deemed to have perpetual existence.
*RULLA allows for domestication and conversion of entities to LLCs, and visa-versa.
*Information: Each member of a member-managed LLC is entitled to certain information which is material to such member’s rights and obligations.
–However, in a “manager managed” LLC, the members are entitled to information which is “just and reasonable.”
–Affirmative duty on company, members, and manager to provide specified information to the others.
Consider the following default provisions in the RULLA, which may cause the greatest concern to LLC members:
– Voting and distribution of assets and losses; and
– Loyalty and due care.
There will be a potential for conflict where pre-RULLA Operating Agreement provisions fail to address the new default rules, and in instances where members are unable to compromise on new terms.
This article is not intended to be relied upon as advice for your particular circumstances. Therefore, consult with a qualified business attorney about how the RULLA may affect your membership interest in a limited liability company.
© Kilcommons, Shanahan, LLC 2013
Special thanks to Jeffrey M. Shapiro, Esq. and Eileen Overbaugh, Esq., “Big Changes for LLCs – New Jersey Enacts Revised LLC Act,” 2013 Emerging Issues 6936, Matthew Bender & Company, Inc., February 28, 2013.