Changes in LLC Rules Could Affect Your Business
If you are an owner or manager in a Washington limited liability company ("LLC"), it's time to dust off your LLC agreement (commonly referred to as an operating agreement) for an update. In 2015, the Washington Legislature adopted a new LLC Act to replace the current law, which had not been significantly revised since the 1990s. The new Act went into effect on January 1, 2016.
The new law contains a number of significant changes from the old law, several of which impose new "default" rules that apply absent a differing provision in the operating agreement. Below are some of the key changes in the Act and their potential impact on your business:
Prior to January 1, the default rule was that actions requiring approval of the LLC owners (called "members") must receive the vote or consent of members contributing (or required to contribute) more than 50 percent of the value of all member contributions . In other words, the members that invested the most in the business got more voting power. The new Act changes the default so that each member gets one vote regardless of the percentage interest held or amount invested by the member. For example, in a three-member LLC with two members each holding 10 percent and contributing a small amount of capital, and the third holding 80 percent and contributing most of the capital, each member's vote is now counted equally. This new standard could create unexpected results for many LLCs, whose members may expect voting to align with equity contributions or percentage interest. Members should ensure that their operating agreement properly "overrides" the new rule if desired.
Profit and loss allocations
Under the old law, profit and losses were allocated in proportion to the value of contributions made by each member, absent an agreement otherwise. Under the new Act, no default allocation method is prescribed. In the example above with three members, the owners no longer have assurance under the Act that their taxable profit allocation will be proportionate to their invested capital. Members should update their operating agreements to ensure allocation provisions are drafted in a manner that reflects the intent of the parties.
An operating agreement is the primary document governing the management of an LLC. While members generally have a large degree of flexibility in crafting governance and management provisions, there are a number of statutory terms that cannot be modified. Further, for the first time, the Act now permits oral operating agreements. Business owners should be diligent in drafting an operating agreement. Although oral agreements are permitted under the new law, a written agreement is preferable to create a clear record of the terms. In light of the new law, it is advisable to require that all amendments to an operating agreement be in writing.
The standards of conduct of persons managing Washington LLCs have previously not been defined by statute. However, the new Act prescribes a manager's or managing member's fiduciary duties of loyalty and care. The law allows an operating agreement to expand, modify, restrict or eliminate these fiduciary duties, subject to certain limitations. Notably, the duty of loyalty can be waived. Defining the duty of loyalty may be important, for example, when a managing member will work for several separate but overlapping businesses. Now is a good time to discuss what duties should be owed and to make sure the operating agreement reflects the members' intent.
Under the new Act, boards and committees can manage an LLC, similar to a board of directors of a corporation. Previously, individual persons or entities—but not boards or committees—could be managers. A board may be useful when owners prefer that decisions be made as a group, particularly when there are outside or non-owner managers involved. If an LLC will be managed by a board or committee, fiduciary duties will apply to all individuals comprising the board or committee. If you intend to change the management structure of your LLC, be sure the change is consistent with other governing provisions in the operating agreement.
LLC members have broader record inspection rights under the new Act. Perhaps most significantly, all members now have the right to access LLC accounting records—subject to meeting certain requirements, including a valid purpose. Managers should review the new requirements to ensure that all records are in order, and should consider developing procedures for handling requests.
Traditionally, nonprofit entities have organized as corporations, in part because there was doubt about whether the Act permitted nonprofits to operate as LLCs. However, the new Act specifically allows LLCs to be formed to carry out not-for-profit activities. The LLC structure may be preferable for some nonprofit enterprises. Now is the time to review your LLC documents and update them in light of the new law. If you do not have an operating agreement, now is the time to get one in place to avoid unintended results under the Act.
As published in the Vancouver Business Journal, January 8, 2016.