The New Connecticut Uniform Limited Liability Company Act and its Effect on Your Operating Agreement
The Connecticut Uniform Limited Liability Company Act (“CULLCA”) went into effect in Connecticut on July 1, 2017. The new statute replaces Connecticut’s limited liability company act (the “Old LLC Act”) and is based on the Revised Uniform Limited Liability Company Act which has been enacted in eighteen (18) states and proposed in at least two (2) others. CULLCA applies to all limited liability companies in Connecticut but generally respects the terms of existing Operating Agreements, with a few exceptions. These exceptions should prompt LLC members and managers to review their company documents and consult with counsel to ensure the changes will not adversely affect the business going forward.
New Default Provisions
As with the Old LLC Act, the terms of CULLCA primarily serve as “defaults” or “gap fillers” designed to supplement any missing provisions in an LLC’s operating agreement (sometimes referred to as an “LLC agreement”). As in the previous statutory regime, an LLC’s operating agreement can vary these default provisions by simply providing an alternative rule or standard in the operating agreement.
Unanimous Consent Required to Amend the Operating Agreement. Previously, if an LLC’s operating agreement did not provide otherwise, an amendment to the operating agreement had to be approved by two-thirds (2/3) in interest of the members. Under CULLCA, absent a provision to the contrary, any amendments to the operating agreement must be by unanimous consent of the members. It may sometimes be difficult to get unanimous approval, and this provision could give a minority member a great deal of power. LLCs with operating agreements that are silent as to the vote needed for amendment should strongly consider whether the operating agreement should be amended to include a less-than-unanimous amendment approval requirement before a more contentious amendment to the operating agreement surfaces.
Admission of New Members. Under the Old LLC Act, if an LLC’s operating agreement did not provide otherwise, a mere majority in interest of members was required to approve the admission of a new member to the LLC. Under CULLCA, absent a provision to the contrary, admission of a new member must be by unanimous consent of the members. LLCs with operating agreements that do not address the vote needed for approval of new members should strongly consider whether the operating agreement should be amended to allow the admission of a new member with less-than-unanimous approval. Any decision requiring unanimity gives a holder of a minority membership interest the ability to prevent company action.
Transactions Outside the Ordinary Course of Business. The Old LLC Act provided that, the approval of the majority of the managers of a manager-managed LLC or the approval of the majority of the members of a member-managed LLC was “required to decide any matter connected with the business or affairs of the limited liability company,” unless the operating agreement provided otherwise. CULLCA requires a majority of managers in a manager-managed LLC or a majority of members in a member-managed LLC to approve those actions taken “in the ordinary course of the activity of the company.” However, actions that are “outside the ordinary course of the company’s activities and affairs” must be decided by a two-thirds (2/3) majority of the members, regardless of whether the LLC is manager-managed or member-managed. Companies that provide for different approval mechanisms should review their operating agreements to ensure any actions “outside the ordinary course” are clearly included in such approval mechanisms, otherwise they may find themselves subject to the 2/3 vote requirement.
New Prohibited Provisions
In addition to the changed operating agreement default provisions provided in the new act, CULLCA also prohibits the inclusion of fourteen (14) provisions in operating agreements. If your operating agreement includes any provision contrary to these specific items, which are listed in Section 34-243d(c) of Connecticut General Statutes, such provision became ineffective as of July 1, 2017. While most of these fourteen (14) prohibited provisions would not normally be included in an operating agreement, a few deserve mention.
An Operating Agreement Cannot Vary the Applicable Law. A Connecticut LLC must be governed by CULLCA. A Connecticut LLC’s operating agreement cannot subject the company to the laws of another state in an attempt to escape the application of CULLCA.
An Operating Agreement Cannot Eliminate Certain Fiduciary Duties. CULLCA clarifies the extent to which certain fiduciary duties of a manager or member to the LLC or its members may be limited or altered by an operating agreement. Fiduciary duties can be substantially altered or eliminated by the operating agreement unless they are “manifestly unreasonable.” For example, fiduciary duties may be delegated to certain members or managers, within reason. The obligation of good faith and fair dealing may not be eliminated, and neither can liability for gross negligence, recklessness, or knowing violations of the law. CULLCA also provides significant guidance on how courts should interpret whether certain provisions exculpating members or managers are “manifestly unreasonable”. Any Connecticut LLC attempting to vary the members’ or managers’ fiduciary duties, which is particularly common in LLCs formed for the purpose of a joint venture or an investment fund and in LLCs governed by a board of managers, should consult counsel and consider limiting any alterations of fiduciary duties to those within the statutory standard.
An Operating Agreement Cannot Vary the Provisions that Allow for Derivative Actions by Members. Derivative actions have long been recognized in the context of corporations, allowing a shareholder to bring a claim to enforce a right of the corporation itself. CULLCA extends the concept of derivative actions to LLCs. CULLCA prohibits an operating agreement from eliminating a member’s right to bring a derivative action. However, CULLCA provides other options for LLCs to discourage derivative actions. For example, an LLC can require a member to submit a derivative claim to a special litigation committee which can evaluate whether pursuing the action is in the best interests of the company. An operating agreement can also include forum selection clauses, can require mediation or arbitration, can include a universal demand requirement, and can specify liquidated damages. Those LLCs wishing to limit the ability of their members to pursue derivative claims should consult counsel about amending the operating agreement to provide for some or all of the above-mentioned restrictions.
Changes Affecting Members
Changes to the Admission of New Members. CULLCA provides that new members are now automatically deemed to assent to the operating agreement without signing it upon becoming a member, although obtaining a new member’s signature on the operating agreement or joinder to it is still recommended. In the absence of consent from all of the members or adherence to the terms of the operating agreement, a transferee of a member’s interest will only receive a “transferrable” interest (the right to receive distributions as provided in the operating agreement) but will not be a member entitled to vote or participate in the management of the LLC.
Changes Affecting Capital Contributions. A member’s promise to contribute capital to the LLC also does not need to be in writing to be enforceable. However, without a form of writing or other documentation the promise may be difficult to enforce.
Changes Affecting the Ability of Creditors to become Members. CULLCA provides that a judgment creditor of a member of an LLC is not entitled to assume the entire membership interest of a member, but rather is only entitled to a charging order (i.e. a lien) on the debtor member’s interest that requires the LLC to pay the creditor directly any distributions the member would have received with respect to that interest. This prevents the other members from suddenly finding themselves involuntarily in business with a creditor.
Additional Responsibilities of Members. CULLCA imposes a new duty on individual members to furnish certain information about the LLC to other members to the extent such individual member knows of the information. This responsibility may be burdensome for some members, and companies may seek to limit this obligation in their operating agreements to a reasonable extent.
Dangers in Distributions
Distributions include most transfers from the LLC to a member or other person entitled to receive distributions. CULLCA makes it improper for an LLC to make distributions if it would make the LLC insolvent, either by making it unable to pay its debts as they become due or rendering its total assets less than its total liabilities. In addition, a member of a member-managed LLC or a manager of a manager-managed LLC will be personally liable to the LLC if he or she consents to a distribution that renders the LLC insolvent. Even the recipient of the distribution might be personally liable to the LLC if he or she knows that such distribution is in violation of CULLCA. However, the operating agreement may seek to impose the duty for ensuring lawful distributions on one or more specific members, and may specify how a member can determine if a distribution is lawful (i.e. by relying on certain financial statements). It can also require that the LLC not make a distribution unless it will remain solvent thereafter.
Changes in Filing Procedures
Agent. The Secretary of State’s office, perhaps recognizing that lawyers, corporate agents, and office staff, are often the ultimate filers on behalf of LLCs, now allows an authorized agent of the company to effect filings. This should streamline many administrative tasks for LLCs, but means that LLC members and managers should remain vigilant about unauthorized filings.
Annual Report. Annual reports are now due between January 1 and April 30 of each year instead of in the month of the anniversary of the LLCs’ formation. CULLCA also does not require the Secretary of State to send out reminders of the filing deadline. Companies should mark their calendars now for January 2018, to file their first annual report on the new filing schedule.
Mistaken Filings. To the relief of filers everywhere, inaccurate filings can also now be corrected by filing a Statement of Correction with the Secretary of State. Before this filing existed, companies were forced to file amended documents or interim reports to correct an erroneous filing.
CULLCA also makes several changes that do not require existing LLCs to update their operating agreements, but that members and managers should be aware of. First, the Articles of Organization will now be called the “Certificate of Organization.” Second, the LLC no longer must specify in the Certificate of Organization whether it is member-managed or manager-managed—rather, the operating agreement must specify that the LLC is manager-managed or it will be considered member-managed. Finally, the LLC no longer needs to specify its purpose in the Certificate of Organization. Connecticut LLCs that existed before July 1 are not required to amend their certificates of organization to reflect these changes, but those wishing to change the manager-managed designation or references to their purpose in their Certificate of Organization may file an amendment to their Certificate of Organization.
Members and managers of Connecticut LLCs should take this opportunity to review their operating agreements and consult with counsel. Your operating agreement may not require a major overhaul in light of CULLCA, but you may find a way to improve it now that saves hours of headaches later.