The Washington State Legislature adopted a newly-revised version of the Washington Limited Liability Company Act this year (the “New Act”). The New Act is effective January 1, 2016.
The New Act
The New Act is a result of the efforts of the Partnership and LLC Law Committee of the Washington State Bar Association in consultation with the office of Washington’s Secretary of State. The major changes are as follows:
- Oral Agreements. LLC operating agreements can now be “oral, implied, in a record, or in any combination” thereof instead of only in writing. This new provision allows less formal arrangements to override the New Act’s default rules. This is helpful in the event a company has started its operations with some understanding between its owners, but without adopting a formal written operating agreement. Obviously, adopting a written agreement prior to beginning operations is still the gold standard for LLCs as it provides both clarity and stability at that outset. The process of drafting and reviewing a written LLC operating agreement forces the prospective members to consider all of the important aspects of their legal relationship to each other and the business.
- Member Managed. Members are no longer required to indicate on the LLC’s certificate of formation whether the LLC is member managed or manager managed. The new default rule is that LLCs are member managed. Thus, if members want their LLC to be manager managed, they need to say so in their operating agreement.
- Agency Rules. The old act provided that when the certificate of formation indicated that an LLC was member managed, a third party doing business with the LLC could rely on a member as having apparent authority to act for the LLC in the ordinary course of the LLC’s business. Now that the certificate of formation no longer indicates whether LLCs are member or manager managed, third parties dealing with LLCs will have to rely on agency rules for actual and apparent authority to determine whether a member may act on behalf of the LLC.
- Board of Directors. The New Act allows a manager to be “a person, or a board, committee or other group of persons.” Under the old version of the act the definition of manager excluded groups. Thus, LLCs may now have a board of directors that as a group will constitute a single “manager.” In other words, no single member of the board will have the authority, by virtue of his/her membership on the board, to act on behalf of the LLC. As with corporations, each individual member of an LLC’s board will have fiduciary duties to the LLC and its members.
- Fiduciary Duties. In response to Washington case law recognizing that LLC managers have fiduciary duties like those of partners in a partnership, the New Act has a new section that describes a manager or managing-member’s duties of loyalty and care. It also delineates how much an operating agreement may expand, restrict, eliminate or otherwise modify these fiduciary duties.
- Voting. The New Act’s default rule is that member voting is done on a per capita basis. In other words, if there are 5 members total and 3 vote in favor of a company resolution, then the resolution will pass. The default version under the old version of the act required the consent of members contributing, or required to contribute, more than 50% of the agreed value of contributions made, or required to be made, by all members to the LLC. This is a big deal. It means that even if one member controls 90% of the LLC’s equity, the other four can outvote that member if the default rules apply. If the members of an LLC want a different outcome, they should be sure their operating agreement provides as much.
- Records and Information. The New Act gives members an expanded right to inspect an LLC’s records, including accounting records. This new right is modeled after the two-tiered approach found in Washington’s Business Corporation Act.
- Allocations of Profits and Losses. The New Act provides a new default rule that requires distributions to be made based on the agreed value of contributions, but is silent as to how profits and losses should be allocated. The old version of the act required profits and losses to be allocated to the members in proportion to the agreed value of their contributions. The drafters of the New Act recognized that how LLCs choose to allocate profits and losses will depend on the applicable accounting, tax and other regulatory requirements.
- Liability for Improper Distributions. The old version of the act made it clear that a member who receives a distribution from an insolvent LLC will be liable to the LLC for the amount of the distribution. The New Act adds that a manager or member (in a member-managed LLC) will also be personally liable for the amount of the distribution if he/she/it consents to it when it violates the LLC agreement or the solvency requirement.
- Mergers and Personal Liability. The New Act provides that if a member of a merging LLC will have personal liability with respect to the surviving entity, then the member must sign a separate consent in order to become subject to such liability. If the consent is not signed, the merger will not be approved.
There are other minor or more technical changes that are not listed above. We would encourage members of LLCs to carefully review their operating agreements to ensure that the adoption of the New Act does not result in any unwelcome surprises.