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This is the third of a three-part series discussing the Utah Revised Limited Liability Company Act passed by the Utah Legislature on February 23, 2001. Part I, which appeared in the
June/July 2001 issue, gave an overview of the Revised Act and described part of the changes made by the Revised Act. Part II appeared in the August/September issue and discussed other
changes made by the Revised Act.
PART III
This is Part III of a three-part series that describes changes in Utah's prior Limited Liability Company Act (the "Old Act") made by the Utah Revised Limited Liability
Company Act - 2001 (the "Revised Act"). The Revised Act became effective on July 1, 2001. In this Part, we discuss transition issues and provide some tips for drafting
LLC governing documents and planning under the Revised Act.
I. Transition Issues
As of July 1, 2001, the Revised Act replaced the Old Act. On that date, the Old Act ceased to apply and all existing Utah LLCs ". . . shall have all the
rights and privileges and shall be subject to all the requirements, restrictions, duties, liabilities and remedies" prescribed in the Revised Act.1
Each foreign LLC authorized to transact business in Utah on July 1, 2001, became subject to the Revised Act on that date but is not required to obtain a new certificate of authority to
transact business in Utah by reason of the Revised Act coming into effect.2
There are several other transition issues that existing LLCs should consider:
1. Importance of File at Division of Corporations.
Each Utah LLC has a file at the Utah Division of Corporations. That file contains the Articles of Organization, any filed
amendments to the Articles, each annual report filed with the Division, and Division correspondence regarding the LLC. Since certain information in such file now gives constructive
notice, per the Revised Act, the file should be reviewed to see if information in it is accurate - i.e., are the managers correctly identified? Are the members (of a member-managed LLC)
correctly identified? Is the LLC in good standing? Is corrective action needed - via amendment to the Articles, or written notice - to bring current the information in the LLC file at the
Division.
If the LLC's file shows former managers or former members as still being "on board", those persons could file a written statement with the Division to indicate their
disassociation from the LLC. Also, an amendment to the Articles of Organization will need to be filed to reflect changes in management.
2. Written Operating Agreement.
Oral operating agreements have no effect. If an LLC has no written operating agreement, that document should be prepared and adopted by the LLC
members - unless the members want to live by all of the default rules under the Revised Act. Or, if the LLC has a "bare bones" form of operating agreement, the members may want
to expand that document to override the statutory default rules under the Revised Act. Thus, even where an LLC has no written operating agreement, it really does have one - in the Revised
Act.
3. Designated Office.
Now, each Utah LLC must identify in its Articles of Organization a "designated office" - which must be a geographical address in Utah. For
existing LLCs, the Articles need not be amended to include that address if that address is indicated on the next annual report (and all subsequent annual reports) the LLC files with the
Division of Corporations.3 The LLC's basic records must be kept at its designated office. The designated office also controls the venue for court actions for several key events under the
Revised Act, such as an action to remove a manager, to compel inspection of LLC records, to compel the Division of Corporations to accept a document for filing, to interpret the LLC's
Articles of Organization or Operation Agreement or to dissolve the LLC.
4. Keep Records at Designated Office.
The Revised Act continues the requirement of the Old Act that specified LLC records be available for inspection and review by LLC members
and managers (and their representatives). The Revised Act requires that such LLC records be kept at the LLC's designated office. Lawyers should counsel their clients to assemble such
records in a file or binder that is kept at the LLC's designated office.
5. Consider Limits on Management Authority.
If the LLC members desire to place any limits on the authority of LLC management in dealing with third parties on behalf of the LLC,
the Articles of Organization should be amended to include those express limits. In doing so, no "incorporation by reference" or cross-reference to other documents is permitted.
Instead, any limits on authority must be expressly stated in the Articles. Corresponding provisions could also be added to the LLC's operating agreement, if desired.
If an LLC's existing operating agreement includes limits on authority of members or managers, such provisions now need to be shifted to the LLC's Articles of Organization if notice to
third parties is desired.
6. Fiduciary Duties of Management.
The fiduciary duties imposed on LLC management by the Revised Act are minimum standards - not maximum standards. Thus, if the members of an
LLC desire to have higher duties placed on LLC management, those higher duties should be included in a written document signed by the LLC managers.
7. Clarify Scope of "Business".
LLC managers have apparent authority to bind the LLC in transactions with third parties based on the scope of the LLC's business as
described in the Articles of Organization. Therefore, consideration should be given to clarifying or restricting the definition of the LLC's "business" as stated in the Articles
of Organization. Any such clarification or restriction will require an amendment to the Articles of Organization.
8. Lapsed Voting Rights of Assignees.
Where an LLC member assigns his/her LLC interest to a person who is not admitted as a member of the LLC - thus becoming a mere
"assignee", the voting rights pertaining to such LLC interest lapse. This situation could alter the power structure in an LLC. Consideration should be given as to how such
lapsed voting rights are to be treated - are they to be ignored, or are they to be re-allocated among the remaining members or is the voting structure to be altered in some other way as a
result of such lapse?
9. Standard for Valuing LLC Interests.
The Revised Act now provides a statutory default standard for valuation of an LLC interest. In response, consideration should be given to
whether such standard should be adopted for the LLC (by default) or whether such standard should be overridden by an alternative valuation standard or formula in the LLC's operating
agreement, buy-sell agreement or other applicable document.
10. Professional LLCs.
There are several changes which apply to professional service LLCs under the Revised Act. First, the name must include a "P", thereby being
a "PLLC". Second, a Utah PLLC cannot practice multiple professions or become a "multi-disciplinary practice". That issue is left for other legislation or rule-making.
Third, the Revised Act borrows the buy-out provisions from the Utah Professional Corporation Act (which deals with the death, incapacity or disqualification of a professional LLC member)
and allows the estate of a deceased LLC member to force the LLC to purchase the interest if such interest is not purchased within 90 days - unless other buy-out provisions are contained
in the LLC's governing documents or in a separate agreement.
11. Review LLC's Accounting Methods.
The Revised Act imposes the new "capital account" standard for allocating profits and losses, distributions and voting.
However, since that standard is merely a default rule, an LLC's governing documents may use any other standard, including the "contributions" measuring standard under the Old
Act. Thus, if an existing LLC has an operating agreement that does not refer to the "contributions" measuring standard, and is silent as to any other standard, then the new
"capital account" standard began to apply on July 1, 2001. To deal with these and other accounting-type issues, which are critical to any LLC, the operating agreement needs to
be amended to reflect the intentions of the LLC members.
12. Breaking Deadlocks.
If a management deadlock exists in an LLC, the Revised Act contains a procedure for breaking the deadlock. This could be especially beneficial for
LLCs that are owned 50/50 by two members who cannot agree on basic issues affecting the LLC or its property. The ultimate remedy for deadlock is the dissolution and winding up of the LLC,
which would either require a sale of LLC assets (and distribution of the proceeds) or distribution of the LLC assets in kind, after satisfaction of LLC liabilities.
13. Changes in Management.
A change in those who manage an LLC - either the managers in a manager-managed LLC or the members in a member-managed LLC - is a critical
structural event. Since the identity of those managing an LLC is reflected in the LLC's file at the Division of Corporations, any change in management must be reflected in an amendment to
the Articles of Organization. A mere notation on the annual report for the LLC is insufficient to make a change in LLC management, since annual reports are merely informational filings.
Also, where an LLC is manager-managed and has only one manager, the death, withdrawal or removal of the sole remaining manager (or if the sole manager transfers or assigns his entire
interest in the LLC or is expelled as a member or files bankruptcy), the management structure of the LLC changes from being a manager-managed LLC to a member-managed LLC, unless another
manager is appointed by the members within 90 days after such event. Thus, provisions for succession of managers within a manager-managed LLC become critical since an abrupt shift in
structure to a member-managed LLC could possibly give each member in the LLC power to bind the LLC in transactions with third parties, similar to the authority the LLC manager had enjoyed.
Accordingly, consideration should be given to adding a "back-up manager" for an LLC that has only one manager to cover such events affecting the sole manager.
14. Remove Unwanted Managers.
There may be existing LLCs where the members desire to have a new manager but, under the Old Act, did not have a clear procedure for how to
change the manager. The Revised Act contains a default rule that allows the members holding a majority of profits interests to remove a manager without cause - unless the LLC governing
documents require some other procedure for removal. Accordingly, the LLC members can now remove an unwanted manager subject, of course, to any contractual rights which the manager may
have.
15. Expel Unwanted Members.
There may be some existing LLCs that have a member who is unwanted by the other members. Although the standards for expelling a member are quite
high, consideration might be given to using those procedures in order to re-align the membership of an LLC and rid it of unwanted members.
16. Convert Partnerships to LLCs.
Since the Revised Act allows for a seamless conversion of limited partnerships and general partnerships to LLC form, consideration should
be given to converting those entities to LLCs in order to obtain limited liability for all owners of the enterprise - at least as to future liabilities.
17. Use of Organizer to Form LLC.
The Revised Act now allows an organizer who is not a member or a manager to organize an LLC. This will be convenient for lawyers and
others organizing LLCs on behalf of clients. However, a caution is needed here. Lawyers should still require clients to review the governing documents and obtain the client's signature
approving the governing documents before filing to ensure that the clients understand and have consented to provisions in such documents. Otherwise, misunderstandings could later arise
where the lawyer, in good faith, prepared Articles of Organization and included some provisions which the clients later contend were not approved. This could arise, especially, with
provisions relating to limitations on authority of LLC managers.
18. Attraction of LLCs for Estate Planning Purposes.
Under the Revised Act, there are several default rules which make the LLC attractive for estate planning purposes.
First, a member cannot withdraw from an LLC until the end of the term of the LLC or until dissolution and winding-up of the LLC. Second, the default valuation standard is the
"willing buyer, willing seller" standard, taking into account all applicable discounts. Third, an assignee of an LLC interest has no voting rights. Fourth, an LLC member can
obtain payment in redemption of the LLC interest (a return of capital, so to speak) only upon dissolution and completion of winding-up of the LLC. As with other default rules, these can
all be overridden by more liberal provisions put into the LLC operating agreement.
II.Drafting Considerations
1. Hierarchy.
There is now a statutory hierarchy of documents pertaining to LLCs with the highest power given to the Revised Act, then to the Articles of Organization and then
to the operating agreement, in that order. For any conflict between the Articles of Organization and the Revised Act, the provisions of the Revised Act will prevail - unless the
provisions of the Revised Act are merely default provisions. And, if there is any conflict between the Articles of Organization and operating agreement, the provisions of the Articles of
Organization prevail.
2. Statutory Default Rules Apply.
Where an LLC's own governing documents - the Articles of Organization and the operating agreement - are silent as to a particular issue and
there is a statutory default rule on point, the statutory default rule will apply. Due to the large number of statutory default rules that now apply to LLCs, it behooves all lawyers who
draft LLC documents to familiarize themselves with the default rules to determine if the default rules should be retained or overridden.
3. Bring Articles of Organization into Compliance.
To bring an existing LLC's Articles of Organization into compliance with the Revised Act, the following concepts should be
considered:
1) make all conforming changes effective as of July 1, 2001;
2) restrict the scope of the LLC's business to the actual activities planned for the LLC - not just to "any lawful
purpose" - in order to limit the apparent authority of LLC managers and members to bind the LLC;
3) include the address of the designated office for the LLC; and
4) insert limits on the authority of managers to bind the LLC, and particularize those limits.
4. Bring Operating Agreement into Compliance.
If an existing LLC already has a written operating agreement, consider reviewing and comparing that operating agreement to the
non-waivable provisions of the Revised Act 4 to determine whether the operating agreement should override the default rules under the Revised Act.
5. Move Provisions From Operating Agreement to Articles of Organization.
The Revised Act allows certain provisions in an LLC's Article of Organization to give constructive
notice - provisions required to be included in the Articles of Organization as well as provisions relating to limitations on authority of managers and limitations on the scope of business
of the LLC. Under the Old Act, limitations on manager authority were typically included in the operating agreement. Now, those limiting provisions should be shifted to the Articles of
Organization if they are to have effect on third parties. Merely leaving such provisions in the operating agreement alone will not provide the protection allowed under the Revised Act.
6. Determine Who Can Amend LLC Documents.
The Revised Act includes default rules for amending the LLC's governing documents, i.e., the Articles of Organization and operating
agreement can be amended only with the consent of all members or, in some cases, with consent of the members holding 2/3 of the profits interests in the LLC. Consideration should be given
as to who should hold the power to amend the LLC's governing documents and whether the consent requirements should change based on the importance of the issues subject to amendment. For
example, if the governing documents provide that members holding 2/3 interests in profits may amend the Articles of Organization or the operating agreement, would it be permissible for
such members to add, for the first time, provisions allowing for assessment of all LLC members for additional capital contributions?
7. Separate Management Agreement.
For an LLC that is manager-managed, provisions spelling out the duties and responsibilities of the manager could be contained either in the LLC
operating agreement or in a separate management agreement. If the LLC members expect the LLC manager to be bound by the provisions of the operating agreement, the manager should sign the
operating agreement, since it will be difficult to enforce provisions against an LLC manager where the manager has never consented in writing to be bound by such provisions. One caution
here might be relevant: if a separate management agreement is used and the corresponding provisions are not included in the LLC's operating agreement, then, if the LLC ever shifts from
being a manager-managed LLC to a member-managed LLC, the management agreement would probably cease to apply and there would be no corresponding provisions in the operating agreement.
8. Expanded Indemnification.
With the Revised Act allowing for expanded indemnification for an LLC, it may be advisable to draft more detailed indemnification provisions to
cover issues such as who is covered by indemnification, whether indemnification is mandatory or permissive, which actions are covered by indemnification and whether the indemnified party
is entitled to select legal counsel in defending (or pursuing) a claim subject to indemnification.
9. Need to Override Capital Account Default Rule.
There could be numerous situations where the default rules for capital accounts would not be advisable. One of those would be a
3-member LLC where one LLC member puts up services, another LLC member puts up land and another LLC member puts up cash as their contributions to the LLC. Under the capital account
concept, the service member would have a zero capital account, initially, while the other two would have capital accounts based on the value of what was contributed. Under the default
rules in that scenario, the service member would have no share of profits or losses and would not share in distributions or voting. Over time, as the profits from the enterprise are
retained in the LLC and not distributed, the service member could gradually build up a capital account balance. If there is no modification of the default rule of capital accounts as the
standard for allocation of profits, losses, distributions and voting, the service member would be totally left out - at least in the early years of the LLC's activities.
10. Action Without a Meeting.
The Revised Act borrows a concept from the Utah Revised Business Corporation Act regarding actions by members without a meeting. Under that
default rule, if less than all of the members (the number sufficient to meet the minimum percentage that would be necessary to authorize the action) consent to an action to be taken,
notice must be sent to the other members who did not consent at least five days before consummation of the transaction. In some situations, members may not want to have the five day
notice and wait period apply. Provisions to address such desires should be added to the LLC operating agreement.
III. Conclusion
The Utah Revised LLC Act recodifies and substantially expands the prior Utah LLC law. In doing so, it relies on the contract model to enable the drafter to adapt provisions to liking of
the LLC members. Although there are still non-waivable provisions which apply, considerable latitude is given to the drafter.
All Utah lawyers dealing with limited liability companies should become familiar with the provisions of the Utah Revised LLC Act.
Footnotes
1. Utah Code ¤ 48-2c-1902(2)
2. Utah Code ¤ 48-2c-1902(3)
3. Utah Code ¤ 48-2c-1902(1)(b)
4. Utah Code ¤ 48-2c-120(1)
©2001 Brent R. Armstrong
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