This post was written by Matthew D’Ascenzo.
The Pennsylvania Uniform Limited Liability Company Act of 2016 (the “Act”) became effective on April 1, 2017. It applies, however, to all Pennsylvania limited liability companies (“companies” and “company”) formed before April 1, 2017. It provides new benefits to companies as well as a number of default rules from which companies may need to opt out of in their limited liability company operating agreements (“operating agreements”).
The Act contains many beneficial provisions, default rules that should be addressed to avoid unanticipated negative consequences, and the ability to modify fiduciary duties. Except where otherwise stated, the default rules under the Act may be altered in an operating agreement.
The Act contains the following provisions beneficial to companies:
- A member is bound by the operating agreement, whether or not the member has signed it.
- The Act embodies the “pick your partner principal,” prohibiting members from transferring governance rights – including voting, consent, and information rights – in a company. This default rule avoids the situation where a spouse, child or estate of a member may become a voting member.
- On the other hand, members freely may transfer their right to receive distributions from the company, which can facilitate a member’s estate planning or other financial goals.
- A judgement creditor of a member may obtain a charging order against a member’s right to receive distributions from the company but cannot obtain a member’s voting or other governance interests. This default rule prevents a creditor in bankruptcy or an ex-spouse from becoming a voting member.
- Upon personal bankruptcy, engagement in criminal activity, death, disability, and dissolution a member loses voting and other governance rights and retains only rights to distributions.
Serious consideration should be given to opting out of the following provisions of the Act:
- The Act requires the unanimous written consent of the members or managers to take actions outside of the company’s ordinary course of business. The operating agreement, however, may provide instead that an action by written consent may be taken by a majority of the members or managers.
- Members have dissenter’s rights in connection with a fundamental transaction under the PA Entity Transaction Act – such as a merger – or upon any amendment of the certificate of organization or operating agreement, and these rights may impede a company’s ability to close fundamental transactions and amend their charter documents.
- A company cannot make a distribution to members unless the total assets of the company exceed its liabilities plus the amount that would be needed to satisfy any preferred member’s preferences if the company was dissolved on the distribution date. The Act, however, allows for the alteration of this prohibition in an operating agreement so that the amount of any preferred distribution upon a deemed liquidation on the date of distribution is disregarded for purposes of determining whether a distribution is allowed.
- Members have broad information and inspection rights that cannot be eliminated, although they can be subject to reasonable restrictions. Operating agreements, however, can contain strong confidentiality provisions preventing members from disclosing confidential information to third parties or using it for purposes unrelated to their investments.
- Any member may voluntarily dissociate from the company at any time. A company can opt out of this provision if it does not want to permit members voluntarily to withdraw.
- Aggrieved members have a direct right to sue another member, manager or the company to enforce the members’ rights and protect the member’s interests under the operating agreement and the Act. An operating agreement cannot eliminate this right but it can place reasonable restrictions on it. An operating agreement, for example, can require that a member give prior written notice of any direct lawsuit against another member, manager or the company and provide an opportunity to cure the noticed action in order to minimize the likelihood of suits.
Unlike the Delaware Limited Liability Company Act, the Act does not permit the elimination of the duties of loyalty and care of members in a member-managed company and managers in a manager-managed company. The Act, however, permits operating agreements to limit fiduciary duties, and a company may want to do so in order to protect its members or managers against breach of fiduciary duty claims.
The duty of loyalty includes the duties:
(1) to account to the company and to hold as trustee for it property, profit or benefit derived by a member or manager:
(i) in the conduct or winding up of the company’s activities and affairs;
(ii) from the use by a member or manager of the company’s property; or
(iii) from the appropriation of a company opportunity;
(2) to refrain from dealing with the company in the conduct or winding up of its activities and affairs as or on behalf of a person having an interest adverse to the company; and
(3) to refrain from competing with the company in the conduct of its activities and affairs.
Of these duties, (1)(iii) and (3) may be eliminated. For example, a private equity sponsor who is a member can provide in the operating agreement that the sponsor may appropriate company opportunities without first presenting them to the company and may compete with the company through its interests in other portfolio companies.
On the other hand, the duties listed at (1)(i), (1)(ii), and (2) cannot be eliminated but they may be subject to reasonable limitations. For example, an operating agreement may stipulate that a transaction shall not violate these duties if it is either (a) approved by a majority of the disinterested members or managers after full disclosure of all material facts by the interested member or manager and/or (b) is on terms no less favorable to the company than terms that could be could be obtained from a third-party on an arm’s-length basis.
The duty of care of a member or manager in the conduct of a company’s business is to refrain from engaging in gross negligence, recklessness, willful misconduct or knowing violation of the law. The company may alter the duty of care if such alteration is not “manifestly unreasonable.” The Act, however, does not provide guidance regarding what constitutes reasonable and unreasonable restrictions on the duty of care, and the reasonableness of such restrictions likely will be resolved by the courts in future litigation. The elimination, however, of the obligation to refrain from gross negligence likely will be found to be reasonable and can be considered for inclusion in operating agreements.