Washington’s new Limited Liability Company Act will become effective beginning January 1, 2016. The New Act includes significant modifications to the existing Limited Liability Company Act, and will have significant implications for LLCs formed after January 1, 2016, as well as existing LLCs.
LLC Agreement Can Be Oral
Under the current Act, an LLC agreement must be in writing. Additionally, the current Act prescribes certain default rules that apply to all LLCs where an LLC agreement is silent as to certain aspects. Thus prior to January 1, 2016, Washington LLC agreements were governed by the written agreement itself, as well as any default rules that were applicable. The LLC agreement and the default rules applicable could only be modified by written agreement of the members.
The new Act permits oral or implied agreements and amendments. As such, in addition to the LLC agreement itself, the default rules set forth in the Act can also be modified by oral or written agreement of the members.
What Terms are Applicable?
As a result of the New Act and possible oral modifications to an LLC agreement, LLC members may be unclear as to what terms control the LLC. Additionally, the ability of a member to claim that a modification occurred without written proof increases the risk of expensive and protracted litigation. If you are concerned that your LLC agreement may be unintentionally modified or amended, please call us so that we may help protect you and your interests against the risk of unintended results. These risks can be reduced with a properly drafted LLC Member or Operating Agreement.
Non-Waivable Default Rules
The current Act provides certain default rules or “gap filers” to be utilized in the event an LLC’s agreement is silent on a specific relationship between the members or if the LLC does not have an agreement. Certain default rules could be modified by agreement of the members, while others were nonwaivable. However, there is no single provision of the current Act which outlines the nonwaivable rules. The new Act collects and lists the nonwaivable default rules in a single provision.
Indication of Member-Managed or Manger-Managed Status
Currently, the Certificate of Formation of an LLC must indicate whether an LLC will be managed by its members or by a manager. The new Act eliminates this requirement. As such, an LLC’s agreement must indicate whether it will be managed by its members or by one or more managers.
Currently, any member of a member-managed LLC has the statutorily based apparent authority to bind the LLC in the ordinary course of the LLC’s business, provided the party with whom the member is dealing does not have actual knowledge that the member lacks authority. As such, so long as a third party does not have actual knowledge that a member lacks the authority to bind the LLC, the third party may enforce an agreement signed by a member against the LLC.
The new Act deletes the statutorily based apparent authority of the members in a member-managed LLC. As such, third parties dealing with an LLC can no longer rely on the statutory apparent authority of the member to bind the LLC. Contracts with members of a limited liability company can be drafted to include language limiting this risk.
An LLC May Be Managed By A Board
Pursuant to the new Act, an LLC may be managed by a board, and not just a number of managers. If the LLC is managed by managers, then each manager any be considered an agent of the LLC and could act on behalf of the LLC. With a board, the individual directors are not considered agents, but rather, the board as a whole is the agent of the LLC.
Fiduciary Duties of Managers or Managing Members
The current Act does not explicitly provide standards for a manager’s or managing member’s fiduciary duties to the LLC. Courts in the State of Washington have recognized the duties owed by a manager or managing member are similar to those owed between partners in a general partnership.
The new Act sets forth the fiduciary duties owed by a manager or managing member to the LLC, including the manager or member’s duties of loyalty and care. The new Act further provides that the LLC agreement may modify, expand, restrict or eliminate certain duties. These duties will apply to LLCs formed after January 1, 2016, as well as existing LLCs.
For any action requiring member approval, the default rule set forth in the current Act requires the vote or consent of the members contributing, or required to contribute, more than 50% of the agreed value of contributions made or required to be made by all the members. The new Act modifies the default member voting to provide that voting is to be done on a per capita basis with one vote per member.
This is a drastic modification and goes against what many investors expect. Traditionally, an investor will require that his or her voting power be equal to the investor’s ownership interest in the LLC. LLC agreements need to make the voting system for the LLC clear and in conformance with the agreement of the members.
Access to LLC Records and Information
The current Act provides that members shall have the right to inspect certain records and information of the LLC. The new Act expands on this right and includes additional records and information that a member has the right to inspect.
Following written request from a member, the LLC has a limited time to provide the records and information to the member. We encourage you to consult with consul to ensure that your LLC has the correct procedures in place to ensure that your LLC is maintaining adequate records, and that it can timely handle a member’s request to inspect records.
Profits and Losses
The new Act provides that the distribution of profits and losses will be allocated to the members in proportion to the agreed value of each member’s contributions of the member, however, the new Act eliminates the default rules regarding allocation of profits and losses. The new Act recognizes that allocation of distributions in an LLC will depend on tax and regulatory requirements.
In addition to the prohibition against distributions to members while an LLC is insolvent (and the liability imposed upon members who knowingly receive such a distribution), under the new Act, a manager or managing member can be personally liable for effectuating an improper distribution.
These are just a few of the significant changes that will be made to the Washington Limited Liability Company Act. If you have any concerns regarding the effect of the Act on your existing LLC or if you will be forming a LLC after January 1, 2016, we would welcome the opportunity to speak with you about your LLC.