How Could Due Diligence Be Affected By New LLC Act?

Note: All articles on Utah’s New LLC Act are in the process of being updated to conform to the changes made before it was enacted in 2014. Please check back to see the revised articles.

In any transaction that involves an LLC on one side (or both sides) due diligence is a must. Due diligence is needed whether it be buying, leasing, exchanging or selling property, negotiating a loan, a merger, a business sale, division or separation, or any other critical business transaction.

Due diligence is essential to protecting a client’s interests and for issuing legal opinions on transactions.

In the due diligence process that involves an LLC, assurances are needed in several key areas, such as:

  • Was LLC properly formed?
  • Under which state’s statute was LLC formed?
  • Is LLC in good standing?
  • Is LLC authorized to do business in Utah?
  • Has complete copy of LLC’s governing documents, including all amendments, been furnished and reviewed?
  • Is proposed transaction within the scope of LLC’s business purpose?
  • Has person(s) with authority to bind LLC to the transaction been identified?
  • Are there any limits on such authority and, if so, do those limits affect the proposed transaction?
  • Is approval of the managers or members required?
  • Is approval of any third party required?
  • Have all such approvals been obtained?

Under the Existing LLC Act, the person(s) holding management authority over an LLC, and all limits on such authority, must be identified in the articles of organization. When the holder of that authority changes, the articles of organization must be amended to reflect that change.

Easy Access Over Internet

The public file at the Division for each Utah LLC — including images of the articles of organization, amendments thereto and other filed documents — can be accessed over the Internet. Accordingly, under the Existing LLC Act, anyone using a device connected to the Internet (computer, smart phone, etc.) can verify, 24/7, from almost anywhere in the world, who holds management authority for a specific Utah LLC, and any limits on that authority.

Further, per §48-2c-121, such disclosure in the filed articles of organization constitutes constructive notice to third parties of that information. Thus, a verifier need check only the filed documents in most cases.

Currently, it usually takes less than 1 minute to access, via the Internet, the database at the Division and view the data on any Utah LLC that has filed Articles of Organization. It takes only about 2 additional minutes (and $2.00 per document) to enter credit card data and download a full PDF image of those documents. [See the bank clerk scenario in “NCCUSL’s Struggle With ‘Apparent Authority’“]

Access to Limited Data on LLC Formed Under New LLC Act

How might a similar inquiry work under the New LLC Act?

Assume that Internet access to the database at the Division continues to be available as it is now. But what information might be included in that database for an LLC formed under the New LLC Act? Start with the LLC’s charter document — the ‘Certificate of Organization’. What can be learned from that document?

Not much. Only 2 items are required to be disclosed in the Certificate of Organization: (1) the name of the LLC, and (2) the name and address of the registered agent for the LLC.

Although the New LLC Act allows other information to be included in a filed Certificate of Organization [see §48-3-201(3)(a)], the New LLC Act goes on to state:

However, a statement in a certificate of organization is not effective as a statement of authority.

Supposedly, this means such ‘other information’ cannot be relied on.

Yet the New LLC Act also contains what could be viewed as a saving provision [§48-3-103(4)(c)] that enables other documents to be filed and give constructive notice to third parties:

 (4) A person who is not a member is deemed:

. . .
(c) for a filing not described in Subsection (b) [dissolution, termination, merger, etc.] to have constructive notice of an action taken by a filing that is filed with the division.

Perhaps this provision gives the verifier all he/she needs. [RULLCA has no such provision.]

But what does this provision mean? It seems ambiguous. Does it mean that third parties have constructive notice of the contents of a document filed with the Division? Or, do they have constructive notice only that the document was filed but no notice of the contents of the document? Or, do third parties have constructive notice of some future action to be taken after the filing and that is described in the document filed?

Can the verifier reasonably rely on all documents filed at the Division under this provision? Perhaps that provision could be re-written to say:

(4) A person who is not a member is deemed:

. . .
(c) for a filing not described in Subsection (b), to have constructive notice of all information contained in any record filed with the division.

Or, to say:

(4) A person who is not a member is deemed:

. . .
(c) for a filing not described in Subsection (b), to have constructive notice of all information contained in, and any action taken that is described in, any record filed with the division.

Statement of Authority

Despite its attempt to disavow statutory apparent authority [see “NCCUSL’s Struggle With ‘Apparent Authority’“], the New LLC Act expressly adopts that concept by allowingan LLC to prepare and file a “statement of authority”.  What is a statement of authority? It is a separate document that is prepared, signed and filed by an LLC with the Division to declare which ‘positions’ in the LLC have authority to bind the LLC and to identify which persons hold those positions or otherwise have authority to bind the LLC, and if applicable, to describe the limits on any such authority. [§48-3-302(1)]  Of course, if the LLC had filed a statement of authority that was carefully prepared, the persons who have authority to bind the LLC, and any limits on such authority, should be delineated in that document. Yet, for real estate transactions, the New LLC Act requires that such document not only be filed with the Division, but a certified copy thereof must be recorded in the office of the county recorder where the affected property is located, in order to give constructive notice of its contents as to a real estate transaction. Merely filing it with the Division is not enough!

But what about other information critical to conducting due diligence inquiries on an LLC? Will that information always be readily available over the Internet, information such as:

business or purpose of the LLC? No
identity of all LLC managers (for manager-managed LLC)? No
identity of all LLC members (for member-managed LLC)? No
identity of the LLC’s management structure — manager-managed/member-managed? No
address of the LLC’s principal office? No–until the LLC’s first annual report is filed
 limits on authority of those who manage the LLC? No–unless a 2nd document–Statement of Authority–is filed

Where must the verifier go to identify the manager and members and any limits on their authority? Answer: the LLC’s operating agreement or a filed and effective statement of authority. The inquiry becomes far more difficult, however, where some or all of the LLC’s operating agreement is oral or implied. [See section on “Oral and Implied Operating Agreements Allowed“]

If No Statement of Authority Filed

But what if there is no filed and effective statement of authority? Or what if a statement of authority is filed but is deficient in scope, clarity, text or in some other way? Where does one find the operating agreement for an LLC formed under the New LLC Act? It will not be on public file anywhere. Does one ask the IRS? How about the registered agent? No way! Since the operating agreement is a private document, it is doubtful the registered agent would release a copy to a stranger even if it had a copy (which is unlikely)!

This could get worse. The New LLC Act allows LLC operating agreements to be wholly or partly oral or implied! There is no writing requirement!

How does someone access, examine, or determine the contents of an oral or implied operating agreement? Do you need to review all emails and text messages to or from the LLC’s managers and members over the prior 2 years? Whom must you interview? Where do you find all relevant evidence of an oral or implied operating agreement? Whom do you ask? The LLC’s manager or members? But how do you find out for certain who is a manager and who are the members?

Even if you contact someone knowledgeable about a particular LLC formed under the New LLC Act, must they disclose anything to a stranger? Will they be willing and able to describe clearly and reliably the authority and all limits on authority of the LLC’s manager? How could you verify those limits for sure?

There’s more. Not only may a new Utah LLC have an oral operating agreement, that agreement could be oral, implied, or part written, part oral, part implied (from the actions or inactions of the LLC’s members or their prior course of dealing) and the written part could be in multiple documents, bits of paper, records, emails and text messages–all private. With that breadth, how could such an operating agreement be subject to any examination and how could the verifier ever attain confidence in the outer limits of what constitutes the operating agreement?

If the verifier were so lucky as to be able to ascertain all components of the LLC’s operating agreement, how could the verifier be sure, even then, that the oral or implied parts could be enforced in a court of law? Would the Statute of Frauds be an obstacle to enforcement? How about the best evidence rule?

Conclusion: organizational due diligence under the New LLC Act will be much more difficult and result in less certainty than under the Existing LLC Act.