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.
Utah’s New ‘Uniform’ LLC Act is touted to be a complete replacement of the existing Utah LLC statute. It is a replacement — but, several repealed provisions of the Existing LLC Act were not replaced. [See “What is Utah’s New ‘Uniform’ LLC Act?”] The New LLC Act makes major changes to existing LLC law in Utah, starting generally as of July 1, 2012. [See “When Does New LLC Act Take Effect?”]
The following discussion highlights some, but not all, changes to the Existing LLC Act imposed by SB 131 and the New LLC Act.
- Deadlock Remedies Deleted
- Per Capita Rule Adopted for Voting and Distributions
- New Hierarchy of Governing Documents
- Oral and Implied Operating Agreements Allowed
- No Disclosures Required in Certificate of Organization
- No Business Purpose Required
- No Disclosure of Management Structure
- Separate ‘Statement of Authority’ Document May/Must Be Filed to Declare/Limit Authority
- New Flexibility in Fiduciary Duties
- Indemnification Protocols Deleted
- Early Member Withdrawal Allowed
- Duty to Return Mistaken Distributions Deleted
- No Capital Accounts
- No Definition of Profits and Losses
- No Disclosures in Annual Report
- New Limits on Foreclosure of Charging Order Lien
- Fair Market Value Definition Deleted
- New Cause of Action for Errors in Filed Documents
- Foreign LLCs Owning Property in Utah
- Member Needs No ‘Skin in the Game’
- Direct Action by Members
- Non-Waivable Provisions
- Transferable Interests
- Member — Power to Bind?
- No Default Guidelines for Member Meetings
- Perpetual Duration of LLC
- Derivative Action Changes
- Member-Creditor Parity With Other Creditors
- Non-Specified Records Subject to Inspection
The New LLC Act fails to replace critical statutory remedies for members that were repealed by SB 131. The Existing LLC Act [§48-2c-1210(2)] lists 5 separate grounds that enable a member to seek judicial dissolution of an LLC:
(a) the managers are deadlocked in management of [LLC] affairs and the members are unable to break the deadlock, irreparable injury to the [LLC] is threatened or being suffered, or the business and affairs of the [LLC] can no longer be conducted to the advantage of the members generally, because of the deadlock; or
(b) the managers or those in control of the [LLC] have acted, are acting, or will act in a manner that is illegal, oppressive, or fraudulent; or
(c) the members are deadlocked in voting power and the deadlock has continued for a period of at least six months; or
(d) the [LLC] assets are being misapplied or wasted; or
(e) it is not reasonably practical to carry on the business of the [LLC] in conformity with its articles of organization and operating agreement.
None of these remedies can be ‘varied’ by the LLC’s governing documents. [§48-2c-120(1)(g)]
Judicial dissolution is the ultimate remedy for a deadlock or for an LLC member who is oppressed or disadvantaged and cannot withdraw early to receive the value of his/her LLC interest. [See 11. Early Member Withdrawal Allowed] Why? Because dissolution requires a winding up. What is winding up? The Existing LLC Act defines winding up:
The winding up of a dissolved [LLC] is the process consisting of collecting all amounts owed to the [LLC], selling or otherwise disposing of the [LLC’s] assets and property, paying or discharging the taxes, debts and liabilities of the [LLC] or making provision for their payment or discharge, and distributing all remaining [LLC] assets and property among the members of the [LLC] according to their interests. [§48-2c-1301]
Dissolution and winding up results in eventual distribution to all members of their respective shares of the LLC’s net assets. The New LLC Act requires all distributions during winding up to be in cash. [§48-3-709(4)] Thus, if an LLC member is not receiving distributions to which he/she is entitled and cannot withdraw early to receive the value of his/her LLC interest [See 11. Early Member Withdrawal Allowed], a forced dissolution will cause the LLC’s assets to be liquidated, LLC debts to be paid, and the cash ‘surplus’ to be distributed to its members.
But, the only judicial dissolution remedies included in the New LLC Act are those similar to paragraphs (b) and (e) above, neither of which deals with deadlocks. The two existing ‘deadlock’ remedies for LLC members [paragraphs (a) and (c) above] were repealed by SB 131 and not replaced by the New LLC Act. Also not replaced is the remedy for misapplication or wasting of LLC assets [paragraph (d) above].
Such member remedies in the Existing LLC Act (listed in paragraphs (a) through (e) above) have been part of Utah law for over 10 years and were adapted from parallel provisions in Utah’s corporate statute–§16-10a-1430–which is based on the Model Business Corporation Act that has been adopted in 24 states including Utah.
Owner remedies for deadlock in management or control of a business entity are critical to protecting the economic interests of the owners. That is as true for LLCs as it is for corporations. Yet, neither the New LLC Act nor RULLCA on which it is based includes member remedies for deadlocks. That is a major omission.
The New LLC Act departs from RULLCA and does include [§48-3-702] the ‘boomerang’ buy-out provisions of the Existing LLC Act [§48-2c-1214] — provisions that are also found in Utah’s corporate law [§16-10a-1434]. All of those provisions are accurately captioned “Election to Purchase In Lieu Of Dissolution” and are tied directly to the provisions that spell out grounds for judicial dissolution, which should include deadlock. Yet, because the New LLC Act ties that buyout remedy to only one subparagraph dealing with judicial dissolution [§48-3-701(5)] — a provision that does not mention deadlock — and the New LLC Act otherwise fails to include any deadlock remedy, the ‘boomerang’ buy-out remedy may not be available to LLC members in a deadlock situation. The reason for this oversight and the related discontinuity between comparable LLC and corporate remedies is difficult to fathom.
Could there be another way to solve this oversight? Could an LLC include the two deadlock remedies in its operating agreement and, thereby, enable a court to dissolve the LLC in those situations? You would think so.
But there is another hurdle in the New LLC Act. One of its “nonwaivable” provisions states that an LLC’s operating agreement:
. . . may not:
. . .
(g) vary the power of a court to decree dissolution in the circumstances specified in Subsections 48-3-701(4) and (5);
At first glance, it seems the power of a court to decree dissolution cannot be changed in any way by the operating agreement. Yet, the underlying purpose of this “do not vary” clause is to prevent any attempt to diminish the power of a court to decree dissolution. What about adding to the power of a court to decree dissolution? Shouldn’t that be permitted? Could that be accomplished by a provision in the LLC’s operating agreement?
But, could the word “vary” in this context be construed to mean increase or decrease? If so, the New LLC Act creates a major dilemma for the LLC advisor — i.e., this defect in the New LLC Act may be of such a magnitude, as applied to a particular proposed LLC (such as an LLC that is to have 2 members with 50/50 ownership where future deadlock is a real possibility), as to cause the LLC’s advisors to suggest using a ‘friendlier’ LLC statute of another state besides Utah to form the LLC!
a. Voting. The word ‘voting’ is not found in the New LLC Act. There’s a reason — the default rule for member decisions under the New LLC Act is by a “majority of the members” — a per capita rule. [§48-3-407(2)(c), §48-3-407(3)(e)] With a per capita rule, there is no need to calculate percentage interests in profits or capital for voting purposes. But if the per capita default rule is not desired, the LLC’s operating agreement must provide a different rule. See §48-3-110(2)
A similar “majority of managers” rule applies to decisions of multiple managers. [§48-3-407(3)] That rule is a change from the Existing LLC Act’s default rule, which requires unanimous consent for multiple managers. [§48-2c-808(1)]
b. Distributions. In all business deals, owners want distributions—both periodic and on dissolution and winding up. The New LLC Act adopts a ‘per capita’ rule for interim [non-liquidating] distributions [§48-3-404(1)] and no definition is provided for interim distributions [such as limiting it to a distribution of profits]. That means all LLC members, regardless of the existence of profits, or the value of their contributions, or the amount of prior distributions, will receive equal distributions from the LLC until dissolution and winding up — if their operating agreement does not provide otherwise. In contrast, the Existing LLC Act refers to current distributions as ‘distributions of profits and gains’ [§48-20-1001] and sets the default rule for sharing distributions to be “. . . in proportion to the members’ capital account balances as of the beginning of the [LLC’s] current fiscal year.” [§48-2c-1001]
How many deals are there where the owners want all current distributions to be shared equally among all members? Or without regard to the amount of cash or value of other investments in the deal? Yet, this is the default rule under the New LLC Act for all LLCs that have no operating agreement or where the operating agreement is silent on this issue.
There’s more. Under the New LLC Act, provisions for distributions on winding up attempt to take into account the ‘contributions’ made by the members, but then revert to the per capita rule. Those provisions state that, on winding up an LLC, the ‘surplus’ left after paying all LLC debts is distributed in 2 steps:
–[first] . . . (a) to each person owning a transferable interest that reflects contributions made by a member and not previously returned, an amount equal to the value of the unreturned contributions; and
–[second] (b) in equal shares [per capita]among members and dissociated members . . . ” [§48-3-709(2)]
Some obvious questions arise as to the foregoing provision:
- What counts as a contribution in that circumstance? What doesn’t count?
- How is one to know if a ‘contribution’ has previously been returned? Since all distributions are to be in cash, which portion of prior cash distributions was a distribution of current profits and which portion was a return of contributions? How is one to figure that out?
- Which ‘value’ standard is to be applied to the ‘unreturned contributions’? Fair market value? Book value for LLC accounting purposes? Book value for tax accounting purposes? The value, if any, set forth in the LLC’s operating agreement? Liquidation value? Quick-sale value?
- Who is to determine that value?
- When is that value to be determined? As of the date the contribution was originally made to the LLC? The date of dissolution? The date of distribution? The date of sale (in liquidation)?
In contrast to the New LLC Act, the Existing LLC Act requires that, as to winding up, the ‘surplus’ remaining after payment of all LLC debts be allocated and distributed . . . in accordance with the members’ final capital account balances after allocation of all profits and losses including profits and losses accrued or incurred during winding up. [§48-2c-1308(2)]
[See also 13. No Capital Accounts]
Under the New LLC Act, the hierarchy of an LLC’s governing documents is reversed from historical practice. Under the Existing LLC Act, the LLC’s operating agreement is subordinate to the LLC’s articles of organization. [§48-2c-502(2)] But under the New LLC Act, an LLC’s charter document filed at the Division (certificate of organization) is subordinate to the unfiled, private operating agreement. Thus, an LLC’s operating agreement will be the LLC’s supreme governing document, trumping its ‘certificate of organization.’ [§48-3-110(1)]
Further, if a document filed with the Division conflicts with a provision of the operating agreement, the operating agreement prevails as to members, dissociated members, transferees and managers, but the filed document prevails as to other persons to the extent they reasonably rely on the filed document. [§48-3-112(4)]
Oral and implied operating agreements are allowed under the New LLC Act. It defines ‘operating agreement’ as:
. . the agreement, whether or not referred to as an operating agreement and whether oral, in a record [written], implied, or in any combination thereof, of all the members of [an LLC]. . . [§48-3-102(13)(a)]
Thus, operating agreements may consist of various oral expressions of the members or may be implied. Implied from what? The body language of the members? The daily habits of the members? The past dealings among members before the LLC was formed? No standards are provided.
To further confuse the situation, the New LLC Act uses the term ‘express’ in several places, including:
- “expressly provides” §48-3-407(1)(a)
- “expressly provided” §48-3-407(3)(a)
- “express provisions” §48-3-601(2)(a)
- “express will” §48-3-602(1)
Does ‘express’ in those situations mean ‘written’? How is one to know?
Under the Existing LLC Act, operating agreements must be in writing. [§48-2c-102(16)(a)] Some persons may see that as too limiting. But why? In today’s world, with texting and email from hand-held devices very prevalent, with instant messaging readily available, and with computers in use by most of the population (especially in Utah), a writing requirement is hardly a burden or imposition. [See “How Could Due Diligence Be Affected By New LLC Act?”]
Under the New LLC Act, oral and implied operating agreements trump not only the express provisions in a filed written certificate of organization, they also trump written statutory rules, except for the ‘non-waivable’ provisions. [See 22. Non-Waivable Provisions]
Because the New LLC Act authorizes oral and implied agreements to trump written agreements, how will courts apply the Statute of Frauds in such situations?
Additionally, the introduction of oral and implied operating agreements will make transactional and lender due diligence exponentially more difficult. How will a third party dealing with an LLC ever know whether there are any oral or implied agreements among the members? That fact alone means the New LLC Act both introduces uncertainty and reduces efficiency of the marketplace. And, allowing oral and implied operating agreements is certain to become a litigator’s guaranteed employment plan!
Under the New LLC Act, an LLC’s certificate of organization (Articles of Organization under existing law) must contain only 2 items: (a) the name of the LLC and (b) the name and address of the registered agent. Nothing else is required unless the LLC is a PLLC [Part 11 of 48-3] or a low-profit LLC [Part 13 of 48-3] or a notice is to be given of liability limitation of a series. [§48-3-201(3)(b)]
There is no requirement to disclose in the LLC’s certificate of organization the purpose of the LLC, or whether the LLC is manager-managed or member-managed, or the identity or address of any manager or any member, or any limits on authority of those who manage, or the address of the LLC’s principal office. Since the LLC’s operating agreement reigns supreme under the New LLC Act, one must look to that document (if written or discernible) for guidance on all these issues. But if the operating agreement remains private and parts or all of it may be oral or implied, how does one know the LLC’s purpose or management structure, or the identity of the members or managers?
In contrast, under the Existing LLC Act [§48-2c-403], an LLC’s articles of organization must contain several items:
- if LLC is to have series and desires to limit liability of such series, a notice of limit of liability of a series [§48-2c-207, §48-2c-606(3)(d)]
- LLC name
- business purpose [see 6. No Business Purpose Required]
- name and address of registered agent
- name and address of organizer
- if LLC is to be manager-managed, a statement to that effect and the name and address of each manager
- if LLC is to be member-managed, a statement to that effect and the name and address of each member
- if there are to be effective limits on authority of managers or members to bind the LLC, a description of those limits
- if period of duration is to be less than 99 years, a statement of the lesser term of duration
- if LLC is to be low-profit, a statement to that effect [§48-2c-412(1)(a)]
- if LLC is to be a PLLC, a statement to that effect and the names and addresses of all professionals who are members [§48-2c-1509]
Because this information must be in a publicly-filed document, and that document is readily available on the Division’s website, third parties are saved the trouble and expense of hunting down that information.
Under the New LLC Act, no business purpose is required and no purpose or business need be stated in an LLC’s certificate of organization. [§48-3-201(3)] Thus, an LLC may be formed and operated for ‘any lawful purpose.’ [§48-3-104(2)]
The New LLC Act gives no definition of ‘business’ and goes to some effort to avoid use of that word. But NCCUSL’s website states that an LLC is a “business organization”, that an LLC may have managers who do “the business of the [LLC]” and that an LLC “may be tailored to the business . . . of the members.” [see Limited Liability Company (Revised) Summary at uniformlaws.org.]
In contrast, the definition of ‘business’ in current Utah LLC law provides:
‘Business’ includes a lawful trade, occupation, profession, business, investment, or other purpose or activity, whether or not that trade, occupation, profession, business, investment, purpose or activity is carried on for profit. [§48-2c-102(2)]
The Existing LLC Act requires that an LLC’s business purpose be declared in its articles of organization, which will have the effect of limiting the LLC’s authority to conduct business outside its stated purpose.
Under the New LLC Act, although members in a member-managed LLC have a duty to refrain from competing with the LLC (as part of their duty of loyalty) [§48-3-409(2)(c)], where the LLC’s business purpose is not clearly stated, the burden of proving the exact scope of the LLC’s business may be difficult.
The New LLC Act tried to not use the word ‘business’ in any provision. It gives no definition of ‘business.’ Despite their best efforts, the drafters slipped up and left the word ‘business’ in one provision. [§48-3-110(3)(h)] Instead, the New LLC Act replaced the word ‘business’ with the term ‘activities’ in all places where the reader would reasonably expect the word ‘business’ to appear. Thus, there are numerous references to the LLC’s ‘activities’, including §48-3-105, §48-3-110(1)(c), §48-110(8)(b), §48-3-409(2),(3), §48-3-703, and §48-3-803(1). Yet, the New LLC Act does not define ‘activities.’
While the Existing LLC Act requires that an LLC’s management structure be designated in its articles of organization, the New LLC Act has no such requirement. Nor must the LLC’s annual report disclose the management structure. [§48-3-209(1)] Therefore, there is no easy way to know whether an LLC is manager-managed or member-managed.
There is another problem. The New LLC Act provides a default rule that each LLC is deemed to be ‘member-managed’ unless the operating agreement expressly states otherwise. [§48-3-407(1)(a)]
How does one discern an operating agreement that is oral or implied but not written? Further, what if the LLC has no operating agreement until several weeks (or months) after the certificate of organization [New LLC Act term] is filed? Does that mean the LLC is member-managed until an operating agreement is adopted and signed by all members–with each member having power to bind the LLC in the meantime? But how does one ascertain the identity of the LLC’s members when no such information is in the public file? The New LLC Act seems to leave these questions unanswered.
Those who drafted RULLCA — the template source for the New LLC Act — have asserted that RULLCA eliminates the doctrine of apparent authority by negating the constructive notice effect of statements in a filed charter that purports to limit authority of those who manage the LLC. [See “NCCUSL’s Struggle With ‘Apparent Authority’“] Despite that stated objective, RULLCA and the New LLC Act embrace statutory apparent authority in a specific way by allowing a document, separate from the certificate of organization, to be filed — a document called a ‘statement of authority’ — that expressly identifies the positions or the persons with authority to bind the LLC, and any limits on that authority. [§48-3-302] But then, to have constructive notice effect, that separate document must be filed in the same Division file where the certificate of organization is filed and, as to real property transactions, a certified copy of that statement must be filed in the records of the recorder of the county where the affected real property is located. [§48-3-302(6), (7)]
So, a second document may be filed in the same Division file to do what the first document in that file is prohibited from doing! Does this make sense?
Moreover, parties conducting due diligence will now be required to search both the Division’s website and county recorder records for statements declaring/limiting LLC authority. This duplicate burden is a trap for the unwary. [See “How Could Due Diligence Be Affected By New LLC Act?”]
Existing LLC Provisions
The Existing LLC Act established two basic fiduciary duties for persons who manage or control an LLC — the duty of care and the duty of loyalty. [§48-2c-807]
(a) The standards for the duty of care under the Existing LLC Act are:
- gross negligence
- willful misconduct
- breach of a higher standard provided in the LLC’s governing documents [§48-2c-807(1)]
The New LLC Act deleted the third type of prohibited conduct. Also, the New LLC Act did not adopt RULLCA’s duty of care standard. RULLCA, in its prior (1996) version, defined the duty of care as the duty to refrain from conduct that is grossly negligent or reckless, intentional misconduct or knowing violation of law. Then, in its 2006 version, RULLCA switched and adopted a different standard — the standard of ordinary care (care that a person in like position would reasonably exercise) subject to the business judgment rule. RULLCA §409(c); Limited Liability Company (Revised) Summary at uniformlaws.org.
(b) The standard for the duty of loyalty is generally to refrain from any self-dealing. [§48-2c-807(2)]
(c) These duties may not be reduced or eliminated by any provision in the LLC’s governing documents. [§48-2c-120(1)(b), (i)]
(d) On a related matter, the Existing LLC Act provides that the obligation of good faith and fair dealing cannot be eliminated by the LLC’s governing documents, except that the members, by written agreement, may set standards by which performance of such obligation is to be measured, if such standards are not manifestly unreasonable. [§48-2c-120(1)(c)]
New LLC Act Provisions
The New LLC Act allows for substantial changes in the rules on fiduciary duties:
If not unconscionable or against public policy, the LLC’s operating agreement may:
- restrict or eliminate the duty of loyalty; [§48-3-110(4)(a)]
- identify specific types of activities that do not violate the duty of loyalty; [§48-3-110(4)(b)]
- alter the duty of care, except it cannot authorize intentional misconduct or knowing violation of law; [§48-3-110(4)(c)]
- alter or eliminate “any other fiduciary duty” [which opens the door to creation of other unspecified fiduciary duties]. [§48-3-110(d)]
The main restriction on eliminating or changing fiduciary duties under the New LLC Act is that such changes cannot be “unconscionable or against public policy”. Yet, this statement seems circular since legislation itself is a statement of public policy. If the relevant public policy is not as expressed in the New LLC Act, where is that public policy stated?
In any event, the New LLC Act opens the door to eliminating or diminishing fiduciary duties by provisions in the LLC’s operating agreement.
The Existing LLC Act includes detailed provisions relating to indemnification of LLC members, managers, employees, fiduciaries and agents [§§48-2c-1801-1809], which, like most other statutory provisions, serve as default rules. Those provisions were adapted verbatim from the Utah Revised Business Corporation Act [§§16-10a-901-909], which is based on the Model Business Corporation Act that has been adopted in 24 states including Utah.
While adopting the New LLC Act, SB 131 repealed all indemnification provisions of the Existing LLC Act and enacted only a partial replacement. [§48-3-408] This legislative pattern is similar to other provisions of the Existing LLC Act that were repealed and not replaced.
The replacement provisions for indemnification under the New LLC Act include:
- Mandatory reimbursement by an LLC for payments made for any liability incurred by:
- a member in a member-managed LLC, or
- a manager in a manger-managed LLC
on behalf of the LLC but only if the member or manager complied with the statutory limitations on distributions [§48-3-405] and the standards of conduct for members and managers (duty of loyalty, duty of care, etc.) [§48-3-409]; and
- Mandatory indemnification from such liability for such members or managers; and
- Permission to purchase and maintain insurance to protect a member or manager from liabilities incurred while acting in those capacities for the LLC. [§48-3-408(2)]
However, as part of its “nonwaivable” provisions under §48-3-110, the New LLC Act indicates that the LLC’s operating agreement may:
- Alter or eliminate such indemnification, and
- Limit or eliminate a member’s or manager’s liability to the LLC and other members for money damages except for:
a. breach of duty of loyalty [§48-3-409(2)]; or
b. a financial benefit received by the member or manager to which he/she was not entitled; or
c. a breach of statutory limitations on distributions [§48-3-406]; or
d. an intentional violation of criminal law [§48-3-110(7)].
The New LLC Act did not replace indemnification provisions relating to:
- LLC employees, fiduciaries or agents
- Attorney fees
- Advancements for fees and expenses
- Penalties, fines or excise taxes
- Protocols for determining eligibility for indemnification
- Witness costs
- Derivative actions
- Where a member or manager is successful on the merits in a proceeding
- Services rendered, at the LLC’s request, to another entity or to an employee benefit plan
The New LLC Act allows . . . a person to dissociate [withdraw] as a member at any time, by withdrawing as a member by express will [§48-3-601(1)] but, A person’s dissociation does not entitle the person to a distribution. [§48-3-404(2)] Thus, a person cannot withdraw to force a buy-out of his/her interest.
Generally, withdrawal is ‘wrongful’ if it breaches the operating agreement or occurs before termination [not mere dissolution] of the LLC, under certain conditions. [§48-3-601(2)]
Upon dissociation [withdrawal]:
- the person loses the right to participate in management or conduct of the LLC’s activities [business];
- the person’s fiduciary duties, if any, stop as to matters/events arising after dissociation;
- the person’s status as to his/her transferable interest becomes that of a transferee; [§48-3-102(24)] and
- the person continues liable for debts incurred while a member. [§48-3-603]
In contrast, the Existing LLC Act provides that a member may NOT withdraw until dissolution and winding up of the LLC unless the operating agreement permits otherwise or all other members consent at the time. [§48-2c-709]
Under the Existing LLC Act, if a member receives an LLC distribution by mistake or in violation of the LLC’s governing documents or in violation of statutory limits on LLC distributions [§48-2c-1005], that member is obligated to return the wrongful distribution to the LLC and such obligation can be recovered in an action filed within 5 years. [§48-2c-1006]
The New LLC Act applies that obligation only to distributions in excess of statutory limits [§48-3-405] and only where the person who received the distribution knew at the time that the distribution exceeded statutory limits [§48-3-406(3)] and bars any action not commenced within 2 years after the distribution. [§48-3-406(5)]
Apparently, there is no statutory obligation in the New LLC Act to return a distribution made under mistake or that otherwise violates the operating agreement but not the statutory limits. In other words, there is no statutory remedy against a ‘person’ who receives an LLC distribution under such circumstances.
The New LLC Act makes no mention of capital accounts or anything similar, and its default rule for sharing non-liquidating distributions is per capita (based on the number of members without any reference to their capital contributions to the LLC). [See “2. Per Capita Rule Adopted for Voting and Distributions“]
In contrast, the Existing LLC Act defines capital accounts [§48-2c-102(3)], requires that a capital account be maintained for each member [§48-2c-903(1)(a)], describes what adjustments are to be made to capital accounts [§48-903(1(c)], and uses the capital account concept for allocating profit/loss [§48-2c-906] and allocating distributions in winding up. [§48-2c-1308(2)]
Speaking of non-uniformity, capital accounts are treated differently in UUPA, UULPA and the New LLC Act — the 3 ‘uniform’ Acts included in SB 131. Under UUPA, each partner is deemed to have an ‘account’ that is credited with the amount or value of the partner’s contributions and the partner’s share of profits, and that is charged with distributions to the partner and the partner’s share of losses. [§48-1b-401(1)] Under UULPA, there is no express mention of capital accounts but the default rule for sharing distributions is geared to the value (at the time of distribution) of the contributions the limited partnership has already received from each partner (and, presumably, not previously returned). [§48-2d-503] Such value would likely be recorded in a separate account for each partner that, in effect, constitutes a capital account.
The New LLC Act’s failure to mention capital accounts or anything similar and its per capita rule for non-liquidating distributions seems out of sync with NCCUSL’s website, which states: “A [LLC] has members who primarily contribute capital and who share profits or losses.” [See Limited Liability Companies (Revised) Summary at uniformlaws.org]
With no provisions for capital accounts, how could the New LLC Act be consistent with the capital account maintenance rules of Section 704(b) of the Internal Revenue Code, for which compliance is required by all multi-member LLCs (tax partnerships)?
The New LLC Act has no definition of profits or losses nor any default rule for sharing profits and losses. Surprisingly, NCCUSL’s own website refers to members “who share in the profits or losses” and “rules governing distributions of profits or losses to members” [Limited Liability Company (Revised) Summary at uniformlaws.org.]
Contrary to the New LLC Act, the Existing LLC Act defines profits and losses and makes numerous references to a member’s interest in LLC profits – such as for calling a meeting of members [§48-2c-704(1)], for determining a quorum at a meeting of members [§48-2c-704(7), for voting at a meeting of members [§48-2c-704(10)], and for approving certain actions. [§48-2c-803(3), §48-2c-803.1]
[Note: federal and state income tax laws generally defer to state law to determine how profits and losses are allocated; but where state law fails to cover the issue, there is no default rule. In that case, tax rules may well become the default rule and will treat unincorporated multi-member entities, by default, as tax partnerships — which are defined as a joining together of 2 or more persons in business for profit.]
The New LLC Act requires an annual report to be filed with the Division for each LLC, but only three items need be disclosed in the annual report for a Utah LLC:
- LLC’s name
- name and address of registered agent in Utah
- street and mailing addresses of LLC’s principal office [§48-3-209(1)]
Nothing else is required. In contrast, the Existing LLC Act requires that each annual report set forth:
- any changes in the street address or legal name of any manager (of a manager-managed LLC), or of any member (in a member-managed LLC), or of any person with management authority (in a foreign LLC); and
- any changes in the identity of such manager, member or other person. [§48-2c-203(1)(b)]
Similarly, Utah corporate law requires the annual report for each corporation to list several items, including the names of its principal officers:
- corporation name
- state law under which corporation was formed
- name and street address of registered agent in Utah
- street address of its principal office
- names of its principal officers [§16-10a-1607(1)]
The Existing LLC Act expressly allows a court, at any time, to order foreclosure of a charging order lien against a judgment debtor’s interest in an LLC. [§48-2c-1103(2)(b)]
The New LLC Act limits the foreclosure remedy by prohibiting foreclosure from proceeding until after . . . a showing that distributions under a charging order will not pay the judgment debt within a reasonable time. [§48-3-503(3)]
Question: What right does the judgment creditor have to dig into LLC finances to marshal information to make that showing?
The New LLC Act provides a general answer:
“(2) To the extent necessary to effectuate collection of distributions pursuant to a charging order . . . , the court may
. . .
(b) make all other orders necessary to give effect to the charging order. [§48-3-503(2)(b)]
Presumably, the “showing” required under the New LLC Act must be a showing or affirmation to the court before the court orders foreclosure to proceed. The word “showing” is not implying a “finding” by the court although one could argue that the court must make a finding based on the “showing”.
To say all of this another way — if a judgment creditor can show that its judgment debt will not be paid within a reasonable time due to minimal or nonexistence distributions from the LLC, it could then ask for immediate foreclosure of its lien against the judgment debtor’s LLC interest in order to receive payment on the judgment debt; otherwise, the judgment creditor must sit and wait for distributions from the LLC.
But what is a “reasonable time”? One year? Two years? No standard is provided.
SB 131 repeals provisions of the Existing LLC Act [§48-2c-904] that set a framework for determining the fair market value of a member’s LLC interest. Yet, the New LLC Act retains intact the ‘judicial dissolution boomerang buy-out’ provisions of the Existing LLC Act, which allow an LLC or its other members to elect to purchase the LLC interest of a member who files a court action to dissolve the LLC, and sets the purchase price in that circumstance “. . . at the fair market value, determined . . . in this section.” [§48-3-702(1)]
Then, in that section [§48-3-702(4)], the New LLC Act indicates that, where a valuation proceeding is needed, the court “. . . shall . . . determine the fair market value . . . based on the factors the court determines to be appropriate” without giving any guidance or standards on how fair market value is to be determined. [Under similar provisions of Utah corporate law, the price is based on ‘fair value’ – not ‘fair market value’.]
The ‘fair market value’ definition in the Existing LLC Act has often been invaluable in both estate planning and judicial dissolution situations. Why was this definition/standard deleted without a functional replacement?
The New LLC Act continues a provision of the Existing LLC Act to the effect that an individual who signs a document that is authorized or required to be filed pursuant to the New LLC Act affirms under penalty of perjury, by signing, that the information stated in the record is true. [§48-3-207(3); cf. §48-2c-204(4)]
But, the New LLC Act goes further and creates a private cause of action for damages for a loss suffered by reliance on inaccurate information in a document filed with the Division. [§48-3-207(1)] Such damages are recoverable from:
- a person who signed the document or who caused another to sign the document on the person’s behalf, and
- a member of a member-managed LLC or a manager of a manager-managed LLC if:
- the document was delivered for filing on behalf of the LLC; and
- the member or manager had notice [§48-3-103] of the inaccuracy for a reasonably sufficient time before the information was relied upon so that, before the reliance, the member or manager reasonably could have:
- effected an amendment under §48-3-202; or
- filed a petition under §48-3-204; or
- delivered to the Division for filing a Statement of Change [§48-3-207(1)] or a Statement of Correction. [See “LLC Documents that New LLC Act Says Must/May Be Filed at Utah Division of Corporations“]
Under the New LLC Act, a foreign LLC is deemed to be ‘doing business’ in Utah if it owns any real property or tangible personal property in Utah that produces any income. That differs from the treatment of foreign LLCs under the Existing LLC Act, which provides that “owning, without more, real or personal property” in Utah does not constitute ‘doing business’ in Utah. [§48-2c-1602(2)(h)]
That rule of current Utah LLC law is consistent with similar provisions for corporations under the Utah Revised Business Corporation Act [§16-10a-1501(2)(i)] and for nonprofit corporations under the Utah Revised Nonprofit Corporations Act. [§16-6a-1501(2)(j)] This disparate treatment of Utah business entities needs explanation and justification.
Many foreign LLCs owning property in Utah are likely not aware of this new filing requirement. Once enforced, this new rule may cause a windfall of fees to the State of Utah.
To become an LLC owner, must a person acquire an economic interest in the LLC or make a contribution to the LLC or be obligated to make any contribution? Under the New LLC Act, the answer is ‘no.’ [§48-3-401(4)] Yet, the definition of ‘contribution’ [see §48-3-102(a),(b)] implies that a contribution is needed to become a member, and NCCUSL’s own website expressly presumes that each LLC member will contribute capital to the LLC:
[An LLC] has members who primarily contribute capital to the [LLC] and who share in the profits and losses. [Limited Liability Company (Revised) Summary at uniformlaws.org]
The New LLC Act [§48-3-901] expressly provides for a direct cause of action by one member against another member or against a manager or the LLC itself:
“(1) subject to subsection (2), a member may maintain a direct action against another member, a manager, or the [LLC] to enforce the member’s rights and otherwise protect the member’s interests, including rights and interests under the operating agreement or this chapter or arising independently of the membership relationship.
(2) A member maintaining a direct action under this section must plead and prove an actual or threatened injury that is not solely the result of an injury suffered or threatened to be suffered by the [LLC].”
Since only members are expressly granted this right, do dissociated members and transferees have no such right of action?
The Existing LLC Act has no similar provision.
Generally speaking, LLC statutes are a bundle of default rules–rules that apply when the LLC’s organic documents are silent on an issue. But most of the statutory rules can be overridden by an LLC’s organic documents (articles of organization and operating agreement).
However, there are a few LLC statutory rules that cannot be overridden by private agreements. Those rules are commonly referred to as the ‘non-waivable’ provisions.
Utah’s New LLC Act has its own set of non-waivable provisions. Some of those are similar to the non-waivable provisions of the Existing LLC Act. Others are new. Following, on the left side of the table, is a list of the non-waivable provisions from the New LLC Act, with a comparison, on the right side of the table, to the non-waivable provisions of the Existing Utah LLC Act:
|New LLC Act Provisions
An Operating Agreement May NOT:
|Existing LLC Act Provisions
Articles of Organization/Operating Agreement May NOT:
|(a) vary an LLC’s capacity to sue and be sued||[no comparable provision]|
|(b) vary law applicable to LLCs [but see §48-3-110(2) which states ‘To the extent the operating agreement does not otherwise provide for a matter described in [§48-3-110(1)], this chapter covers the matter’]||[no comparable provision]|
|(c) vary power of court to order a person to sign, file and deliver a record to the Division or to order the Division to file an unsigned record||[no comparable provision]|
|(d) subject to §48-3-110(4) – (7), eliminate duty of loyalty, duty of care or ‘any other fiduciary duty’||(b) reduce the duties of members or managers under §48-2c-807, eliminate or limit personal liability of any person vested with management authority to the LLC or its members for damages for any breach of duty in the capacity where a judgment or other final adjudication adverse to the manager establishes:
|(e) subject to §48-3-110(4) – (7), eliminate contractual obligation of good faith and fair dealing under §48-3-409(4)||(c) eliminate obligation of good faith and fair dealing, but may determine standards by which performance of such obligation is to be measured – if not manifestly unreasonable|
|(f) unreasonably restrict duties and rights to information under §48-3-410||(a) restrict right to inspect and copy records under §48-2c-113|
|(g) vary power of court to decree dissolution under §48-3a-701(4) and (5) on application of a member*||(g) vary remedies under §48-2c-1210 for judicial dissolution|
|(h) vary requirement to wind up an LLC’s business upon dissolution||[no comparable provision]|
|(i) unreasonably restrict right of member to maintain an action [under Part 9]||[no comparable provision]|
|(j) restrict right to approve a merger, conversion or domestication under §48-3-1014 to a member who will have personal liability in surviving organization||[no comparable provision]|
|(k) restrict rights of a person other than a member (except for charging order after a person becomes transferee or dissociated member)||(h) except as allowed by §48-2c-1103 [charging orders] or any other provision of law, restrict the rights of, or impose duties on, persons other than members, assignees and transferees, managers, or LLC, without consent of those persons|
|[no comparable provision]||(d) vary any filing requirement under §48-2c-101 et seq.|
|[no comparable provision]||(e) vary any requirement under §48-2c-101 et seq. that a particular action or provision be reflected in a writing|
|[no comparable provision]||(f) vary right to expel a member under §48-2c-710(3)|
*Does this mean operating agreement cannot expand the grounds for judicial dissolution? [See 1. Deadlock Remedies Deleted]
The New LLC Act adopts a new term called ‘transferable interest.’ It treats ownership in an LLC under one of two categories–either as a ‘member interest’, which is full ownership (including management, voting and information rights), or as a ‘transferable interest’, which is only economic rights, defined as “ . . . the right, as originally associated with a person’s capacity as a member, to receive distributions from a [LLC] in accordance with the operating agreement, whether or not the person remains a member . . .” [§48-3-102(23)] The Existing LLC Act includes a concept substantially identical to ‘transferable interest’, i.e., the ‘rights of an assignee’, with its related limits. [§48-2c-1102]
Needless to say, a transferable interest is transferable. Yet, speaking in the negative, a transfer of a transferable interest does not entitle the transferee to participate in management or to conduct the LLC’s ‘activities’ [business], or to have access to LLC records or information concerning the LLC’s activities. [§48-3-502(1)(c)] Similar limits apply to an assignee’s interest under the Existing LLC Act. [§48-2c-1102]
The New LLC Act states, without any qualification or exception, that “A member is not an agent of the [LLC] solely by reason of being a member.” [§48-3-301(1)] Does that mean that agency law does not apply? Yet, in §48-3-407(2)(b), it also states that, in a member-managed LLC: “Each member has equal rights in the management and conduct of the . . [LLC’s] activities [business].” But if a member is not an agent of the LLC, by what authority does a member have power to manage and bind a member-managed LLC? It appears the New LLC Act leaves this paradox unresolved or, at least, unclear.
Neither the Existing LLC Act nor the New LLC Act requires that any LLC member meetings be held. Yet, the Existing LLC Act does provide default rules for calling and conducting member meetings if such meetings are allowed or required by the LLC governing documents. [§48-2c-704]
The New LLC Act has no such default provision.
The Existing LLC Act also includes detailed default guidelines for actions by members without any meeting, which apply where the LLC’s governing documents are silent on the issue. [§48-2c-706] The New LLC Act has no such default guidelines.
The Existing LLC Act provides that an LLC has a duration of 99 years unless otherwise provided in its articles of organization. [§48-2c-403(5)]
The New LLC Act grants to all LLCs perpetual duration. [§48-3-104(3)]
Is there any practical difference between 99 years and perpetuity? For example, how may Utah entities formed more than 99 years ago are still in business today?
The Existing LLC Act requires that:
“. . the plaintiff [in a derivative action] must be a member at the time of bringing the action and:
1. must have been a member at the time of the transaction of which the member complains; or
2. the member’s status as a member must have devolved upon him by transfer or by operation of law or pursuant to the terms of the operating agreement from a person who was a member at the time of the transaction.” [§48-2c-1702]
The New LLC Act abandons the ‘contemporaneous ownership’ rule and merely requires that a plaintiff in a derivative action be a member at the time the action is commenced and must remain a member while the action continues [§48-3-903(1)] and provides that, if the sole plaintiff dies while the action is pending, the court may permit another member to be substituted as plaintiff. [§48-3-903(2)]
The official Comment on Section 903(b) of RULLCA states: This Act does not take a position on whether the death of a member abates a direct claim against the LLC or a fellow member.
The New LLC Act and RULLCA include detailed provisions for ‘special litigation committees’ in derivative proceedings, apparently borrowing from corporate statutes. [§48-3-905]
A provision deleted by SB 131 and not replaced by the New LLC Act is the requirement for security that a derivative plaintiff may be required to post to cover the costs and expenses that may be incurred by the LLC attributable to defending a derivative action. [§48-2c-1706(1)] That security could be demanded by the LLC as a matter of right if the fair market value of the plaintiff’s interest in the LLC does not exceed the greater of $25,000 or 5% of the fair market value of the LLC. [§48-2c-1706(1)] The provision deleted and not replaced is similar to provisions in Utah’s existing ‘uniform’ limited partnership statute. [§48-2a-1005]
The Existing LLC Act requires that, on winding up, liabilities to creditors other than members be paid before liabilities to members in their capacity as creditors. [§48-2c-1308(1)]
The New LLC Act changes this rule and, without qualification, puts claims of member-creditors on par with claims of other creditors. [§48-3-405(4); §48-3-709(1)]
Under both Acts, all members are deemed to be creditors of the LLC as to distributions when the member becomes ‘entitled to receive a distribution’ [cf. §48-2c-1004 to §48-3-404(4)]. By comparison, Utah’s existing limited partnership statute — the ‘Utah Revised Uniform Limited Partnership Act,’ enacted in 1990, requires disparity as to liabilities for distributions. It states:
Upon the winding up of a limited partnership, the assets shall be distributed [first] . . . to creditors, including partners who are creditors, to the extent permitted by law, in satisfaction of liabilities of the limited partnership other than liabilities for distributions to partners under . . . [interim distributions and upon withdrawal] [§48-2a-804]
Under the New LLC Act, there is no definition of ‘profits’ and no mention of profits or earnings. Accordingly, its definition and concepts for ‘distributions’ make no distinction between a distribution of profits and a return of capital. [§48-3-102(4) and §48-3-404]
Further, there are different rules as to distributions made by mistake, or in violation of the LLC’s operating agreement, or in violation of the Act’s rules on ‘improper’ distributions. [See 12. Duty to Return Mistaken Distributions Deleted] Thus, is a member under the New LLC Act ‘entitled’ to receive a distribution made by mistake? And, does a member’s status as a creditor apply to mistaken distributions?
The New LLC Act provides no detailed list of specific records that are to be maintained and available for inspection by members, managers and their representatives. Instead, it merely grants to each LLC member the right to inspect and copy “. . any record maintained by the [LLC] regarding the [LLC’s] activities, financial condition, and other circumstances, to the extent the information is material to the member’s rights and duties under the operating agreement or this chapter.” [§48-3-410(1)(a)]
Some things to note here: First, there is no statutory duty on the LLC to keep and maintain any records; Second, only the records that are maintained are subject to inspection and copying; and Third, only records that are “material to the member’s rights and duties” are subject to inspection.
In contrast, the Existing LLC Act spells out in detail the documents and records that must be maintained and be available for such inspection. [§48-2c-113] That listing provides a bit of a ‘safe harbor’ for LLC managers to know when the LLC is in compliance with that provision of the statute.