The Washington State Legislature has adopted a major overhaul of Washington’s current Limited Liability Company Act (the “Act”). The updated Act is the result of a multi-year effort by the Washington State Bar Association to make the Act more modern, flexible, and user-friendly and to remove or revise those sections that tend to create problems for businesses. The new Act goes into effect January 1, 2016.
For most Washington LLCs, the new Act’s provisions relating to company agreements, or operating agreements, will have the biggest impact. Although the new Act maintains the ability of LLC members to adopt a company agreement that may vary some of the Act’s default provisions, it does clarify in one section which of those default provisions may not be changed. For instance, an operating agreement may not:
- Vary an LLC’s ability to sue, be sued, and defend an action in its own name;
- Change the governing law of the LLC to a state other than Washington;
- Eliminate or limit the duties or the liabilities of a member or a manager to avoid intentional misconduct and knowing violations of law, to act in accordance with the duty of good faith and fair dealing, or to make improper distributions in contravention of the Act or the company agreement;
- Indemnify a member or manager for intentional misconduct, a knowing violation of law, or an improper distribution in contravention of the Act or the company agreement;
- Vary Secretary of State requirements pertaining to the execution and filing of documents;
- Vary the records to be maintained by an LLC or unreasonably restrict the rights of members to access those records and other company information;
- Vary a manager’s power to resign as provided in the Act;
- Vary the requirements pertaining to company distributions covered under the Act;
- Eliminate or limit the liability of a member, manager, or transferee that consents to, or has knowledge of, a distribution in violation of the Act or the company agreement;
- Vary the power of a court to decree dissolution of the LLC as provided under the Act;
- Vary the requirements to wind up an LLC as provided under the Act;
- Unreasonably restrict the right to maintain a derivative action;
- Restrict the right of a member that will have personal liability with respect to a surviving or converted entity to approve a merger or conversion; and
- Restrict the rights under the Act of a person other than a member, manager, or transferee.
In addition to the operating agreement prohibitions, the new Act also includes many new provisions never before seen in Washington, including:
- Oral Operating Agreements. Under the current version of the Act, any changes to the Act’s default provisions must be contained in a writing. This writing is commonly known as the company’s operating agreement or company agreement. The updated Act’s revised definition of an LLC agreement would allow a Washington LLC agreement to be “oral, implied, in a record, or in any combination.” Under the new Act, an oral LLC agreement, as well as a written agreement, could override any of the statutory default provisions of the new Act (with the exception of those nonwaivable sections). The only exception to this allowance of an oral LLC agreement is that a written LLC agreement would be required to limit the applicability of dissenters’ rights to a merger.
- Elimination of Certificate of Formation Designation of Member-Managed or Manager-Managed. Under the current Act, an LLC‘s certificate of formation must indicate whether the LLC is managed by its members or by managers. The current Act also requires that an LLC’s initial and annual reports to the Secretary of State identify the LLC members or, if the LLC is manager-managed, the LLC’s managers. The revised Act eliminates the requirement that the certificate of formation identify whether the LLC is member-managed or manager-managed. Under the revised Act, the management of the LLC would be identified in the LLC agreement.
- Allowance for Board of Managers. The revised Act provides for the management of an LLC by a board of directors. This is accomplished through a revision to the definition of “manager.” Whereas before “manager” was defined as “person,” the revised Act defines “manager” as “a person, or a board, committee or other group of persons,” named or designated by the LLC agreement as a manager of the LLC. Under the revised Act, if a manager is a board or other group of persons, the fiduciary standards of conduct would apply to each person in the board or group. Further, if the LLC’s manager is a board or other group of persons, no member of the board would have authority, merely by virtue of being a board member, to act individually on behalf of the LLC.
- Establishment of Standards of Conduct. Currently, the Act does not describe any fiduciary obligations that a member or manager, as the case may be, owes to the LLC (these obligations are currently found only in case law). The revised Act includes a new section outlining a manager’s or managing member’s fiduciary duties of loyalty and care to the LLC. This new section of the Act also outlines provisions for an LLC agreement to modify, expand, restrict, or eliminate the fiduciary duties of a manager or managing members.
- Voting by Members. The revised Act provides that, as a default, a majority of members be established through per capita voting (i.e., one vote for each member). This is a deviation from the current version of the Act, in which a majority is established through the consent of members contributing, or required to contribute, more than 50 percent of the agreed value (as stated in the records of the LLC) of contributions made or required to be made by all members.
- Unanimous Voting Requirements. The revised Act explicitly provides, in one list, all actions for which the default rules require unanimous member approval.
- Member Access to Records and Information. The revised Act provides more robust rights to members to access certain additional records not currently available under the Act, including accounting records. Under the revised Act, members’ access to LLC records is similar to shareholders’ access to records provided in the current Washington Business Corporation Act.
- Allocation of Profits and Losses. Under the current Act, profits and losses are allocated to the members in proportion to the agreed value of contributions by each member. The revised Act provides a default rule for distributions, based on the agreed value of contributions, but provides no default rule for allocating profits and losses.
- Mergers and Personal Liability. A new approval requirement for mergers was added to the revised Act. If a member of a merging LLC will have personal liability with respect to the surviving entity, then for the merger to be approved, the member must sign a separate written consent to become subject to such liability. This requirement is in addition to the requirement for majority member approval of the merger.
For many existing LLCs, the practical effect of these changes is that the LLC’s operating agreement may require updating. LLCs may want to consider opting out of some of these new default rules, if authorized under the Act, or expanding on them. In addition, some LLCs may find that certain provisions contained in their LLC agreements are no longer authorized and may be required to update them to ensure compliance with the revised Act.