Connecticut’s new Liability Company Act takes effect on July 1, 2017. It introduces numerous changes to Connecticut law and imposes several new requirements on LLCs and their members and managers. Of immediate importance to many LLCs are the several changes that the new law requires to existing operating agreements. This note will review some of those required changes.
While the new law was written to limit the impact it has on existing LLCs, it does require attention to every new and existing operating agreement so members and managers can be sure their agreements comply with the law and avail them of the opportunities within it.
At the outset, the new law changes the name of the initial LLC filing document from “Articles of Organization” to “Certificate of Organization.” The Act retroactively deems “Articles” filed under the old law to be a “Certificate” under the new law.
The new law also creates at least four statutory impositions which, if not suitably addressed by the operating agreement, control the LLC by new statutory requirements. Existing LLCs should immediately review their operating agreements (or the lack thereof) with an eye toward the effect of the new law.
One example of such impositions addresses admission of new members. Under the prior law, if the operating agreement was silent on the issue, the vote of a majority in interest was required to admit a new member. Under the new law, the default vote required is unanimity. If members want to retain the majority-in-interest vote for admission of new members, they must be sure the operating agreement affirmatively reflects this intent.
In a similar way, the old law required a two-thirds majority of votes in interest to amend the operating agreement. The new law now requires unanimous approval if the operating agreement is silent.
The new act describes in some detail the duty of care and level of loyalty required of members and managers. It also provides four areas in which the operating agreement may depart from these prescribed standards, so long as the departures are not “manifestly unreasonable.” The operating agreement may:
- Alter or eliminate certain portions of the duty of loyalty
- Identify specific behaviors that do not violate the duty of loyalty
- Alter, but not eliminate, the duty of care
- Alter, or eliminate, any other fiduciary duty
The notion of “manifestly unreasonable” will be refined by the courts over time. Pending that, it is imperative that LLCs preferring a less strict standard of loyalty or care for their members or managers, review and revise their operating agreements to so reflect.
It is also important to observe that the new law does not automatically recognize “sweat equity” as a valid metric for distributions. Rather, unless the operating agreement provides otherwise, the law now requires that distributions be based on their respective capital contributions rather than their percentage ownership. C.G.S. §34-255c(a). It is worth noting that federal partnership tax law has also changed to attribute losses differently under the new regulations under Section 707 of the Code.
C.G.S. §34-243d(d)(1)(B) allows for the operating agreement to provide for a more liberal definition of illiquidity than is provided by the default provision of §34-255d(a), which prohibits a LLC from making a distribution if any of the following tests for illiquidity are met: (1) The company would not be able to pay its debts as they become due in the ordinary course of the company's activities and affairs; or (2) the company's total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the company were to be dissolved and wound up at the time of the distribution, to satisfy the preferential rights upon dissolution and winding-up of members and transferees whose preferential rights are superior to those of persons receiving the distribution.
If the members want to use the more liberal provision of § 34-243d(d)(1)(B), they may include in the operating agreement a provision that a lawful distribution requires only that the company's total assets not be less than the sum of its total liabilities.
While the new law provides LLCs considerable discretion in formulating their operating agreements, it provides fourteen circumstances in which LLCs either may not override the statutes or limits their ability to do so.
C.G.S. §34-243d(c) now provides:
(c) An operating agreement may not:
(1) Vary the law applicable under section 34-243c;
(2) vary a limited liability company's capacity under subsection (a) of section 34-243h, to sue and be sued in its own name;
(3) vary any requirement, procedure or other provision of sections 34-243 to 34-283d, inclusive, pertaining to: (A) Registered agents; or (B) the Secretary of the State, including provisions pertaining to records authorized or required to be delivered to the Secretary of the State for filing under sections 34-243 to 34-283d, inclusive;
(4) vary the provisions of section 34-247c [giving the Superior Court jurisdiction to compel signing, filing, or filing of unsigned records with the Secretary of the State]
(5) alter or eliminate the duty of loyalty or the duty of care, except as provided in subsection (d) of this section;
(6) eliminate the implied contractual obligation of good faith and fair dealing under subsection (d) of section 34-255h, except that the operating agreement may prescribe the standards, if not manifestly unreasonable, by which the performance of the obligation is to be measured;
(7) relieve or exonerate a person from liability for conduct involving bad faith, willful or intentional misconduct, or knowing violation of law;
(8) unreasonably restrict the duties and rights under section 34-255i [generally governing rights of members and managers, and rights for former members to information], except that the operating agreement may impose reasonable restrictions on the availability and use of information obtained under said section and may define appropriate remedies, including liquidated damages, for a breach of any reasonable restriction on use;
(9) vary the causes of dissolution specified in subdivisions (4) and (5) of subsection (a) of section 34-267 [which address the jurisdiction of the Superior Court to dissolve the LLC on application by a member for any of four reasons: i) The conduct of all or substantially all of the company's activities and affairs is unlawful; ii) it is not reasonably practicable to carry on the company's activities and affairs; iii) the managers have acted, are acting or will act in a manner that is illegal or fraudulent; or iv) the managers have acted or are acting in a manner that is oppressive and was, is, or will be directly harmful to the applicant]
(10) vary the requirement to wind up the company's activities and affairs as specified in subsections (a) and (e) of section 34-267a [articulating general and specific circumstances of the wind up of certain LLCs] and subdivision (1) of subsection (b) of section 34-267a [describing duties of filing and debt payment for wound-up LLCs]
(11) unreasonably restrict the right of a member to maintain an action under sections 34-271 to 34-271e, inclusive;
(12) vary the provisions of section 34-271d [generally describing the duties and powers of a special litigation committee], except that the operating agreement may provide that the company may not have a special litigation committee;
(13) vary the required contents of a plan of merger under subsection (b) of section 34-279h or, a plan of interest exchange under section 34-279m; or
(14) except as provided in section 34-243e [assent to Operating Agreement] and subsection (b) of section 34-243f, [obligations of LLC and members to transferees] restrict the rights under sections 34-243 to 34-283d [addressing a broad range of rights and duties of LLCs, members, and managers], inclusive, of a person other than a member or manager.
Under the new act, an LLC operating agreement may not relieve a person from liability for conduct involving bad faith, intentional or willful misconduct, or a knowing violation of the law. C.G.S. §34-243d(c)(7). I note especially this change in law here because many existing operating agreements exempt members or managers from liability exempting from such exoneration only in cases of “fraud, gross negligence, or willful misconduct.” LLC members should review their operating agreements and reconcile their intended relief with the new statutory requirements, insofar as possible.
The new statute also addresses the rights of members to access and inspect LLC records. In practice, we have seen access to records as a point of friction, often within LLCs experiencing dissent among members. The law now provides that an operating agreement may not impose unreasonable restrictions on access to information. It may, however, impose reasonable restrictions on the availability of use of the information. For example, the LLC may require the accessing member to execute and deliver a non-disclosure agreement. The operating agreement may also define particular remedies for breaches of reasonable restriction on the use of the information. C.G.S. §34-243d(c)(8).
While the new act explicitly articulates that “[i]t is the policy of the act to give maximum effect to the principles of freedom of contract and to enforceability of LLC agreements,” the limitations and restrictions it establishes demand careful attention to both existing and new operating agreements.
LLCs that have never had an operating agreement are not required by the new law to adopt one, but LLCs without a compliant agreement will now be subject to the default provisions of the law, whose effect may not be intended or desired by the members or managers.
This note is intended only to illustrate general principles and is not legal or tax advice. The reader should discuss his or her specific circumstances with a qualified practitioner before taking any action.