Articles Posted in Limited Liability Company Law

photo - rescuing ltd. partnership (by WJBscribe)There can be life and death struggles playing out in a courtroom. One of those struggles could involve the fate of a limited partnership. Through a judicial dissolution, the partnership could be broken apart and ended, or a party not filing for dissolution would have the option of buying out the other parties and saving the limited partnership from destruction.

All this revolves around one section of California’s Commercial Code, §15908.02. Its provisions include a way for dissolution or a buy out amongst the partners and it states in part,

(a) On application by a partner, a court…may order dissolution of a limited partnership if it is not reasonably practicable to carry on the activities of the limited partnership in conformity with the partnership agreement.

(b) In any suit for judicial dissolution, the other partners may avoid the dissolution of the limited partnership by purchasing for cash the partnership interests owned by the partners so initiating the proceeding (the “moving parties”) at their fair market value…

(c) If the purchasing parties (1) elect to purchase the partnership interests owned by the moving parties, (2) are unable to agree with the moving parties upon the fair market value of the partnership interests, and (3) give bond with sufficient security to pay the estimated reasonable expenses…(the court) shall stay the winding up and dissolution proceeding and shall proceed to ascertain and fix the fair market value of the partnership interests owned by the moving parties.

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photo - LLC duties strings attached (Wikipedia)Managers and managing members of limited liability corporations (LLC’s) owe duties of care and loyalty (called fiduciary duties) to the LLC and its members. A member of an LLC has far more responsibility to fellow shareholders than an employee would have to an employer.

Duties, Responsibilities and How They Can be Modified

The Revised Uniform Limited Liability Company Act (RULLCA), which went into effect this year, sets out the fiduciary duties of managers and managing members and limits the fiduciary duties to the duty of care and the duty of loyalty. Members,

  • Must account to an LLC and hold as trustee for it any property, profit, or benefit derived by the member in the conduct and winding up of the activities of an LLC or derived from a use by the member of an LLC property, including the appropriation of an LLC opportunity.
  • Must not deal with an LLC in the conduct of its business or winding up of its activities as or on behalf of a party having an adverse interest to the LLC.
  • Must not compete with an LLC in the conduct of its business or winding up of its activities.
  • Duty of care to an LLC and its other members in the conduct of its business and winding up of the activities is limited to refraining from grossly negligent or reckless conduct, intentional misconduct or a knowing violation of law.

§17704.09(a)-(c).

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photo - fiduciary duties Ha (by 2brg8)Those who manage Limited Liability Companies (LLC’s) have many responsibilities. It’s up to them to run a business and make a profit while living up to their responsibilities to fellow company members. Most managing partners, if their businesses aren’t making record profits, at least managed honestly and ethically. James Ha was not one of those managers.

Members of LLC’s owe duties of care and loyalty (called fiduciary duties) to the LLC and its members. Mr. Ha was the managing member of the 139 S. Occidental Blvd., LLC, which was started in 2005 to purchase a building in Los Angeles, tear it down, build condos and sell them. The project was abandoned.

He was sued by the LLC in 2006 for breach of contract, fraud and breach of fiduciary duties. A trial court found in the plaintiff’s favor and an appellate court affirmed the decision. 139 S. Occidental Blvd., LLC, v. Ha, 2013 WL 2421073

According to the appellate decision,

  • Ha was responsible for real property ownership, management and proposed development.
  • He made a $34,120 commission from the sale of the property which wasn’t reported to fellow LLC members.
  • Ha opened a bank account in the name of the LLC with an initial deposit of $150,000, which was provided by members other than Ha and member Nam Kyung Cho. The bank account, as well as the LLC operating agreement, required that any check over $10,000 be signed by both Ha and member Hyon Mi Yi.
  • Soon after the account was set up, Ma withdrew several checks for less than $10,000 for a total of $60,000 to supposedly pay back a loan to the LLC by Cho. There was no such loan agreement produced during the trial and there was no explanation as to what happened to the extra $10,000.
  • Cho paid Ha $216,065.29 for a 12.5% interest in the proposed building. Ha deposited the money into his personal account.
  • In 2006 members of the LLC voted Ha out as managing member and sued Ha and Cho.

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2013_03_23__5015st of 2014 by the new California Revised Uniform Limited Liability Company Act (RULLCA). The new provisions of RULLCA significantly alter the default and mandatory rules that previously governed California based LLCs. Although many of the provisions are similar to the previous act, in many cases the new provisions are more robust. These new provisions may become the source of member disputes so members should review the following changes to ensure that these provisions will not conflict with their expectations.

Management and Consent Requirements

RULLCA requires that both the articles of organization and the operating agreement contain a statement establishing the LLC as a manager-managed LLC. Prior to this only the articles of incorporation required a statement establishing the LLC as manager-managed. This new default gives minority members more power, and it also means that minority members can assert veto power over the decisions of a manager by claiming that the decision was not made in the ordinary course of business. Defining ordinary course of business in the operating agreement is strongly recommended because that term is undefined in RULLCA.

Additionally, minority members will have veto power over the will of the majority in votes to amend the operating agreement. Under the prior law if an operating agreement was silent regarding the voting threshold only a majority of LLC interest was required to pass an amendment.

Limits on Managerial Powers

Under RULLCA managers will be expressly forbidden to undertake several acts without approval of all members or express authority via the operating agreement. This includes the ability to sell, lease, or exchange all or substantially all of the LLC’s assets.

Fiduciary Duties

RULLCA defines the duty of loyalty as the duty to account, the duty to refrain from self-dealing, and the duty to refrain from competing. These duties are not itself new, but RULLCA allows an operating agreement to alter the scope of the duty of loyalty by designating certain acts as not violating the duty. However, the duty of loyalty may not be eliminated via the list, and the standards may not be so low that the duty of loyalty becomes manifestly unreasonable.

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2013_03_23__5015If you are a shareholder of Costco or Home Depot, you rest easy when they get involved in lawsuits. You, as the shareholder of a company listed on the New York Stock Exchange, have nothing to worry about because even if these companies lose the lawsuits, you will not be liable for the corporate debt. However, if you are a shareholder of a small business, you need to know how the corporation is structured and managed so that you will not be liable for the business debts.

Why do we form corporations?

Most people form corporations for their business ventures so that they can shield their personal assets. For example, if you operate your business as a corporation, in the unfortunate event that the business sustains a huge debt, the creditor will most likely only be able to recover whatever assets are owned by the corporation. Your house, car, and personal bank account will be shielded from these creditors. Even if your business is crippled by the debt, your personal assets will remain untouched. Most business owners, if not all, receive their financial rewards for taking on calculated risks. Thus, having such security is very important for them.

Are shareholders liable for business debts?

This veil of protection is provided by law to encourage people to take on risks in running their capitalistic ventures. In the eyes of the law, the corporation is a separate entity, that is, it is different and separate from the shareholders. Thus, the corporation is responsible for its debts and not the shareholders. However, this veil is not absolute, and it can be pierced by the creditor if the corporation is not treated as a separate entity.

What?

Well, you are right, in the most part, as the law is intended to be fair. It offers protection for both debtors and creditors. Thus, if you don’t treat the corporation as a separate entity, then your creditors may treat your personal assets as compensation for company debts.

So under what circumstances could this happen?

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2013_04_02__5058When the members decide to dissolve a limited liability company (LLC) in a court proceeding, it is generally the last resort for the aggrieved investors and business owners.  It is an extreme court remedy which is initiated by a lawsuit from a member.  It is often not a preferred outcome, since the members will rarely get market value for their share.  However, it is sometimes the only choice, and the consequences of not filing such a lawsuit could be even worse.

Any member or the manager of an LLC can file a suit in court seeking a decree of dissolution under the circumstances listed below.  These are the grounds for judicial dissolution provided under the California Corporations code §§17005(c), 17351(a), and they cannot be modified or waived in the Article of Incorporation (Article) or Operating Agreement signed by the members.

1.  “It is not reasonably practicable to carry on the business in conformity with the Article or Operating Agreement.”  Corp C §17351(a)(1).

In other words, the economic reasons for forming the LLC and the purpose of operating it are likely to be unreasonably frustrated.  For example, the LLC might have started out manufacturing a product, but due to the changing economy it became more profitable to engage as a service company in product design.  In this example, the LLC’s dissolution can be ordered through a court proceeding.

2.  “Dissolution is reasonably necessary for the protection of the rights or interest of the complaining members.”  Corp C §17351(a)(2).

The term “reasonably necessary” is broad in scope.  Let’s say that you are being unfairly treated by the member who holds a majority of shares of the LLC, and you feel your rights as a minority member are not being honored.  Then under this circumstance, you may ask the court’s assistance to dissolve the LLC.

3.  “The business of the LLC has been abandoned.”  Corp C §17351(a)(3).

In the event that the LLC has stopped conducting business, this provision can be utilized to obtain a formal court dissolution and winding up of the LLC’s business affairs.

4.  “The management of the LLC is deadlocked or subject to internal dissension.”  Corp C §17351(a)(4).

Internal discord is generally the most common reason for the LLC’s members to seek the court’s intervention for dissolution.  This provision merely states that internal dissension or a deadlock must exist, without the need for showing specific details such as dissension resulting in the inability to carry on business as required under judicial dissolution of a corporation.

5.  “Parties in control have been guilty of, or knowingly permitted, persistent and persuasive fraud, mismanagement, or abuse of authority.”  Corp C §17351(a)(5).

Oftentimes, the dysfunction of the members leads to accusations of serious misconduct, mismanagement, fraud, or abuse of authority by members who own the majority share of the LLC Continue reading

IMG_0645When the investors or entrepreneurs set up a limited liability company (LLC) for their business ventures, most of the time they want the endeavor to be successful and lasting. However, there are times when the members will need to dissolve the business affairs of the LLC, either as the result of unforeseeable circumstances or for strategic reasons. The Corporations Code §17350 provides that an LLC shall be dissolved and its affairs wound up after the following events:

1.   At a Time Specified in the Article

During the formation of the LLC, if the investors specify that the LLC will only exist for a definite length of time or if there is a specific date for the termination of the LLC, the LLC may be dissolved when this date has been reached. This is sometimes done when a specific date for terminating an LLC is important to the investor. Before the expiration date, however, the investor can always change or delete this condition from the Article.

2.  Upon an Event Specified in the Article or Operating Agreement

In addition to reaching a specific time for dissolving an LLC, investors can also set a specific event to trigger this, designated either in the Article or the Operating Agreement. For example, the members of the LLC can state that when a specific real estate project is sold, completed, or developed, the LLC will be dissolved. This way, the members can be assured that the LLC they invested in will only serve that particular purpose, and they can always create a new one for a different purpose. This example pertains to real estate transactions. As to the LLC in different segments of business, the condition can be set upon a condition of certain gross sales or net profits being generated for a specific business. Almost any legitimate business purpose can be set as a condition.

3.  By the Majority Vote of the Members

The most obvious method for dissolving an LLC is when the majority of the members vote to dissolve the LLC. This right cannot be waived, and the Operating Agreement cannot withdraw the members’ right to vote on dissolution. However, the Operating Agreement can set a condition for the vote, such as to increase the vote from a majority to unanimity.

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