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November 3, 2015
Washington's New Limited Liability Company Act -- Informational Overview
Attorneys: 

A new and updated version of the Washington Limited Liability Company Act ("New Act") will take effect on January 1, 2016. The New Act will impact not only current and future Washington LLCs, but it will also impact individuals and entities engaging in business with a Washington LLC. While the New Act fully supplants the current Limited Liability Company Act ("Current Act"), the following changes are those most likely to impact the way business is done in Washington. If you feel that these changes may impact you or your business, or if in light of these changes, you believe that altering your business practices would prove beneficial, we at Eisenhower Carlson invite you to contact us and discuss your needs.

LLC Agreements

The New Act defines an LLC agreement as any agreement among the members of the LLC concerning the affairs of the LLC, "whether oral, implied, in a record, or in any combination." This is a significant shift from the Current Act, which required that all LLC agreements be in writing. Oral agreements can easily be misstated or misunderstood and members of an LLC may inadvertently amend a written LLC agreement through an offhanded statement. To mitigate the opportunities of misunderstanding and mistake, you should ensure that your LLC agreement expressly states that all agreements and amendments must be made in writing.

Fiduciary Duties

A fiduciary duty is a legal duty to act in another party's interest. Unlike the Current Act, the New Act establishes a default set of fiduciary duties owed by managers of the LLC. The effect of establishing these default duties will actually limit the degree of default duties owed. Under the New Act, managers of an LLC owe the following fiduciary duties:

1.  The duty of loyalty, which is the duty to:
a.  account to the LLC and hold as trustee, any property, profit, or benefit derived in the conduct and winding up of the LLC's activities, from the use of LLC's property, or by the appropriation of an LLC opportunity;
b.  refrain from dealing with the LLC as or on behalf of a party having an adverse interest; and
c.  refrain from competing with the LLC.

2.  The duty of care, which is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law in the conduct and winding up of the LLC's activities.

An LLC agreement under the New Act may include provisions that expand or narrow the duties owed by an LLC manager, provided that such provisions do not eliminate or limit (i) the liability of a manager for acts that involve intentional misconduct or knowing violations of the law; (ii) the duty not to make a distribution in violation of the LLC agreement that would leave the LLC unable to pay its debts; or (iii) the implied contractual duty of good faith and fair dealing.

However, without any provisions expanding or narrowing the duties owed by managers, the default duties under the New Act will control. Each LLC is different, and depending on the nature of your LLC and its business, these default duties may not be the best fit.

Management Structure

The New Act provides significantly more flexibility as to the management of the LLC. Under the Current Act, the certificate of formation dictated whether an LLC is member-managed or manager-managed. Under the New Act, however, the provisions of the LLC agreement govern, and an LLC may shift from member-managed to manager-managed, and vice versa, via an amendment to the LLC agreement. This alleviates the need to file a change of management structure with the Secretary of State.

Board Management

While the Current Act permits an LLC to be managed by multiple managers, the New Act now permits a board to carry out management duties. The difference, while subtle, is in the relationship an individual member of a management board has with an LLC. Managers in a multiple-manager system are all agents of the LLC, capable of acting and making commitments on behalf of the LLC. In contrast, in a board-managed system, only the board is an agent; individual board members are not agents and may not act on behalf of the LLC.

Understanding this difference is important. If your LLC is managed either by multiple managers or a management board, you should review your LLC agreement to ensure that system best fits your LLC's needs.

Records Requests

A particularly cumbersome change under the New Act is the expansion of record request rights of members. The following is a list of company records that must be maintained by the LLC and may be requested by all members and for any purpose:

  • A copy of the LLC's certificate of formation and all amendments thereto;
  • A copy of any written limited liability company agreement and any written amendments;
  • Unless contained in the LLC's certificate of formation, a written statement of: (a) the amount of cash and agreed value of benefits contributed and to be contributed by each member; (b) the times or events that trigger each member's additional contributions; and (c) any right of a member to receive distributions that include a return of all or any part of a member's contribution; and any events that will trigger the LLC's dissolution;
  • The LLC's three most recent federal, state, and local tax returns;
  • The LLC's three most recent years' financial statements;
  • Copies of any consents or votes of the members for the past three years;
  • The LLC's three most recently filed annual reports;
  • Any filed articles of conversion or merger; and
  • Any certificate of dissolution or certificate of revocation of dissolution.

Upon demand by a member, an LLC has just ten days to inform the member of (a) what records the company will provide; (b) when and where they will provided; and (c) if the LLC declines to provide any records, the reason for declining.

While the list of records cannot be reduced by agreement, an LLC may establish procedures for requesting company records, provided the new procedures do not "unreasonably restrict" a member's right to records. Further, given the sheer volume of records that LLCs are now required to maintain, it would also be wise for LLCs to adopt a retention plan for the above referenced documents. Regardless of the approach to these changes, every LLC is subject to these new records request regulations and should be prepared to comply.

Voting Rules

The New Act establishes a default rule that members vote on a per capita basis (one member, one vote), irrespective of the value of member contributions to the LLC. In effect, the default rule under the New Act would give a member that made 70% of the contributions to the LLC the same voting power as a member that made 30% of the contributions.

The "one member, one vote" default rule is likely inconsistent with the expectations of most LLC owners. If your LLC agreement is silent on voting procedures, it may be beneficial to discuss with the other members of your LLC the ramifications of relying on the default voting rules.

Non-Voting Class Permitted

Clarifying the ambiguity under the Current Act, the New Act expressly permits an LLC to have members without voting rights. While this may not be a monumental shift since it was assumed in the Current Act, this clarification clarifies the ability for LLC's to establish different classes, including non-voting classes, of membership rights.

Non-Profit LLCs

Not-for-profit organizations in Washington now have the option of operating as an LLC, as the New Act permits LLCs to be formed "for any lawful purpose, regardless of whether for profit." This may prove to be an attractive option for  not-for-profit organizations that are looking for an alternative to not-for-profit corporations or trusts.

However, just because an LLC can operate as a not-for-profit organization does not necessarily mean it will necessarily qualify as a tax-exempt organization under the Internal Revenue Code. While the Internal Revenue Service does not dictate the form in which to organize a tax-exempt organization, qualifying for tax-exempt status requires satisfying several formalities, many of which might deter organizations from choosing an LLC as their choice of entity.

Distributions

The New Act offers two safe harbors for members receiving and/or approving improper distributions.  Like the Uniform Limited Partnership Act, it expressly states that an LLC may base a distribution determination on financial statements or fair valuations that are reasonable under the circumstances.  Also, members in a member-managed LLC cannot be found personally liable for receiving improper distributions if their LLC agreement relieves the receiving member of the authority to make and responsibility to consent to distributions, and the member did not know the distribution was improper. In addition to these new protections, the New Act shortens the statute of limitation for claims based on improper distributions from three years to two years.

Additionally, the New Act restricts the rights of members to receive distributions (a) occurring during dissolution and winding up, (b) on account of disassociation, or (c) that are otherwise in a form other than money. These changes will impact different LLCs in significantly different fashions, so be sure to understand these changes before making any LLC distributions.

Transfers of LLC Interests

Provisions in the New LLC Act governing transfers of LLC interests have also been patterned after the Uniform Limited Partnership Act. Under the New Act, judgment creditors of a member can still obtain a charging order against the member's transferable interest, but the order now constitutes a lien on the member's interest.  That lien may be foreclosed, and upon foreclosure the purchaser obtains the rights of a transferee.  If necessary, a court may also appoint a receiver to act in the place of the member.  However, the rights of a transferee under the New Act are limited and do not include the transferee's ability to participate in management and decision-making of the LLC, or the right to obtain information other than limited information during the winding-up of the LLC.

Other Changes

As the New Act will entirely supplant the Current Act, there are certainly changes that were not discussed herein. Should you want to discuss any effect that the changes in the New Act may have on your business, we invite you to contact us. 

Disclaimer

This advisory is a publication of Eisenhower Carlson PLLC. Our purpose in publishing this advisory is to inform our clients and friends of recent legal developments. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations.

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