Enacted in September of 2012, on March 18, 2013 New Jersey’s Revised Uniform Limited Liability Company Act (sometimes referred to as “RULLCA” but hereinafter called the “Revised Act”) became effective. The Revised Act applies to any LLC formed on or after March 18, 2013; and, beginning on April 1, 2014, it applies to all LLC’s formed before March 14, 2013 pursuant to the New Jersey Limited Liability Company Act (the “Prior Act”).
Most of the of the provisions of the Revised Act are “default provisions”, meaning that they only apply if there is no Operating Agreement or if the written Operating Agreement provides otherwise. Because the Revised Act differs from the Prior LLC Act in a number of material respects, the Operating Agreements for LLCs formed before March 18, 2013 under the Prior Act should be reviewed with the LLC’s attorney to consider the potential impact of certain provisions of the Revised Act and whether there should be amendments to specifically override those provisions.
Here are some of those differences:
As to Distributions
Absent an Operating Agreement which provides otherwise, distributions and allocations of income and losses to members are per capita instead of in proportion to the agreed value of their respective capital contributions. This means, for example, that if there are three members, one with an 80% interest and with the other the other two members each having a 10% interest and their capital contributions are not equal or proportionate to their LLC Percentage Interests, the distributions will be one-third each.
As to Management
If the LLC is managed by the members and not by a manager, absent a contrary provision in an Operating Agreement, management decisions will be made by vote or consent of the members, per capita, not as in the Prior Act on the basis of their respective LLC Percentage Interests in profits and losses and with a majority vote or consent to control. Furthermore, even in a manager-managed LLC, absent a contrary provision in an Operating Agreement, a unanimous vote or consent of member is required for certain major matters, including sale of all or substantially all of the LLC’s assets.
Remedies for Oppression and Other Wrongful Acts
The Revised Act, borrowing in part from the New Jersey Business Corporation Act, provides in Section 701 that a member may apply to a Court for an order dissolving the LLC or for other court ordered remedies on the ground that the managers or those members in control of the LLC have acted, are acting or will act in a manner that is illegal or fraudulent or have acted or are acting in a manner that it oppressive and was, is, or will be directly harmful to the applicant. The other remedies might be the appointment of a fiscal agent or provisional managing member, sale of the applicant’s membership interest to the oppressors or sale by the oppressors to the applicant. The Revised Act provides that an Operating Agreement cannot alter a court’s power to decree dissolution for oppression but can waive the other new remedies.
Voluntary Withdrawal of a Member
The Revised Act provides that a member who wants to withdraw and service a notice of resignation is not automatically entitled, as under the Prior Act, to be paid the fair value of the withdrawing member’s LLC Interest and to special distribution. Instead, a resigning member is disassociated as a member-thereafter having an economic interest but no voting or other member rights.
The Prior Act provides only for permissive indemnification of managers and members. Thus a member of manager of an LLC is not entitled to be indemnified by the LLC except to the extent provided by the common law principals of agency law. The Revised Act has requirements, in part modeled on the provisions of New Jersey’s Business Corporation Act, for an LLC to indemnify and hold harmless members and managers of the LLC, which requirements are mandatory unless the Members provide otherwise in the Operating Agreement.
ADDRESSING DEADLOCK AND EVENTS OF DISSOCIATION IN THE OPERATING AGREEMENT
Philip L. Chapman
Lum, Drasco & Positan, LLC
- A deadlock can occur where there is an even number of members entitled to vote and voting and the governance provisions of the Operating Agreement do not cover this contingency.
- If the Operating Agreement says nothing about the consequences of a deadlock, while RULCA does not have a specific provision for a member or members to make application to the Court, I believe a member or members could do so pursuant to J.S.A. 42:2C-48(a)(4)(b) to seek dissolution or an alternate remedy because deadlock on the particular issue makes it not reasonably practicable to carry on the company’s activities in conformity with one or both of the company’s certificate of formation and the operating agreement.
- Furthermore J.S.A. 42:2C-48(b) provides that in such instance the court may appoint a custodian or one or more provisional managers in a summary proceeding or order the sale of a member’s interest.
- It may be counter-productive to address this issue on formation such matters might result in the parties changing their minds about going into business.
- In an LLC which owns and leases real estate which involves a lesser number of issues than a personal service or product company, sometimes the deadlock breaking provision entails the following:
A member (an “Offeror”) can make an offer to purchase the interest of the other member (the “Offeree”) and if the Offeree not accept the offer, he or she must purchase the Offeror’s Interest at the same price and upon the same terms and conditions
- However, if they want to address possible deadlock, they could designate a mutually trusted third party to cast a deciding vote but not in a formal arbitration. It will not be easy to find a person who will do this, for free or even for compensation. A provision dealing with this would have to contain details dealing with time line lines, what if the designee declines or fails to act, compensation if any, and provision analogous to binding arbitration-the third party’s decisions controls.
- In the alternative they could provide in the Operating Agreement for non-binding mediation.
- J.S.A. 42:2C-2 (Definitions) does not define “dissociation”, but it means the person ceases to be a member.
- J.S.A. 42:2C-46, entitled “Events causing Dissociation,” provides that a person is “dissociated” as a member in case of certain events; and in subsection (e) one of those events it that on application by the Company (and not the superseded LLC Act which states on application by the Company or a member) the person is expelled by judicial order because the person
- has engaged, or is engaging, in wrongful conduct that has adversely and materially affected, or will adversely and materially affect, the company’s activities;
- has willfully or persistently committed, or is willfully and persistently committing, a material breach of the operating agreement or the person’s duties or obligations under section 39 of this act [relating to standards of conduct for members and managers];
- has engaged, or is engaging in conduct relating to the company’s activities which makes it not reasonably practicable to carry on the activities with the person as a member.
- Under J.S.A. 42:2C-47 (Effect of Person’s Dissociation as Member):
- The person loses any right to vote.
- If the person is expelled pursuant to subsection (e) of J.S.A. 42:2C-46 the court may order a sale of the expelled member’s interest in the company.
- In professional LLCs and Professional Corporations (e.g., for doctors, lawyers, architects, engineers) it is customary to have provisions for mandatory departure from the entity in case of a loss of the required license to practice or in case of certain types of disreputable conduct.
- However, for other types of businesses I recommend that the parties do not try to define what activities by a Member would constitute grounds for an application to the Court to expel the member under subsection J.S.A. 42:2C-46(e)(3).
- For the Court’s approach to an application to expel a member under J.S.A. 42:2C-46(e)(3) and its predecessor provision in the prior LLC Act, see the Supreme Court’s opinion in I.E. Test v. Kenneth Carroll, 226 N.J. 166 (2016), 2016 WL 4086260.