The May 2014 issue of the ABA Business Lawyer contains forms, drafted by the LLCs, Partnerships and Unincorporated Entities Committee of the ABA Section of Business Law, for single-member LLCs whose members are entities and for single-member LLCs whose members are individuals, with explanatory articles about each of these forms. When my schedule permits, I intend to study all of these materials carefully, and I will share my thoughts about them in this listserv.
Category: Operating agreements
The Utah RULLCA case discussed in this recent post by Doug Batey illustrates the great importance of drafting LLC operating agreements to make crystal-clear when a manager’s actions will bind the LLC and when they will not.
Of all the issues New Hampshire business people should address when forming LLCs, the most important, but also the most neglected, is the issue of what to do when one or more members come to believe that one or more other members are breaching their LLC duties. A very common situation of this kind is when LLC minority members claim they’re being “oppressed” (the technical term for “treated unfairly”) by the majority.
The New Hampshire Revised Limited Liability Company Act (the “Revised Act”) does a much better job in providing for oppression claims than the old act, but it doesn’t provide a magic bullet.
- The old act provided that the minority would have to make its oppression claim in a “derivative action” against the majority—i.e., in a lawsuit not in the minority’s own name but in the name of the LLC itself. The rules governing derivative actions are complex, they are expensive to comply with, and they’ve never made the slightest sense for small, informal LLCs—namely, for 95% of all New Hampshire LLCs.
- The Revised Act didn’t eliminate the right of the minority to bring derivative actions, since, among other considerations, if these actions succeed, the minority will be entitled to reimbursement of their attorneys’ fees—a result otherwise difficult to achieve in New Hampshire courts. However, in new Section 190, the Revised Act also permits minorities to bring “direct actions”—i.e., lawsuits in their own name. In direct actions, successful plaintiffs won’t normally get reimbursement of their attorneys’ fees. But they may get other forms of relief—e.g., generous money damages—that will make their lawsuits worthwhile.
However, direct actions, like derivative actions, have a problem that, for many LLC plaintiffs, can be very serious—namely, that they have to be brought in court. It happens that in New Hampshire, we have a first-rate business court—technically, the “Business Docket” of the New Hampshire Superior Court. This court is fair, smart, fast and reasonably affordable. However, by definition, lawsuits in the Superior Court are public. So they often involve a painful airing of an LLC’s dirty laundry.
So, in their operating agreements, how should New Hampshire business people address the possibility of eventual claims between minority and majority members of their LLCs?
The Revised Act provides the members with four main options for drafting these provisions. Each of these options has major advantages and major disadvantages. I’ve already discussed the main advantages and disadvantages of the first two options—namely, provisions for derivative and for direct actions. The third and fourth options—namely, provisions for mediation and arbitration—aren’t expressly addressed in the Revised Act, but they are unquestionably permitted by it.
- In mediation provisions, the members agree that if they have claims against one another, they must hire a mediator to resolve them. Skilled mediators can work miracles. But mediators can only mediate LLC disputes; they can’t decide them. And often disputes among LLC members are so serious and so bitter that even the most skilled mediators can’t find solutions for them. So mediation provisions in LLC operating agreements, valuable as they may be, should always be accompanied either by provisions for derivative or direct actions, as discussed above, or by arbitration provisions.
- Arbitration provisions in operating agreements usually provide that if members make claims against other members that they can’t resolve among themselves and that mediators can’t resolve, these claims will be finally resolved, without any access to court appeal, by a single arbitrator. In effect, this arbitrator will be a paid private judge for the members. The operating agreement should provide comprehensive rules governing arbitration among the members—for example, rules as to the degree of discretion of the arbitrator in deciding what evidence to admit and what to address in writing arbitration orders.
If these arbitration rules are well drafted, arbitration can often be faster and cheaper than any possible litigation. Furthermore, as in Las Vegas, what happens in arbitration stays in arbitration. Arbitration, like litigation in court, can get very ugly. But at least it will be confidential.
Roughly 60% of all LLCs are single-member LLCs whose members are individuals. Among of the most important provisions of the operating agreements of these LLCs are those providing for the succession of the members’ memberships. These provisions are usually best drafted as providing for the transfer of these memberships under TOD statutes or to the deceased members’ revocable trusts (if they have them). This recent post by Doug Batey in his “LLC Monitor” blog demonstrates the litigation horrors that can arise if the above provisions are not properly drafted.
If you engage in LLC practice long enough, you will eventually be asked to draft an operating agreement that effectively gives continuing control of the LLC to the “dead hand” of the patriarch or matriarch in control of the LLC after his or her death. Some of the issues in this drafting challenge are addressed in the attached post by Peter Mahler in his wonderful blawg called “Business Divorce.”
LLC operating agreements are primarily tools to define and enforce the rights and duties of LLC members and managers with respect to their LLCs. These agreements should also be effective pre-formation teaching tools that will help prospective members and managers decide whether to join LLCs, and they should be effective post-formation users’ manuals that guide LLC members and managers in operating their LLCs.
In order to accomplish any of these goals, operating agreements must be written in plain English, and they must avoid legalisms. The latest American Bar Association Journal contains an excellent article by Bryan Garner, the leading U.S. expert on legal prose style, in which he lists the 12 legalisms he hates most. In my experience, many LLC lawyers make constant use of these legalisms in drafting operating agreements. They shouldn’t.
To read Bryan’s article, click here.
If you’re drafting an operating agreement to maximize the chance that you can attract a highly competent manager to manage the LLC in question or if you’re drafting or reviewing a draft of an operating agreement on behalf of a prospective manager, you need to know a lot about advancement and indemnification provisions in operating agreements and about the hidden issues in these provisions. If you don’t already possess this knowledge, here is an excellent place to start.
Here’s a practice issue I ran into this morning:
Clients for whom you’ve written LLC operating agreements sometimes ask you to amend them. These amendments often take the form of a one- or two-page amendment document with signature blocks for all existing members and for any new ones who are coming on board.
But the greater the number of amendments and the greater the complexity of individual amendments, the more you should be thinking about offering to prepare for your client an “amended and restated” operating agreement—i.e., a revised agreement that integrates into a single, clean revision of the operating agreement all existing amendments to the agreement and any new ones the client is planning. This will make it much easier for the members and for third parties to understand the agreement; they won’t have to flip back and forth among the agreement itself and one or more potentially complicated amendment documents in order to do so.
And drafting the amended and restated agreement might be a nice fee for you.
Lexology is a blawg published by the Association of Corporate Counsel. It is a good source for updates about business law statutory and case law developments both in the U.S. and abroad. I follow it because occasionally it has worthwhile posts about LLC issues. For a current Lexology post on the issue whether LLCs need written operating agreements, click here. The attached post also has a link to an interesting post about California’s new LLC act.
The post under the above link states that only five states—namely, California, Delaware, Maine, Missouri and New York—require operating agreements. I find this interesting, but the fact is that while Delaware does require that LLCs have operating agreements, it doesn’t require that they be written. Thus, I’m a bit skeptical about the above statement as to the other four states mentioned in it.
The obvious reason why clients who are members of multi-member LLCs should have written operating agreements is to provide a secure basis for resolving internal disputes. However, my view (reflected in the New Hampshire Revised Limited Liability Company Act) is that while most smaller multi-member LLCs don’t have written operating agreements, many of these LLCs do have oral or implied operating agreements. I think state LLC acts should respect these agreements despite the obvious risk that they may be difficult or impossible to prove.
Most LLC formations of multi-member LLCs have at least a few unusual features that require special legal attention, and the parties you represent in these formations will often have unique personal needs and interests with respect to their LLC. Tailoring operating agreements to address these realities can take substantial legal work and thus can result in substantial legal fees. But many clients who refuse to authorize this work and to pay these fees will eventually be very sorry that they didn’t.
For an excellent post illustrating these points, read the most recent post in Peter Mahler’s superb blawg entitled New York Business Divorce.