BILL ANALYSIS Ó ----------------------------------------------------------------- |SENATE RULES COMMITTEE | AB 506| |Office of Senate Floor Analyses | | |(916) 651-1520 Fax: (916) | | |327-4478 | | ----------------------------------------------------------------- THIRD READING Bill No: AB 506 Author: Maienschein (R) Amended: 8/17/15 in Senate Vote: 21 SENATE JUDICIARY COMMITTEE: 6-0, 7/7/15 AYES: Jackson, Moorlach, Hertzberg, Leno, Monning, Wieckowski NO VOTE RECORDED: Anderson ASSEMBLY FLOOR: 76-0, 5/7/15 - See last page for vote SUBJECT: Limited liability companies SOURCE: Partnership and Limited Liability Companies Committee of the Business Law Section of the California State Bar DIGEST: This bill seeks to make various changes throughout the California Revised Uniform Limited Liability Company Act. Senate Floor Amendments on 8/17/15 add double-jointing language to avoid chaptering out issues in the event that both this bill and AB 1471 (Perea), also amending Section 17710.06 of the Corporations Code, are enacted. The amendments also add double-jointing language to avoid chaptering out issues in the event that both this bill and AB 1517 (Committee on Banking and Finance), also amending 17713.12 of the Corporations Code are enacted. ANALYSIS: Existing law: 1) Governs all California limited liability companies (LLCs) AB 506 Page 2 under the California Revised Uniform Limited Liability Company Act (RULLCA) and defines various terms for purposes of RULLCA. 2) Prohibits an LLC operating agreement from doing certain things, including: Eliminating the duty of loyalty, the duty of care, or any other fiduciary duty, subject to other specified provisions; Eliminating the contractual obligation of good faith and fair dealing under specified provisions of Corporations Code (CORP) Section 17704.09, subject to other provisions allowing for the operating agreement to modify the fiduciary duties of a member or manager, as specified; Unreasonably restricting the duties and rights stated under CORP Section 17704.10, which provides for the right to inspect various LLC documents, the right to a specified annual report for members in an LLC of more than 35 members, among other things, and, the right to a copy of the articles of incorporation or operating agreement, as specified; Varying the requirements of CORP Sections 17707.04 to 17707.08, inclusive, relating to the dissolution of an LLC, except as specified; Restricting the right to approve a merger, conversion, or domestication under CORP Section 17710.14 to a member that will have personal liability with respect to a surviving, converted, or domesticated organization; Varying any Article 10 provision, relating to mergers and conversions, or any Article 12 provision, relating to class provisions; or Eliminating the obligation of good faith and fair dealing under specified provisions of CORP Section 17704.09, but the operating agreement may prescribe the AB 506 Page 3 standards by which the performance of the obligation is to be measured, if the standards are not manifestly unreasonable. 1) Provides that, except as provided in the provisions above and other specified laws, the RULLCA provisions may be varied as among the members or as between the members and the LLC by the operating agreement, provided, however, that certain provisions can only be varied by a written operating agreement, including CORP Sections 17701.13 (relating to the designation of an agent for service of process and required records that an LLC must maintain), 17703.01 (providing that every member is an agent of an LLC unless the articles of organization state that the LLC is manager-managed, at which point only the manager has agency power), 17704.07 (providing specified rules governing an LLC depending on whether it is member- or manager-managed), and 17704.08 (requiring reimbursement of any payments and indemnification of any debt, obligation, or other liability incurred by a member or manager in the course of his or her activities on behalf of the LLC, and authorizing the purchase of insurance for indemnification purposes). 2) Specifies that, notwithstanding prior statements, and in addition to the matters specified in the provisions above, the operating agreement must not: Vary the RULLCA definitions, as specified, except as specified therein; or Vary a member's rights under specified law that provides that every member is an agent of an LLC unless the articles of organization state that the LLC is manager-managed at which point only the manager has agency power; or other specified law, which provides for the right to inspect various LLC documents; the right to a specified annual report for members in an LLC of more than 35 members, among other things; the right to a copy of the articles of incorporation or operating agreement, as specified. 1) Governs distributions made by an LLC before its dissolution AB 506 Page 4 and winding up. 2) Provides that an LLC is a member-managed LLC unless the articles of organization and the operating agreement do either of the following: Expressly provide that the LLC is or will be "manager-managed" or "managed by managers" or that management of the LLC is or will be "vested in managers;" or Include words of similar import. 1) Specifies that in a member-managed LLC, certain rules apply, including that a difference arising among members as to a matter in the ordinary course of the activities of the LLC shall be decided by a majority of the members of the LLC which the difference among the members has arisen. 2) Specifies that in a manager-managed LLC, certain rules apply, including that the consent of all members of the LLC is required to: Sell, lease, exchange, or otherwise dispose of all, or substantially all, of the LLC's property, as specified; Approve a merger or conversion under the corresponding RULLCA article; Undertake any other act outside of the ordinary course of the LLC's activities; or Amend the operating agreement. 1) Specifies that in a manager-managed LLC, a manager may be chosen at any time by the consent of a majority of the members and remains a manager until a successor has been chosen, unless the manager at an earlier time resigns, is removed, or dies, or, in the case of manager that is not an individual, terminates. A manager may be removed at any time by the consent of the majority of the members without notice or cause. AB 506 Page 5 2) Provides, generally, that members have the right to vote on a dissolution of the LLC and on a merger of the LLC as provided under specified law. 3) Requires an LLC to reimburse for any payment made and indemnify for any debt, obligation, or other liability incurred by a member of a member-managed LLC or the manager of a manager-managed LLC in the course of the his or her activities on behalf of the LLC, if, in making the payment or incurring the debt, obligation, or other liability, the member or manager complied with specified statutory fiduciary duties, duties of loyalty, and duties of care. 4) Authorizes an LLC to purchase and maintain insurance on behalf of a member or manager of the LLC against liability asserted against or incurred by the member or manager from that status, even if the operating agreement could not eliminate or limit the person's liability to the LLC for the conduct giving rise to the liability, under specified law. 5) Provides various rules for when a person dissociates as a member of the LLC. 6) Includes various provisions governing suits for judicial dissolution. 7) Requires that any certificate or statement of conversion be executed and acknowledged by all members, except as specified. This bill: 1) Replaces references to a "holder of a transferable interest in the limited liability company" with "transferee," to reflect correct RULLCA terminology, and also corrects references to "majority in interest," which is not defined by RULLCA. 2) Revises and corrects cross-references throughout various RULLCA provisions and adds missing cross-references to conform potentially conflicting sections. AB 506 Page 6 3) Modifies specified references to participation in the management or conduct of activities of the LLC to clarify that "participate" includes the right to vote. 4) Revises the definition of "electronic transmission by the limited liability company" by removing the requirement that the electronic transmission also satisfy requirements set forth under specified federal law. 5) Expands the definition of "person" to include a trustee of a trust, including, but not limited to, a trust described under the Probate Code, as specified. 6) Modifies the provisions limiting what an operating agreement can do by: Adding or otherwise revising various cross references; Consolidating potentially duplicative language prohibiting the elimination of the obligation of good faith and fair dealing by, instead, providing that, subject to specified law, the operating agreement shall not eliminate the contractual obligation of good faith and fair dealing under existing law, as specified, but the operating agreement may prescribe the standards by which the performance of the obligation is to be measured, if the standards are not manifestly unreasonable as determined at the time the standards are prescribed; Repealing the language prohibiting an operating agreement from unreasonably restricting the duties and rights under specified law, which provides for the right to inspect various LLC documents; the right to a specified annual report for members in an LLC of more than 35 members, among other things; the right to a copy of the articles of incorporation or operating agreement, as specified; Expanding the general prohibition against varying the requirements of CORP Sections 17707.04 to 17707.08, AB 506 Page 7 inclusive, relating to the dissolution of an LLC, to apply more generally to the RULLCA article on dissolution and winding up, as well as the RULLCA article on LLC formation; and Prohibiting the varying of specified provisions relating to the application of RULLCA. 1) Adds a provision to an existing statute on the dissolution and winding up of an LLC to specify that the profits and losses of an LLC shall be allocated among the members, and among classes of members, in the manner provided in the operating agreement. If the operating agreement does not otherwise provide, profits and losses must be allocated in proportion to the value, as stated in the required records, of the contributions the LLC has received from each member. 2) Modifies existing law, above, to provide, instead, that an LLC is a member-managed LLC unless the articles of organization contain a statement to the effect that the LLC is to be manager-managed, as required under specified law. 3) Modifies an existing rule for member-managed LLCs, above, to instead provide that a difference arising among members as to a matter in the ordinary course of the activities of the LLC shall be decided by a majority of members. 4) Modifies the existing rule for member approvals required for certain activities by a manager-managed LLC, above, to remove the requirement that an LLC obtain all members' consent to amend the operating agreement and to approve a merger or conversion under the RULLCA article on mergers and conversions and would, instead, provide that consent of all the LLC members is required to: Sell, lease, exchange, or otherwise dispose of all, or substantially all, of the LLC's property, as specified; or Except as otherwise provided in the article on mergers or conversions, any other act outside of the ordinary course of the LLC's activities. AB 506 Page 8 1) Modifies the existing rule for the removal of a manager of a manager-managed LLC, above, to repeal language authorizing the LLC to remove a manager at any time, upon consent of a majority of the members, without notice. This bill provides, instead, that the manager can be removed at any time by the consent of a majority of members without cause, subject to the rights, if any, of the manager under any service contract with the LLC. 2) Adds that members also have the right to vote on any conversion of the LLC to another business entity, under specified law. 3) Adds that, except as provided under specified law (allowing for an operating agreement to alter or eliminate the indemnification for a member or manager, and to eliminate or limit a member or manager's liability to the LLC and members for money damages, except as specified), an LLC may reimburse any payment made and indemnify any debt, obligation, or other liability incurred by other persons, including, without limitation, any officer, employee, or agent of the LLC, in the course of that person's activities on behalf of the LLC. 4) Expands the existing authorization for an LLC to purchase and maintain liability insurance for "members" and "managers," above, to instead authorize the purchase and maintenance of insurance for any person. 5) Requires, without limiting the requirement to reimburse any payment and indemnify any debt, obligation or other liability incurred by a member of a member-managed LLC or manager of a manager-managed LLC, as specified, that an LLC indemnify an agent of the LLC to the extent that the agent has been successful on the merits in defense or settlement of any claim, issue, or matter in any proceeding in which the agent was or is a party or threatened to be made a party by reason of his or her status as an agent of the LLC, against expenses actually and reasonably incurred by the agent, if the agent acted in good faith and in a manner that the agent reasonably believed to be in the best interests of the LLC and its members. This bill also defines the terms "agent," AB 506 Page 9 "expenses," and "proceeding," for these purposes. 6) Adds a provision specifying that if a member dies, or a guardian or conservator of the estate is appointed for the member, or a member's interest is being administered by an attorney in fact under a valid power of attorney, the member's executor, administrator, guardian, conservator, or other legal representative may exercise all of the member's rights for the purpose of settling the member's estate or administering the member's property, including any power the member had under the articles of organization or an operating agreement to give a transferee the right to become a member. 7) Specifies that nothing in the existing provisions governing suits for judicial dissolution shall be construed to limit the remedies otherwise available to a court of competent jurisdiction over the dissolution. 8) Modifies existing law to instead require that the certificate or statement of conversion be executed and acknowledged by all members of a member-managed LLC or all managers of a manager-managed LLC, unless a lesser number is provided in the articles of organization or operating agreement and meets specified requirements. 9) Makes other technical, or clarifying changes. Background A California LLC is a hybrid between a partnership and corporation in that it generally has the characteristics of a partnership for operational and taxation purposes, but its members enjoy the immunity provided by a corporation to its shareholders for contract debts or tort liability. The interest of a member in an LLC is an economic interest, in the same manner that a partnership interest or a corporate share is an economic interest, which may be transferred under terms and conditions provided by the LLC agreement, the partnership agreement, or the corporate structure. California first recognized LLCs in 1994 with the enactment of the Beverly-Killea Limited Liability Company Act AB 506 Page 10 (Beverly-Killea), which provided comprehensive provisions for the organization, management, and dissolution of LLCs. That same year, the National Conference of Commissioners on Uniform State Laws (NCCUSL) approved the use of a Uniform Limited Liability Company Act. In 2006, after reviewing the development of LLC laws in the United States, NCCUSL adopted RULLCA. In 2012, SB 323 (Vargas, Chapter 419, Statutes of 2012) was enacted to repeal Beverly-Killea and, taking into account California's particular LLC protections, replace it with a modified version of RULLCA. This bill makes various changes to those RULLCA provisions. Comments As stated by the author: This bill would amend the Revised Uniform Limited Liability Company Act ("RULLCA") which took effect January 1, 2014. It will fix certain cross referencing and typographical errors and inconsistencies in RULLCA that make it difficult to understand and less attractive to business owners and investors. It eliminates an inconsistency on what vote is needed to accomplish a merger or conversion and creates indemnification rights for agents similar to those afforded agents of California corporations. It also clarifies RULLCA's transition rules to avoid potential disputes as to whether RULLCA or prior law, the Beverly-Killea Limited Liability Company Act ("Beverly-Killea"), governs the limited liability company ("LLC"). FISCAL EFFECT: Appropriation: No Fiscal Com.:NoLocal: No SUPPORT: (Verified8/17/15) Partnership and Limited Liability Companies Committee of the Business Law Section of the California State Bar (source) Conference of California Bar Associations AB 506 Page 11 OPPOSITION: (Verified8/17/15) None received ASSEMBLY FLOOR: 76-0, 5/7/15 AYES: Achadjian, Alejo, Travis Allen, Baker, Bigelow, Bloom, Bonilla, Bonta, Brough, Brown, Burke, Calderon, Chang, Chau, Chávez, Chiu, Chu, Cooley, Cooper, Dababneh, Dahle, Daly, Dodd, Eggman, Frazier, Beth Gaines, Gallagher, Cristina Garcia, Eduardo Garcia, Gatto, Gipson, Gomez, Gonzalez, Gordon, Grove, Hadley, Harper, Holden, Irwin, Jones, Jones-Sawyer, Kim, Lackey, Levine, Linder, Lopez, Low, Maienschein, Mathis, Mayes, McCarty, Medina, Melendez, Mullin, Nazarian, Obernolte, O'Donnell, Olsen, Patterson, Perea, Quirk, Rendon, Ridley-Thomas, Rodriguez, Salas, Santiago, Mark Stone, Thurmond, Ting, Wagner, Waldron, Weber, Wilk, Williams, Wood, Atkins NO VOTE RECORDED: Campos, Gray, Roger Hernández, Steinorth Prepared by:Ronak Daylami / JUD. / (916) 651-4113 8/18/15 17:18:11 **** END ****