A limited liability company or “LLC” is a form of business entity often used to hold business or investment assets, particularly if the asset presents some financial risk to the owner. For example, an individual purchasing a duplex to rent out might set up an LLC to hold title to the duplex in order to avoid personal liability if a tenant sues for injury occurring on the property. An LLC provides limited liability to members, is generally taxed as a pass-through entity (no separate tax return is filed) and has a flexible management structure. On April 11, 2014, the Minnesota legislature adopted the Minnesota Revised Uniform Limited Liability Act (“New Act”). The New Act makes significant changes to the current limited liability company (“LLC”) law in Minnesota, specifically the default rules for voting rights of members, distribution rights, dissenter’s rights and duties owed by LLC members are modified as discussed further below.
If an LLC does not wish to have the New Act’s default rules apply, an operating agreement should be adopted to specify which default rules the LLC will retain or modify. The New Act broadens the definition of an operating agreement to include oral agreements, agreements implied by conduct or any combination of these forms (written, oral or implied). Therefore, if a written operating agreement is not adopted, this broadened definition could allow a member to assert certain rights (such as voting rights or distribution rights) based on an oral agreement or previous conduct.
The New Act modifies the default rule for voting rights. Under the current law, a member has voting rights in proportion to the value of his or her contribution to the LLC. The default rule under the New Act provides equal voting rights for each member, which is likely a deviation from what most LLC members would choose. For example, under the New Act, if one member contributes 80% of the assets and one member contributed 20% of the assets, the member contributing 80% of the assets would only have voting rights equal to the other member(s). This will be an important issue to address in an operating agreement.
Similarly, the default rule in the New Act for operating distributions provides that each member will receive equal operating distributions instead of distributions based on the member’s percentage of contribution. However, distributions at dissolution (when the LLC is terminated) will be made first to each member based on the member’s percent of contribution, and then any remaining assets will be distributed in equal shares to each member.
The default rules under the New Act for both voting rights and distributions are likely contrary to the wishes or assumptions of individual and entities forming or operating an LLC. Therefore, it will be crucial to have an operating agreement that specifically addresses both issues.
Duties of LLC Member
The New Act also permits the modification of certain duties a member of an LLC owes to the LLC. Under the current law, a member owes a duty of loyalty which requires a member to act in the best interests of the LLC. A member also owes a duty of care to make decisions with a level of care that an ordinary prudent person would exercise in similar circumstances. The New Act permits members to reduce or modify the duty of loyalty and care. The duty of care can be restricted to the extent such restriction is not “manifestly unreasonable,” except the restriction cannot authorize intentional misconduct or illegal conduct. The duty of loyalty can be completely eliminated to the extent not “manifestly unreasonable.” The New Act also imposes a duty of good faith and fair dealing, which is not addressed in the current law.
Finally, the New Act also eliminates a dissenting member’s right to obtain payment for the fair market value of the member’s interest in the LLC in certain circumstances (such as the transfer or disposition of assets) when the member dissents from a decision made by the LLC. The New Act does not provide for a dissenters’ right to be bought out in such circumstances. Under the current law, this right is often waived by LLC members; however, a member with minority voting rights that were not specifically waived under the current law should consider including provisions in an operating agreement that address dissenter’s rights.
The New Act is effective August 1, 2015 for new LLCs and January 1, 2018 for existing LLCs. An LLC formed prior to August 1, 2015 can choose to opt-in or wait until January 1, 2018 when the New Act will apply to every LLC formed in Minnesota.
In sum, the New Law significantly alters the law governing LLCs in Minnesota and any member of an existing or newly formed LLC should consider how the new law will affect the LLC.
Mia E. Thibodeau is an attorney with Fryberger, Buchanan, Smith & Frederick, P.A., and practices in the areas of family law, estate planning, real estate and municipal law.