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The limited liability company (LLC) has been used with increasing frequency over the past decade due to the ease of its creation and the flexibility in its administration and operation. However, before forming an LLC, business owners need to be aware of how new legislation in Utah will affect them and their business in order to avoid potentially costly results.
Oral Operating Agreement
The Utah Revised Uniform Limited Liability Company Act (the LLC Act), effective Jan. 1, 2014, was created in an attempt to recognize the realities of operating an unincorporated business entity. One of the more impactful provisions of the new LLC Act is the recognition of oral or even implied operating agreements. Given that an estimated 40 percent or more of multiple-member LLCs do not have a written operating agreement, this is a significant departure from prior Utah law. While this change could help resolve problems that might occur without a written operating agreement, it could also lead to disastrous results as disputing members of an LLC attempt to establish the terms of an oral agreement. This statutory change could be even more problematic when considered in tandem with other provisions of the LLC Act.
For example, the new LLC Act imposes a duty of loyalty on those that manage the LLC. This duty includes the obligation of a member or manager to account for business opportunities taken by the member or manager that might have been taken by the LLC. An operating agreement may not eliminate this obligation, but the operating agreement may provide how an action in violation of this duty may otherwise be authorized. However, if the operating agreement is oral or implied, a dispute could easily arise as to whether the members or managers agreed to authorize actions that would otherwise be considered to be violations of this imposed duty.
The LLC Act also imposes an obligation of good faith and fair dealing. So long as the provisions of the operating agreement are not unconscionable or against public policy, they may establish the standards by which the performance of this obligation is to be measured. Again, if the operating agreement is oral, such standards could potentially be subject to many interpretations, easily resulting in conflicts among the members and managers.
Another potential problem with an oral operating agreement relates to the admission of new members to the LLC. Any person who becomes a member of an existing LLC will be deemed to have agreed to and will be bound by the terms of any existing operating agreement. If the original members do not accurately and completely communicate to the new member the terms of the oral operating agreement, the new member could theoretically have a different set of terms to which he or she is bound under the operating agreement. This inconsistency among the members could very well be the beginning of a legal nightmare for the members.
An oral operating agreement is not the only wrinkle an LLC may face. Under the new LLC Act, a limited liability company’s articles of organization are no longer required to identify the members or managers that have authority to act on behalf of the company. This could limit the company’s ability to enter into contracts, which would hinder its business opportunities. Similarly, banks will not lend money to LLCs without having assurances of the authority of those signing the loan documents. Fortunately, the LLC Act allows the company to file a statement of authority identifying those who may bind the company under contract, so third parties engaging in transactions with the company may rely on this filed statement of authority.
Another issue of which a member or manager should be aware relates to the payment of excessive distributions. While an LLC may have previously had claims against members who received greater distributions than they should have received, the new LLC Act provides that a member or manager consenting to a wrongful distribution may be personally liable for the amount of any distribution that is deemed excessive.
While the new LLC Act may not immediately apply to an LLC, members and managers will not have much time to determine how the LLC Act affects them. The new LLC Act will govern (a) all Utah limited liability companies formed on or after Jan. 1, 2014, and (b) all Utah limited liability companies registered in the state of Utah as of Jan. 1, 2016, regardless of when the company was formed. Additionally, members or managers of existing LLCs can make an early election to have their company immediately governed by the LLC Act.
To determine whether to make such an election or to learn how the LLC Act will affect their companies, members or managers should consider seeking legal advice to avoid potential pitfalls and to take advantage of any beneficial provision of the LLC Act.
John H. Rees and David J. Langeland are shareholders with the law firm Callister Nebeker & McCullough.