Changes in LLC Laws May Catch Businesses Unaware

Posted on Jan 30, 2016

Big changes are coming to the laws that govern Washington state Limited Liability Corporations (LLCs), and not everyone is prepared. When the new state law went into effect on Jan. 1, some businesses are at higher risk than others, said Michael Royse, associate attorney at Eisenhower Carlson PLLC in Tacoma. 

Specifically, mom and pop operations that may not regularly examine their operating agreements could be caught off guard.

“The people who are familiar with the terms of their operating agreement are much better positioned to deal with the new act,” he said.  “The changes are pretty easy to account for, if you know what’s in your agreement.”

For most businesses, the pertinent parts of the new act involve changes in operating agreements and governance. These include: 

Oral and implied agreements are considered valid 

Currently, all LLC agreements must be in writing. Under the new act, both oral and implied agreements will be recognized as valid, which may lead to interesting complications, said Royse. 

“You could end up with an inadvertent amendment,” he said. “Imagine an LLC member who is a 70 percent equity owner with a partner who owns 30 percent. In a casual conversation, the majority owner might say, ‘I would never make a decision without you.’ It wouldn’t be the intent, but you could argue that that was an amendment.”

The solution is to put a clause into their LLC operating agreement that dictates no oral modification agreements. “Businesses may have been operating under a certain sense of safety, but all are subject to the act,” he said. “Make sure to say that all agreements need to be in writing.” 

Steven Elliott, a CFA and partner at Capstone Investment Group LLC, said the act hasn’t changed how his business operates. “We’re still going to work off of the principle that everything needs to be in writing and signed,” he said. “You’re not going to know how this will be interpreted until someone sues someone else and it sticks.” 

Changes in fiduciary responsibilities

Michael RoyseUnder the current law, no explicit standards are laid out for managers or member-managers of LLCs. “There isn’t a prescribed set of duties, so the courts had to more or less make them up,” said Royse. “Most relied on the Uniform Partnership Act, which sets a really high standard.”

Now, said Kalin Bornemann, associate attorney at Harlow and Falk LLP in Tacoma, the duties that managers and member-managers owe to the LLC are expressly described, and limited to the duty of care and the duty of loyalty. “The intent is to make it clearer for everyone,” he said. The duty of loyalty can be tweaked within the operating agreement.  

“It’s a lower threshold,” said Royse. “Now, a business can compete against other LLCs and there’s a lot of flexibility about how to manage. Before, you couldn’t do that.”  

As registered investment advisors, Capstone Investment Group won’t be impacted by this change. “We’re already required to adhere to duty of care,” said Elliott. “The issue will be more complex for someone who is operating multiple LLCs.” 

Reporting requirements 

Under the new act, the records that can be requested by members are greatly expanded to include tax documents, financial statements, and LLC formation documents, said Bornemann. “Now all the owners have the right to view records and they’ve expanded what records must be available at all times. It will create more of a burden,” he said. “It’s a good idea to start creating procedures for responding to records requests and determining whether members are actually entitled to see them.” 

Royse agrees that the records request will be the most cumbersome part of the new act. 

“The list that businesses need to maintain and be able to produce is pretty extensive,” he said. “Some may not have great records. That might prove problematic for those who have those requests and aren’t able to produce the documents.” 

One member, one vote 

Many smaller LLCs may be caught by surprise by the changes in voting laws. Previously, members’ votes were based on equity ownership, with more equity equaling more voting power. Under the new act, the default operating procedure is a ‘per capita’ vote, or one vote per member. 

“The purpose is to make it simpler,” said Royse. “A lot of people will have trouble calculating contributions like property, sweat equity, and cash equity. Absent a change in the operating agreement, it will go to the per capita vote, which will make people more concerned about taking a look at their agreement.” 

Kalin BornemannBornemann said smaller businesses are more likely to be caught unaware by this change. “Typically if you have multiple owners, the operating agreement is going to talk about voting,” he said. “This comes into play with the more informal businesses and people who haven’t consulted with a lawyer.” 

The best thing to do, both agree, is get out in front of the issue. “On the whole, nothing about the new act is particularly positive or negative -— if you’re prepared for it,” said Royse. “Take a look at your operating agreement and make sure nothing can come back to bite you.” 

At Capstone, said Elliott, they’re ahead of the game. 

“The new act has shown us why it’s important to maintain good lines of communication with our legal counsel,” he said. “It highlights the importance of having a human being that can help you understand the changes. Going forward we’ll be curious as case law becomes available to see what the courts have to say about how this gets enforced.”