What You Need to Know: Florida LLCs
Since January 1, 2015, all Limited Liability Companies in Florida are subject to Chapter 605 ("New Act") The legislature made significant changes to the statute (formerly Chapter 608 - "Old Act"), which are summarized below.
17 UNENFORCEABLE PROVISIONS
Certain provisions in an existing LLC operating agreement may be unenforceable. Whereas the Old Act contained only six non-aivable provisions for LLC operating agreements, the New LLC Act contains 17 such provisions. Operating Agreements may not:
1. Vary a limited liability company’s capacity to sue and be sued in its own name;
2. Vary the applicable law that governs LLCs;
3. Vary the procedure pertaining to registered agents or the Department of State;
4. Vary the requirements related to signing and filing a record pursuant to a court order;
5. Eliminate the duty of loyalty or the duty of care;
6. Eliminate the obligation of good faith and fair dealing;
7. Relieve or exonerate a person from liability for conduct involving bad faith, willful or intentional misconduct, or a knowing violation of law;
8. Unreasonably restrict the duties and rights to records required by the Act;
9. Vary the power of a person to dissociate;
10. Vary the grounds for dissolution;
11. Vary the requirement to wind up the company;
12. Unreasonably restrict the right of a member to maintain an action against another member or manager;
13. Prevent the formation of a special litigation committee upon a court order;
14. Vary the right of a member to approve a merger, interest exchange, or conversion;
15. Vary the required contents of a plan of merger, a plan of interest exchange, a plan of conversion, or a plan of domestication;
16. Except in certain narrow circumstances, restrict the rights under this chapter of a person other than a member or manager; and
17. Provide for indemnification for a member or manager when he or she commits:
Conduct involving bad faith, intentional misconduct, or a knowing violation of law;
A transaction from which the member or manager derived an improper personal benefit;
An improper distribution of funds; or
A breach of the duty of loyalty or the duty of care.
MANAGING MEMBER TERM ELIMINATED
For LLCs formed after January 1, 2015, the term “managing member” will not be recognized by the Department of State in filings or annual reports. Although an LLC will still be able to be manager-managed, the mere use of the term “managing member” in the LLC’s governing documents will not make the LLC manager-managed. Absent other evidence or indication of intent to be manager-managed, any member is clothed with the authority to bind the LLC (unless that member’s authority has been limited as explained below). As a corollary, all members could be liable for certain actions taken by the LLC, such as the authorization of improper distributions.
In light of the potential expansion of liability, the New LLC Act permits an LLC to file a “Statement of Authority” that grants or limits the authority of a person (or class of persons) to take certain actions on behalf of the LLC.
Because all members of a member-managed LLC have apparent authority to bind the LLC, the best way to address management issues with respect to pre-existing member-managed LLCs is either to file a Statement of Authority expressly authorizing one of the members to make decisions and/or limiting the authority of other members to make decisions, or to simply convert the member-managed LLC into a manager-managed LLC.
ADMISSION OF MEMBERS
Now, unless otherwise provided in the Articles of Organization or the Operating Agreement, a person may become a member of an LLC only with the unanimous consent of all the members.
The New Act also allows a person to become a non-economic member without a transferrable interest or any obligation to contribute capital. This is a significant change which facilitates so-called special purpose LLCs, and allows for participation and governance by members with no economic interest whatsoever in the LLC.
VOTING RULES MODIFIED
For manager-managed LLCs, except as otherwise provided in the operating agreement, a majority-in-interest of the members must approve any action outside of the ordinary course of the LLC's activities and affairs, including an organic transaction (such as a merger or conversion). However, the unanimous vote of the members is required to amend the Articles of Organization or the Operating Agreement.
OPERATING AGREEMENT DEFINITION EXPANDED
The New Act expands the definition of “operating agreement” so that it “may be oral, implied, in a record, or in any combination thereof.” The agreement need not even be referred to as an “operating agreement.” Given that a court may now enforce even an “implied” agreement (or an implied amendment to an existing operating agreement), it is more important than ever to have an effective integration clause that merges all prior oral or written agreements into the operating agreement and a provision requiring all amendments to the operating agreement to be in writing.
The New Act (as did the Old Act) prohibits distributions that would render the LLC insolvent. The New Act, however, provides two methods used in the determination of insolvency: (1) the LLC “would not be able to pay its debts as they become due in the ordinary course of the company’s activities and affairs” and (2) if the company’s total assets would be less than the sum of its total liabilities, plus the amount that would be needed if the company were to be dissolved and wound up at the time of distribution to satisfy the preferential rights of members and transferees whose preferential rights are superior to those of persons receiving the distribution.
The test contained in (2) above may, however, be eliminated in the Operating Agreement.
DISSOCIATION OF MEMBERS
A member may now dissociate at any time, rightfully or wrongfully, by withdrawing by "express will." This is a change from the Old Act, where unless authorized in the articles of organization or operating agreement, a member could not dissociate at all prior to dissolution or winding up.
The New Act also introduces the concept of a "wrongful dissociation," which is one in violation of the operating agreement or dissociation, through express will or otherwise, prior to winding up. A limited liability company may have the right to damages against a member who wrongfully dissociates.
Dissociation by expulsion can occur under one of two circumstances under the New Act. First, the Operating Agreement can prescribe a method by which a member may be expelled. Upon expulsion under the Operating Agreement the member is dissociated. Absent a method for expulsion in the Operating Agreement, the members may unanimously agree to expel a member. However, expulsion by unanimous consent is only available if the LLC cannot lawfully carry on its activities with the expelled member, the expelled member has transferred its entire transferable interest in the LLC (other than under a security agreement or a charging order that has not been foreclosed), or the expelled member is a corporation or other entity that has dissolved. Under the Old Act, the transfer of the member’s entire interest would automatically terminate the transferor’s status as a member, but under the New Act, the transfer of the member’s entire interest will not automatically terminate the transferor’s status as a member unless the transferor’s expulsion is unanimously approved. As such, the Operating Agreement should provide for automatic dissociation to avoid the need for approval by all of the members under such circumstances.
A dissociated member under the New Act holds its transferable interest as a transferee only. Thus, the dissociated member has no right to participate in management, nor has any management obligations to the LLC. A member’s dissociation does not discharge any debt that the dissociated member owes to the LLC or any other member of the LLC. Additionally, the New Act eliminates the existing prohibition on a dissociated member receiving distributions from the LLC.
The default events causing dissolution are upon the occurrence of an event described in the operating agreement, upon the consent of all members, upon the passage of 90 days without a member, upon the entry of a decree of judicial dissolution, or upon the filing of a statement of administrative dissolution by the Department.
Judicial dissolution is now an available remedy in a proceeding brought by a member or a manager if it is established that the company's activities are illegal or unlawful, persons in control of the company are acting illegally or fraudulently, if it is not reasonably practicable to carry on the activities of the limited liability company in accordance with its operating agreement, or if the assets are being misappropriated or wasted causing injury to the limited liability company or its members.
The New Act continues to allow judicial dissolution in the event of a deadlock between the managers or members where the managers or members cannot break the deadlock and the deadlock is causing or threatening to cause irreparable injury to the limited liability company. However, the New Act contains a "deadlock sale" provision to deal with situations where the operating agreement lays out what is to happen in the event of such a deadlock.
The legislature adopted the Florida Corporate Statutory “Election to Purchase Instead of Dissolution” provision which essentially permits a corporation or its shareholder to buy- out the shares of a shareholder seeking dissolution. The New Act now authorizes an LLC or its members to purchase the interest of a member in proceedings seeking judicial dissolution. An election to purchase, once filed with the court, is irrevocable unless the court determines that it is equitable to satisfy or modify the election.
Under the Old Act, members of an LLC were entitled to appraisal rights only upon the consummation of a merger or conversion. The New Act adds six additional events that trigger a member’s appraisal rights:
Consummation of an interest exchange.
Consummation of a sale of substantially all of the assets of an LLC.
An amendment to the organic rules of the entity that reduces the interest of the members.
An amendment to the organic rules of the entity that alters or abolishes the voting or other rights of members.
An amendment to the organic rules of the entity that alters or abolishes the appraisal rights of the members.
If otherwise expressly authorized by the organic rules of the LLC.
The New Act allows an LLC to modify, restrict or eliminate appraisal rights as long as it is approved by each member affected by the modification, restriction or elimination. Consequently, if appraisal rights are to be eliminated or limited, it is critical to expressly set forth the terms of such modification, restriction or elimination in the LLC’s Operating Agreement.
The special definitions that apply to the appraisal right rules are set forth in a separate section and are essentially the same as those under the Old Act. However, the New Act provides that the valuation must not reflect any discount for “lack of marketability or minority status.” Under old law, the prohibition on applying this discount applied only to LLCs with ten (10) or fewer members. This provision now creates a difference between the determination of fair value in the LLC context versus the corporate context which still allows for the application of a discount for lack of marketability or minority status to corporations with more than ten (10) shareholders pursuant to Fl. Stat. §607.1301(4)(c).
ENHANCED PROTECTION AGAINST CREDITORS
Creditors of an LLC will no longer have the right to bring an action for judicial dissolution. Moreover, “piercing the corporate veil” (a legal doctrine used to impose personal liability on the owners of a company for the company’s obligations) may become more difficult in light of a new provision establishing that an LLC’s failure to observe formalities in managing its affairs does not constitute a basis for holding a member or manager liable for the LLC’s obligations.
Interest exchanges are now available to LLCs for the first time. This type of transaction was previously available only to corporations. Non-United States entities will be able to domesticate as Florida LLCs while retaining their legal status as non-United States entities in their place of origin.
TYPES OF FILINGS EXPANDED
An LLC may now file a “Statement of Correction” to correct any of the LLC’s filings. When a member or manager is no longer affiliated with an LLC, the Department of State, under the New LLC Act, permits the LLC to file “Statement of Dissociation” (for members) or ”Statement of Resignation” (for managers).
The New Act adds provisions for winding up the LLC's affairs, which are not found in the Old Act. This includes rules for winding up the limited liability company's activities and affairs, providing for payment of its debts and the sale of its assets, as well as bringing or defending actions and proceedings, and distributing assets to its members.
A member, manager, or legal representative may conduct the winding up and may seek judicial supervision of the winding up.
A creditor, with good cause and under specified circumstances, may also initiate an action for judicial appointment of a trustee or receiver for winding up.
DUTY OF LOYALTY
For a manager-managed LLC, the duty of loyalty only applies to managers (and not members). (This is consistent with the Old Act.)
For a member-managed LLC, the duty of loyalty applies to all members. (Under the Old Act, only managing members of a member-managed LLC owed a duty of loyalty to the LLC and its members, so this constitutes a substantial departure from current law.)
The New Act contains a statutory non- compete as part of the fiduciary duty of loyalty that applies to managers of a manager-managed LLC and to all members of a member-managed LLC. The terms of the statutory non-compete are far from clear. Thus, if the members desire to have a non-compete, or to not have any non-compete, the Operating Agreement should expressly set out the specific terms and conditions of the non-compete in order to avoid any uncertainties regarding the statutory non-compete or, if desired, eliminate the non-compete altogether (provided it is not “manifestly unreasonable” pursuant to Fla.Stat. Section 605.0105(5)).
The court decides as a matter of law (taking the decision out of the hands of a jury) whether a term of an Operating Agreement is manifestly unreasonable. The court (a) makes its determination as of the time the challenged term became part of the operating agreement and is to consider only circumstances existing at that time; and (b) may invalidate the term only if, in light of the purposes, activities, and affairs of the limited liability company, it is readily apparent that: (i) the objective of the term is unreasonable; or (ii) the term is an unreasonable means to achieve the provision's objective.
CONFLICT OF INTEREST TRANSACTIONS
Under the New Act, with respect to conflict of interest transactions, the transaction must be “fair to the LLC” even if approved by disinterested members or managers having full disclosure. A transaction is “fair to the limited liability company” if the transaction, as a whole, is beneficial to the LLC and its members, and takes into account whether it is (1) fair in terms of the members or managers dealing with the LLC in connection with that transaction; and (2) comparable to what might have been obtained in an arms-length transaction.
INSPECTION OF RECORDS
The New Act provides different rights for members to inspect records depending on whether the LLC is member-managed or manager- managed.
In a member-managed LLC, the members are allowed unlimited access to specified records, but as to “other” records maintained by the company, they have access rights only to the extent that the other records are “material to the members’ rights and duties under the Operating Agreement or this Chapter.”
In a manager-managed LLC, the managers have the same access rights that inure to members in a member-managed LLC. If a member of a manager- managed LLC seeks access to information, the member must make a demand in a record received by the company, describing with reasonable particularity the information sought, why the information is sought, and whether the information sought is directly connected to the member’s purpose. The standard for receiving access to information requires that the information be for a purpose “reasonably related to a member’s interest as a member.” This differs from a member-managed LLC as discussed above, in which members do not have to make such a record, and the information sought must only be “material to” the members’ rights and duties under the Operating Agreement.
The New Act uses the defined term “transferable interest” rather than “interest” as was used in the Old Act. A “transferable interest” means only the transferee’s rights to distributions, while the term “interest” under the Old Act meant the distribution rights, as well as voting rights, management rights, or other member rights under the Articles of Organization and Operating Agreement.
Under the New Act, a transfer of a transferable interest is allowed and does not cause a dissociation of the transferor, or dissolution of the LLC.
Contrary to the Old Act, which gave the transferee the right to receive distributions and share in profits and losses and allocations of income, gain, loss, deduction and credit, or similar items to which the assigning member was entitled, the New Act is different. Under the New Act, the transferee has only the right to receive the distributions to which the transferor would have been entitled and the Act does not address the transferee’s right to share in profits and losses and to receive allocations of income, gain, deduction and credit. Consequently, it is less likely that the transferee of a transferable interest will be subject to liability for his proportionate share of the taxes of the LLC where no distributions are made to such transferee.
A transferor retains the rights not associated with the transferable interest, and retains all the duties and obligations of a member. If a member transfers a transferable interest to a person who becomes a member with respect to the transferable interest, then the transferee will inherit that member’s liability for a promised contribution, or liability for knowingly receiving an unlawful distribution, if these obligations are known to the transferee at the time of the transfer.
Call us at (386) 677-7965 or send us an email at Elan.Kaney@KaneyLaw.com if you would like us to advise you on forming an LLC or revising your current operating agreement.