The operating agreement of a Florida LLC should be comprehensive and set forth the agreements of the parties as to all material matters to potentially avoid unintended statutory default rules from overriding the parties’ expectations.
The Florida Legislature unanimously passed the new Florida Revised Limited Liability Company Act (the "New Act"), and Governor Rick Scott signed the bill into law on June 14, 2013. The New Act is codified as new Chapter 605 of the Florida Statutes and became effective on January 1, 2014. Limited liability companies (LLCs) formed or registered to do business in Florida on or after the effective date are subject to the New Act immediately. However, Florida LLCs existing prior to the effective date may continue to comply with Florida's current Limited Liability Company Act, Chapter 608 (the "Current Act"), or elect to comply with the New Act until January 1, 2015, at which time the Current Act is repealed and the New Act becomes mandatory for all Florida LLCs. In addition, all documents or records filed with the Department of State on or after January 1, 2014, will be required to comply with the filing requirements of the New Act.
The New Act is based for the most part on the Revised Uniform Limited Liability Company Act (the "RULLCA"), a form of which has been adopted by seven states and the District of Columbia. Currently, the RULLCA is being considered, or is in the process of being adopted, by numerous other states. The benefits of basing the New Act on the RULLCA include improved uniformity of treatment for LLCs across state lines and additional court decisions as precedent. The New Act also retains many provisions and concepts from the Current Act while incorporating language and concepts from other sources, including other Florida business entity statutes; the American Bar Association's Prototype LLC Act and Revised Model Business Corporation Act; and the business entity statutes of other states. The New Act is intended to make Florida a more attractive place to organize and operate an LLC.
New Act Versus Operating Agreement
Like the Current Act, the New Act is a "default statute," which means that it provides default rules that must be followed when there is no operating agreement, the operating agreement does not address a particular issue, or the operating agreement purports to modify or waive certain statutory rights and provisions that cannot be modified or waived under the New Act. Except with regard to those provisions that may not be modified by the operating agreement, under the New Act as under the Current Act, the members of a Florida LLC will continue to be permitted to enter into an operating agreement to establish different provisions than those provided by the statute to regulate the affairs of the LLC and govern the relationship among the members, managers and company.
Most sophisticated members of an LLC will have comprehensive operating agreements intended to address significant default rules that may be altered and the most common issues that arise among the members, managers and company. Unfortunately, even the most sophisticated investors will at times become members of an LLC before executing an operating agreement. Adding to the complexity is the fact that the operating agreement need not be in writing and may even be implied from a course of conduct, although reducing such agreements to writing is a best practice employed by most sophisticated members of an LLC. Even where an operating agreement is executed, it may not address every default rule or issue that arises among the members, managers and company. This occurs particularly when default rules are enacted after the operating agreement is executed. In these cases, the members may become bound by default provisions that may be very different from the terms contemplated. Compared with the Current Act, the New Act expands the list of matters that may not be altered or waived by the operating agreement from six to 17.
Elimination of the Managing Member Form of Management. Among the matters that members alter by the operating agreement is the type of management structure of the LLC. The Current Act allows a Florida LLC to be managed by its members, by one or more managers or by one or more "managing members." The last permitted type of management—management by one or more managing members—is the subject of confusion and disparate interpretations under existing law. This is particularly true with respect to the ramifications of having a managing member on the nature of the management structure of the LLC. Under the Current Act, management by a managing member is a form of a member-management; however, some mistakenly believe the managing member is a "manager" and attempt to treat the managing member as such for purposes of the operating agreement and the Current Act. Under the Current Act, the authority to bind the LLC in dealings with third parties does not rest solely with the managing member. To the contrary, every member of a member-managed Florida LLC has the authority to bind the LLC. In order to dispel the confusion and align Florida law with the law of many other states, the New Act eliminates the concept of the "managing member" as a separate management category. Therefore, any current Florida LLC articles of organization and/or operating agreement with a "managing member" will, by default, be deemed a member-managed LLC, which leads to management voting rights and fiduciary duties for all members, as well as all members having the authority to bind the LLC in dealings with third parties.
Additionally, to assist third parties in understanding the actual authority (or lack thereof) of a Florida LLC's members, managers, officers and agents, the New Act includes a new provision that allows an LLC to file a Statement of Authority with the Florida Department of State to set forth, and provide notice to third parties of, the authority (or restrictions on the authority) of persons who may act on behalf of the LLC. Such Statements of Authority must be re-filed every five years after the statement, or amendment, becomes effective. Third parties named in a filed Statement of Authority may also file a Statement of Denial, denying a grant of authority.
Other Notable Changes in the New Act
Several other changes in the New Act are likely to make it easier for companies to do business as Florida LLCs.
Dissociation. One of the most noteworthy of the new non-waivable provisions deals with the power of a member to withdraw or dissociate from the LLC. Under the Current Act, a member may not dissociate prior to dissolution and winding up of the LLC unless the articles of organization or the operating agreement provides otherwise. This can be particularly problematic when unforeseeable conflicts arise after the LLC is formed. Under the New Act, however, it is impermissible for an operating agreement to vary a member's power to dissociate from the LLC. According to the New Act, a member has the power to dissociate at any time. The operating agreement may, however, set forth circumstances under which dissociation would be wrongful and therefore constitute a breach of the operating agreement. The dissociated member may also be liable to the LLC and other members for damages caused by the wrongful dissociation.
Interest Exchange. Unlike the Current Act, the New Act provides for the concept of an "interest exchange" as a means of an LLC acquiring another entity. In an interest exchange, the acquiring entity exchanges equity interests or other consideration, including debt or cash, for all of the equity interests of the acquired entity. This results in the acquired entity being wholly owned by the acquiring entity, but continuing to exist as a separate and distinct entity. An interest exchange also allows for an acquiring company to use as consideration the assets or securities of a parent company or other related entity of the acquiring entity. In this regard, an interest exchange is similar to a "share exchange" in the corporate context.
Domestication. The New Act will allow non-U.S. entities to "domesticate" as LLCs in Florida. A domestication allows any type of foreign entity to retain its status and existence in the jurisdiction in which it currently exists while it simultaneously exists as a Florida LLC, a result which should promote foreign investment in Florida. Much like the process of approving a merger under Florida law, the New Act requires a plan of domestication and approval of domestication, and it allows for amendment or abandonment of the plan prior to becoming effective. The domestication becomes effective upon the passage and filing of the articles of domestication.
Transferrable Interest. The New Act permits the transfer of a member's "transferrable interest," which is limited to the right to receive distributions and does not include any voting or managerial rights. This is consistent with "mere assignee" treatment of an "assignee" under the Current Act. Under the New Act, the transferor retains its managerial rights, including the right to vote, unless and until the transferee is admitted as a member or the transferor dissociates. Moreover, any voting rights retained by the transferor may be trumped by the terms of the operating agreement.
Non-Economic Members. The New Act will permit Florida LLCs to have non-economic members (members that have the right to vote, but have neither an obligation to contribute, nor a right to receive distributions of, capital). The ability to have non-economic members may facilitate certain transactions (specifically debt financing transactions) as some third parties find it advantageous to appoint non-economic members to the LLC to protect against voluntary bankruptcy filings or for similar actions that require approval by the members.
Service of Process. One noteworthy change in the litigation context relates to proper service of process on an LLC. Under the Current Act, service of process on an LLC is effected in the same manner as service upon a partnership. This approach has been problematic, especially in light of the significant differences between manager-managed and member-managed LLCs. The New Act addresses this concern by employing a "waterfall" approach, starting with the registered agent, which is consistent with service of process on a corporation rather than a partnership.
What the New Act Does Not Change
Although the New Act is different from the Current Act, some notable provisions remain unchanged.
Charging Orders. The New Act maintains the provision added to the Current Act adopted in 2011 as a result of the Florida Supreme Court's decision in Olmstead v. Federal Trade Commission. That provision allows judgment creditors of the sole member of a single-member Florida LLC, under certain circumstances, to foreclose on the sole member's LLC interest, but specifically limits the remedy of a judgment creditor of a member of a multiple-member Florida LLC to a charging order. Therefore, consideration should be given to forming single-member LLCs in Delaware (or another state that limits a judgment creditor's remedy to a charging order for both multiple-member and single-member LLCs). A Florida LLC remains a prudent choice for a multiple-member LLC.
Fiduciary Duties. Both the Current Act and the New Act prohibit the complete elimination of fiduciary duties (as is permitted by the laws of Delaware and other states). The fiduciary duties in Florida are limited to the duty of care (the standard of care that is imposed on those managing an LLC) and the duty of loyalty (the duties of those managing an LLC to refrain from competing with, or taking for themselves opportunities from, the LLC, and to keep from self-dealing or having conflicts of interest). As under the Current Act, fiduciary duties may be modified but not in a "manifestly unreasonable" manner, and whether a modification of fiduciary duties is "manifestly unreasonable" is a determination made by a court without the assistance of a jury. The duty of care under the New Act, which is largely consistent with the Current Act, adopts the standard set forth in the RULLCA. There, the RULLCA replaces the "ordinary care/business judgment rule" standard with a less burdensome "duty to refrain from engaging in grossly negligent or reckless conduct, willful or intentional misconduct, or knowing violations of law."
Series LLCs. The New Act did not approve the organization of a series LLC—which is an LLC that has multiple series, where each series may own distinct assets, may incur separate liabilities, is insulated from liabilities of the other series and may have different managers and members. In order to accomplish this under the Current Act and the New Act, one would need to form and maintain a separate LLC to hold each asset or operate each business. However, because Florida law does not provide for the organization of a series LLC, there are costs and administrative burdens associated with properly forming, qualifying and maintaining each separate LLC. The advantages of a series LLC are that a series LLC may be able to combine administrative functions, pay a single set of annual state fees and prepare one income-tax return each year. The drafting committee of the New Act believes that significant legal and tax issues must still be addressed before series LLCs are approved for organization in Florida.
A review and understanding of the New Act and the matters that may and may not be waived will be a key factor in analyzing its effect on existing and newly formed Florida LLCs and their members and managers. Some new provisions may be a trap for the unwary. For example, the New Act adds more transactions to the list of transactions that trigger appraisal rights. Accordingly, members and managers of Florida LLCs should be aware of and understand these new appraisal triggers, as they may not be desired and may be waived. However, if not properly addressed in the operating agreement, such new appraisal triggers will apply.
The operating agreement of a Florida LLC should be comprehensive and set forth the agreements of the parties as to all material matters to potentially avoid unintended statutory default rules from overriding the parties' expectations. Current members or managers of existing Florida LLCs may desire to have the LLC's operating agreement carefully reviewed and revised, and those planning to form an LLC in Florida should have the LLC's operating agreement drafted with care, in light of the New Act to potentially avert unexpected consequences.
For Further Information
If you have any questions about the New Act, please contact Lida Rodriguez-Taseff, Driscoll R. Ugarte, David A. Kahn, Nicole L. Levy, any of the attorneys in our Corporate Practice Group or the attorney in the firm with whom you are regularly in contact.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.