Important changes to Washington law regarding Limited Liability Companies (LLC) and what you need to know

Posted Friday, February 26, 2016 by Christopher L. Thayer

In 2015, the Washington State Legislature passed legislation making sweeping changes to the Washington Limited Liability Company Act. The Washington State Bar Association (WSBA) requested the changes in an effort to make the law easier to understand and more flexible. Whether it achieved that goal remains to be seen, but the changes were adopted and represent the most significant revision to the Act since its adoption. Governor Inslee signed the legislation into law on May 7, 2015. The changes went into effect on January 1, 2016 and affect newly formed Limited Liability Companies – as well as any existing Limited Liability Companies.

This white paper summarizes some of the key changes that managers and members should be aware of as we begin 2016. This is intended as a short summary of those changes along with action items or areas of concern that you may wish to consider. This paper is not intended to substitute for legal advice and if you should have any questions, we encourage you to contact us a Pivotal Law Group, so that we can evaluate your specific situation and make appropriate recommendations.

LLC Operating Agreements may now be oral or implied. Before the change, operating agreements were required to be in writing. If an LLC did not have a written operating agreement, then default rules in the statute would apply to the company and its members regardless of whether they had some other non-written agreement. Under the new legislation, operating agreements may be “oral, implied, in a record, or in any combination.” While this provides some flexibility, it also raises a concern about informal LLC agreements that are subject to ambiguity and possible dispute. We encourage all clients with LLCs to have a written Operating Agreement, which requires that any amendment be in writing. This will help minimize potential for misunderstanding, ambiguity and possible litigation in the event of a later disagreement.

Certificate of Formation. Under the prior law, an LLC’s Certificate of Formation was required to indicate whether the LLC was managed by its members or by managers. The revised Act eliminates this requirement. Under the revised Act, the management of the LLC need only be identified in the LLC operating agreement, which is private and not public record.

Allowance for Board of Managers. The revised Act provides for the management of an LLC by a board of directors. This is accomplished through a revision to the definition of “manager.” Whereas before “manager” was defined as “person,” the revised Act defines “manager” as “a person, or a board, committee or other group of persons,” named or designated by the LLC agreement as a manager of the LLC. Under the revised Act, if a manager is a board or other group of persons, the fiduciary standards of conduct would apply to each person in the board or group. Further, if the LLC’s manager is a board or other group of persons, no member of the board would have authority, merely by virtue of being a board member, to act individually on behalf of the LLC.

Fiduciary Duties of and Managers and Member-Managers. The old Act did not set forth any fiduciary duties owed by members or managers. The new Act expressly defines the fiduciary duties owed by managers and managing members, and limits extent to which those duties can be modified or eliminated by the LLC. This provision is a change from the prior Act, which did not set forth any fiduciary duties owed by those managing the LLC. The entire provision can be found in RCW 25.15.038. The new Act specifies that the following are the only fiduciary duties owed by managers to the LLC and to one another:

The duty of loyalty, which is limited to:

• Accounting to the LLC for, and holding in trust for the LLC, any benefits derived:

  1. in conducting or winding up the LLC’s activities;
  2. from the use of LLC property; or
  3. by appropriating an LLC’s company opportunity;

• not competing with the LLC or engaging in conflict-of-interest dealings.

The duty of care, is narrowly limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law while conducting or winding up the LLC’s activities. A manager may comply with the duty of care by relying in good faith on the LLC records and the opinions, reports, or statements by any member, manager, officer, employee, or outside professional if such opinions, reports, or statements are within such person’s professional or expert competence.

Under the new Act, members of an LLC can use their LLC agreement to expand or limit the fiduciary duties owed members or managers the LLC, subject only to a few limitations. Specifically, the LLC agreement cannot eliminate or limit the following duties owed by members and managers: the duty to avoid intentional misconduct and knowing violations of law; the duty not to make a distribution in violation of the LLC agreement or which would render the LLC unable to pay its debts as they become due; or the implied duty of good faith and fair dealing.

Note: It appears under the new Act that members of an LLC can enter into an LLC agreement which eliminates the duty of loyalty entirely under the new Act.

Charging order. In the event a judgment is taken against an individual member, a court may now issue a charging order against the LLC member’s interest in the company, which would act as a lien on the member’s interest. See, RCW 25.15.256.

Voting by Members. The revised Act provides that, as a default, a majority of members be established through per capita voting (i.e., one vote for each member). This is a deviation from the current version of the Act, in which a majority is established through the consent of members contributing, or required to contribute, more than 50 percent of the agreed value (as stated in the records of the LLC) of contributions made or required to be made by all members.

Record-keeping obligations. The prior Act provided that LLC members had the right to inspect an enumerated list of company records, but did not give members the absolute right to inspect company records (e.g., accounting records). The new Act expands the list of additional records that must be made available to members under certain circumstances. Under the old Act, an LLC was required to keep records of its foundational documents, members’ capital contributions and disbursements, financial statements, and tax returns and reports.

Under the new Act, a member may request:

• A copy of the LLC’s certificate of formation and all amendments thereto;
• A copy of any written limited liability company agreement and any written amendments;
• A written statement of: the amount of cash and agreed value of benefits contributed and to be contributed by each member; the times or events that trigger each member’s additional contributions; and any right of a member to receive distributions that include a return of all or any part of a member’s contribution; and any events that will trigger the LLC’s dissolution;
• The LLC’s three most recent federal, state, and local tax returns;
• The LLC’s three most recent years’ financial statements; Copies of any consents or votes of the members for the past three years;
• The LLC’s three most recently filed annual reports;
• Any filed articles of conversion or merger; and
• Any certificate of dissolution or certificate of revocation of dissolution.

Note: This list cannot be narrowed or limited by the terms of an LLC agreement.

In addition, there are new obligations for the company in the event a member makes a request for records. After receiving a demand to inspect records from a member, an LLC generally has only ten days to make such records available.

LLC Agreement may alter or eliminate dissenters’ rights. Under the prior Act members of an LLC had certain dissenters’ rights, which allowed members to dissent from a transaction involving the merger of the LLC into another legal entity. Such dissenters would then be entitled to receive the fair market value of their membership interests. Under the prior Act, such dissenters’ rights could not be altered or eliminated by an LLC agreement. Under the new Act, however, an LLC agreement may alter or eliminate the default statutory dissenters’ rights. This may be beneficial for majority members who want freedom to enter into a merger without undertaking a potentially costly fight with dissenting members. However, the removal of dissenters’ rights could have significant consequences for minority members, who would lose all leverage in the event of a proposed merger of the company.

For many Limited Liability Companies formed before these changes took effect, serious consideration should be given as to whether your existing LLC’s operating agreement requires updating. You may wish to consider opting out of some of the new default rules, or modifying them. Moreover, certain provisions contained in existing LLC agreements may no longer be authorized.

Photo credit: State Capitol, overexposed, used under the Creative Commons license.