Construction in Brief: 2014 Volume 1

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Is Newer Always Better? Important Changes in the New Jersey Limited Liability Company Act

By Marian A. Kornilowicz, Alexander F. Barth

On September 19, 2012, New Jersey enacted the Revised Uniform Limited Liability Company Act (N.J.S.A. 42:2C-1 et seq.), colloquially known as RULLCA. Although the new law became effective on March 18, 2013 (the “Effective Date”), it was not until March 1, 2014 that RULLCA controlled or applied to limited liability companies (LLCs) formed prior to the Effective Date. Between the Effective Date and March 1, 2014, RULLCA applied only to LLCs formed during that period or to LLCs that voluntarily amended their operating agreements to specify that RULLCA would govern. Therefore, it was not until March 1, 2014, when the prior act was repealed, that the complete impact of RULLCA applied to all NJ LLCs.

What does this mean to your business? Well, whether you are a new or existing LLC, RULLCA has upgraded and modernized the rules for the formation and operation of LLCs. The key changes can be divided into two categories: those that impact on the formation and governance of LLCs and those that affect the relationships between the members of LLCs.

Formation and Governance of LLCs

There are four important changes regarding the formation and governance of an LLC:

Under the prior act, unless specifically stated, LLCs had a limited lifespan of thirty years. RULLCA provides that LLCs, like corporations, now have a perpetual duration unless specified otherwise.
RULLCA provides that an LLC’s operating agreement, which governs the rights and obligations of an LLC’s members, may be written, oral or, most importantly, IMPLIED based upon the way the parties have operated the company. This is a crucial change for LLCs without a written agreement, as it allows a court to establish an operating agreement through prior conduct. This can be a positive change or a very detrimental one, depending on what side of a dispute you may be, but it is definitely risky for everyone.
LLCs can now file a Statement of Authority with the New Jersey Department of the Treasury, setting forth what individuals or entities can bind the LLC. Filing such a statement can be helpful as it puts third parties on notice as to who can contractually bind the LLC, maintaining control amongst key members and/or minimizing problems with rogue employees.
RULLCA makes it easier for an out-of-state entity to domesticate to an NJ LLC and for any entity to convert into an NJ LLC.

Relationships between Members

As for the changes relating to the relationships between the members of an LLC, there are four that can drastically affect how members interact under the new law:

Distributions. Unless the operating agreement states otherwise, distributions shall be made on a per capita basis with each member entitled to an equal share of the profits or losses. If an LLC’s current operating agreement is silent on this issue, or there is no written agreement, and the members have not been taking distributions on a per capita basis (but based on percentage of ownership interest, for example), the distributions will have to be specifically addressed or the intent of the parties may no longer be protected by the statute.
Voting. Similarly, RULLCA provides that each member shall have an equal vote, regardless of the percentage of ownership. It requires that ordinary business matters be decided by a majority vote of the members, with each member having one equal vote, and that non-ordinary matters (mergers, sale of all assets, or amendment of the operating agreement) be decided by a unanimous vote. Alternate voting schemes must be expressly addressed in the operating agreement.
Disassociation of a member. Previously, if a member elected to withdraw from the LLC, the LLC was obligated to distribute, in a reasonable time after withdrawal, the monetary value of that member’s interest. With the adoption of RULLCA, a member does not have an automatic right to cash-out his interest in the LLC; but rather, upon withdrawal or disassociation, becomes an economic interest holder with an equity interest but no voting rights.
Redress for Oppressed Minority Equity Owners. While RULLCA eliminated the right for a member to withdraw from an LLC at will, it did adopt a statutory scheme, similar to that found in the New Jersey Business Corporation Act, whereby oppressed minority equity owners can seek redress. It also expressly imposed a standard of good faith and fair dealing on the members. So while a withdrawing member is no longer automatically entitled to the value of his interest if he elects to withdraw from the company, a member under RULLCA has remedies if the managers or members in control are acting in a manner to oppress the aggrieved member, and taking actions that were, are or will be harmful to the aggrieved member’s interest. These remedies include seeking dissolution of the company, appointment of a custodian, or requiring the LLC or other members to purchase the interest of the aggrieved member.

While the prior act allowed members to more freely extricate themselves from an investment in a company, RULLCA recognized the crippling effect this automatic right of withdrawal could have, especially where the economic impact of the withdrawal and the required payout could prove detrimental to the operations of the LLC. To address this issue while still providing redress for an aggrieved member, RULLCA requires that the aggrieved member establish that he has been oppressed. This is a critical change in how disputes among members may be resolved, and it will take time for the courts to develop a body of case law related to the oppressed minority member provisions. However, the courts will likely look to the case law developed in response to the Corporation Act.

The bottom line is that key changes have been made to RULLCA that impact the formation and governance of New Jersey LLCs, as well as the relationships between the LLC members. If it was not the case before, it is certainly now critically important for members of LLCs in New Jersey, who have not already done so, to negotiate and execute an operating agreement. For assistance with this or if you have any further questions as to how RULLCA now affects your LLC, please contact the attorneys in our Business Transactions Group.