On September 21, 2012, Senate Bill 323, also known as the California Revised Uniform Limited Liability Company Act (popularly known as RULLCA), was signed into law by Governor Jerry Brown. As of January 1, 2014, RULLCA will apply to all existing California limited liability companies (LLCs) as well as all foreign LLCs registered with the State of California as of that date. RULLCA completely displaces the current California law governing LLCs (Beverly-Killea Limited Liability Company Act, Corporations Code §§ 17000-17656) and will be codified as the new Title 2.6 of the California Corporations Code at §§ 17701.01-17713.06. This new law will apply automatically; there are no new documents that need to be filed by LLCs to fall within its purview. Also, there is no ability to "opt out."
RULLCA serves to provide more guidance on issues that the current law, Beverly-Killea Limited Liability Company Act (Beverly-Killea), is silent on or does not clearly address. Many of the Beverly-Killea provisions are included in RULLCA, however there are some areas that are new, such as the provision that makes an LLC member’s bankruptcy a "wrongful disassociation" of the membership.
RULLCA § 17706.01 governs the power of a member to disassociate from the LLC. In contrast with Beverly-Killea, it introduces the concept of "wrongful" disassociation and lists the circumstances when a member’s disassociation is wrongful. If the member of an LLC wrongfully disassociates, RULLCA provides that the member is liable to the LLC and to the other members for damages caused by that disassociation. Currently, Corporations Code § 17252 gives the LLC only an offset right for damages against the withdrawn member, and then only if the withdrawal is in breach of the operating agreement. RULLCA makes these damages a matter of law.
Bankruptcy as Wrongful Disassociation
RULLCA’s definition is extremely broad and poses significant risks for unwary members. Under RULLCA, any voluntary disassociation is "wrongful" if it occurs prior to the termination of the LLC, unless the LLC’s Operating Agreement specifically provides otherwise. Essentially, now instead of the law following the Operating Agreement terms to determine enforceability, the default scheme will provide stricter and broader liability for damages for withdrawing members than currently.
Bankruptcy is an area that will present significant concerns with RULLCA’s implementation in light of the RULLCA provisions that provide that the bankruptcy of a member of a member-managed LLC triggers that member’s disassociation and that the disassociation caused by the member’s bankruptcy is wrongful (§§ 17706.01(b) and 17706.02(g)). However, federal bankruptcy law preempts these sections of RULLCA, and they might not be enforceable in certain circumstances.
Under Bankruptcy Code § 365(e), a debtor’s rights cannot be terminated by ipso-facto provisions (a provision that is either a provision of an executory contract or a provision of non-bankruptcy law). RULLCA’s provisions concerning bankruptcy is trumped by Bankruptcy Code § 365. Thus, unless the bankruptcy trustee (or a debtor in possession in a Chapter 11 case) cannot assume the contract without consent of the non-debtor parties and such non-debtor parties do not grant their consent. With regard to LLCs, this means that a member’s bankruptcy CANNOT trigger disassociation of that member from the LLC unless the trustee, a successor in interest of the bankrupt LLC member, is restricted from becoming a full-fledged member of the LLC without the consent of the other non-debtor members and the other members withhold their consent. RULLCA’s default rule is that consent is required of all members for association, however, the Operating Agreement will provide guidance on that issue and its provisions will govern over RULLCA’s default rule.
The risk comes when a trustee does not need consent of the other members to succeed to the bankrupt member’s interest, in that case, not only will the trustee be able to take over the debtor’s membership interest in the LLC but that debtor will be considered to have "wrongfully" disassociated, triggering damages liability on his/her part.
Don’t be caught unprepared for the transition from the current law to RULLCA; make sure your Operating Agreement protects the LLC and its members. Contact us to review your Operating Agreement so that your company and its members are protected.
Schneiders & Associates, L.L.P. is a multi-service law firm located in Oxnard, California with a focus in business law related matters. For more information on our firm and services, visit our website at www.rstlegal.com.