Llcl Overhaul Project

LLCL OVERHAUL PROJECT REPORTS ON RECOMMENDATIONS FOR CHANGES TO PORTIONS OF THE NEW YORK LIMITED LIABILITY COMPANY LAW AD HOC GROUP OF BUSINESS LAW SECTION OF NEW YORK STATE BAR ASSOCIATION JANUARY 2019 Opinions expressed are those of the Committee preparing this report and do not represent those of the New York State Bar Association unless and until they have been adopted by its House of Delegates or Executive Committee. Opinions expressed further do not represent those of the Business Law Section until approved by the Section's Executive Committee. 8258673.1 Introduction This booklet contains 16 short reports covering various sections of the New York Limited Liability Company Law [LLCL]. Each report identifies a statutory issue, describes the background and then suggests possible modification, amendment or enlargement of the particular LLCL section. The purpose of the reports is to initiate a wide dialogue by practitioners, business persons and academics about these areas and possibly other LLCL areas based upon their experiences with the LLCL and LLCs over the almost 25 since enactment of the LLCL. During this period, as word became known about the ease of formation, freedom of contract principles and flexibility of use, together with possible tax advantages and limited personal liability, LLCs have become the preferred form of business entity in New York and other jurisdictions. Our hope is that the dialogue will result in extensive recommendations to the State legislature for clarification and updating of the LLCL in order to enhance the use of LLCs in New York over the next decade. The booklet is a product of what we call the “LLCL Overhaul Project,” an ad hoc group within the Business Law Section of the NYS Bar Association. In the summer of 2017, we had prepared the material for the Section’s email survey of its members asking them ten questions about the LLCL. The survey results were quite interesting and the accompanying comments were enlightening and pointed, compelling the next step of more comprehensive research and discussion of the issues, and then suggesting ways to deal with these issues. The survey result are Exhibit A to this booklet. Our group consists of twelve attorneys who write, teach or work extensively with New York LLCs. Over a period of months the 10 survey issues grew to 16 topics. We assigned the topics among ourselves for preparation of initial reports that were presented for discussion before the group, and then sought to revise and conform them, resulting in this booklet. In drafting the reports we looked at various articles and commentaries on LLCs, with an emphasis on New York, judicial decisions, recent updates in the LLC statutes of several other states, NCCUSL’s Revised Uniform Limited Liability Company Act (2006) and the ABA Section of Business Law’s Revised Prototype Limited Liability Company Act (2011). The reports should not be considered definitive expositions of the issues. We sought to provide information sufficient to gain an understanding of the issues and the reasons for the recommendations and conclusions. The positions taken in the reports are those of the members of the Project, and have not been reviewed by nor reflect the positions of the Business Law Committee or the NYSBA. Over the course of our research and drafting we revised several of our initial recommendations. Also, some of the issues have alternative recommendations. This shows that the deeper one digs and the more voices heard from, many of the topics, and especially the possible recommended changes to the LLCL, are viewable from different points. Our goal is get a consensus on the issues. Further, the recommendations are subject to review from applicable state agencies, such as the Department of State, the Attorney General Charities Bureau, the Department of Education and the NYSBA. 8258673.1 We hope that many of the discussions, questions and recommendations in the reports encourage readers to send comments and changes, including dissenting views to us. One expectation is to use your input on the reports and other areas of concern under the LLCL to prepare an expanded version of this booklet. Another expectation is some will join the Project in its future steps. A complete overhaul of the LLCL was beyond our scope. Also, an overhaul did not seem necessary as the New York statutory approach and the Department of State administration for LLCs function fairly well, subject perhaps to the issues we raised, and businesspersons and practitioners seem to have become accustomed to working under the statute. The members of our Project group are: Bruce A. Rich Carter, Ledyard & Milburn LLP Miriam R. Albert Hofstra Law School Terrence M. Bennett Bennett & Samios LLP Everett S. Carbajal The Carbajal Law Firm, P.C. Christine Sgarlata Chung Albany Law School Rachel B. Coan Carter Ledyard & Milburn LLP Nicholas G. Karambelas Sfikas & Karambelas, LLP Emma Lee Thomson Reuters Corporation Peter Mahler Farrell Fritz LLP Meredith R. Miller Touro Law Center Matthew J. Moisan Moisan Legal P.C. Thomas M. Pitegoff LeClair Ryan PLLC We welcome your comments and suggestions. Please send them to [email protected]. (ii) 8258673.1 TABLE OF CONTENTS Page Topic #1 – Operating Agreements ......................................................................................1 Topic #2 –Creation of Series LLCs ....................................................................................7 Topic #3 –Shelf Formations..............................................................................................19 Topic #4 –Publication .......................................................................................................23 Topic #5 –Derivative Actions ...........................................................................................34 Topic #6 –Designation of Type of Management/Authority to Bind an LLC ..................42 Topic #7 –Fiduciary Duties ..............................................................................................46 Topic #8 –Piercing the LLC Veil......................................................................................50 Topic #9 –Judicial Dissolutions of LLCs .........................................................................54 Topic #10 –Activities Excluded from “Doing Business” for Foreign Qualification ........60 Topic #11 –Profit Purpose ................................................................................................64 Topic #12 –Wage Claim Liability ....................................................................................65 Topic #13 –Charging Orders ............................................................................................71 Topic #14 –Professional Service LLCs ............................................................................77 Topic #15 –Conversion of Other Business Entities into a NY LLC .................................85 Topic #16 –Waiver of Creditor Status of Members for Distributions ..............................91 Exhibit A 2017 NYSBA Section of Business Law Survey of LLCL Issues (iii) 8258673.1 8258673.1 Topic #1 – Operating Agreements Issues (1) Should the mandatory word “shall” in New York Limited Liability Company Law (“LLCL”) Section 417(a) be revised? (2) Should LLCL Sections 102(u) and 417 be revised to allow for oral operating agreements? (3) Should LLCL Sections 417 and 402(c)(3) be revised to require unanimous initial adoption of an operating agreement? (4) Should LLCL Sections 417 and 402(c)(3) be revised to specify that, by default, amendments to the operating agreement require consent of all members and, where the operating agreement is in writing, by default, the amendment must be in writing? (5) Should a provision be added to the LLCL to clarify that operating agreements are not subject to the statute of frauds? Recommendations (1) Yes. The only consequence of failing to adopt a written operating agreement is that, to the extent no other agreement of the parties addresses a specific issue, the default rules of the LLCL apply. Thus, the law does not actually require adoption of a written operating agreement (it is not actually a mandatory “shall” but, more appropriately a precatory “may” or “should”). The statute does not impose a penalty for failure to adopt a written operating agreement, and case law holds that there is no penalty for such failure. The courts have taken the optimal approach, it is just a mismatch with the mandatory language “shall.” (2) Yes. The LLCL should be amended to broadly define an “operating agreement” to include unwritten terms. This position is informed by two realities. First, many LLCs are formed without the benefit of counsel (often with “do-it-yourself” online sites) and the parties are not likely to adopt a written document or, if they do, to understand its import. They are, however, very likely to discuss and agree on certain basic terms (e.g., percentage of ownership, share of profits). Second, for those sophisticated LLCs with access to counsel – those most likely to have written operating agreements and understand their importance – they may use the operating agreement to contract for a writing requirement by using common contract provisions such as a no oral modification clause and a merger clause. (3) Yes, LLCL Sections 417 and 402(c)(3) should be revised to clarify that all members must adopt the initial operating agreement. (4) Yes, LLCL Sections 417 and 402(c)(3) should be revised to, by default, require all members to consent to amendments of

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