Client Alert - Act 170 – Changes to Business Entity Laws
House Bill 1398 was signed into law on November 21, 2016 as Act 170. Act 170 is a comprehensive set of laws governing limited liability companies, limited partnerships, limited liability partnerships, limited liability limited partnerships and general partnerships. Act 170 also amends certain laws governing business corporations and nonprofit corporations.
The effective date of Act 170 is:
(i) February 21, 2017 for unincorporated associations (LLCs, LLP, LLLPs, LPs, and GPs) formed on or after February 21, 2017 and for entities which elect to be treated under the new law prior to April 1, 2017; and
(ii) April 1, 2017 for all entities formed before February 21, 2017.
Below is a summary of some of the changes under Act 170:
- Manager Managed or Member Managed. In contrast to prior law, the certificate of formation/organization need not disclose whether an LLC is to member-managed or manager-managed, as such management structure is to be set forth in the Operating Agreement. If not otherwise set forth in the Operating Agreement, the statute provides, by default, that an LLC is to be member-managed.
- Duties and Elimination or Alteration of Duties. Act 170 provides for the duties of members and managers of LLCs. Act 170 provides that members of a member-managed LLC owe to the LLC and to the other members the duties of loyalty and care. Members also have a contractual obligation of good faith and fair dealing. Members of a manager-managed LLC do not have any duties to either the LLC or to the members of the LLC solely by reason of being a member other than the duties of good faith and fair dealing. Managers of manager-managed LLCs owe to the LLC and to its members duties of care and loyalty and contractual obligations of good faith and fair dealing. Under Act 170, the governing documents may alter, and in some instances, eliminate, the rights and duties of members or managers set forth in the statute. For example, members may not eliminate the duty of loyalty or care, but may alter such duties if to do so would not be “manifestly unreasonable”. Members or managers may not eliminate the contractual obligation of good faith and fair dealing, except that, if not “manifestly unreasonable,” the operating agreement may, prescribe standards to measure performance of the contractual duty of good faith and fair dealing. Further, an operating agreement may identify certain activities which would not be a violation of the duty of loyalty and may eliminate the duty to not appropriate a company opportunity or to not compete with the company.
Whether a term of the operating agreement is “manifestly unreasonable”, as set forth above, is to be decided by a court as matter of law based upon the circumstances existing at the time the challenged term became part of the operating agreement.
- Agency/Authority. Act 170 provides that “a member is not an agent of the limited liability company solely by reason of being a member.” In other words, a member no longer possesses statutory apparent authority
- Operating Agreements. Act 170 provides certain default rules and provides certain items that cannot be varied by agreement, including rights of members to approve mergers or other fundamental transactions, providing certain indemnification or exoneration or certain causes of dissolution. But Act 170 permits the operating agreement to vary a number of other statutory provisions, such as certain duties, as discussed above, certain aspects of distributions, and approval of certain actions. For example, if not otherwise set forth in the operating agreement, the default rule is that matters subject to member approval must be approved with reference to the number of members (per capita) without reference to such interests held by members (per capital).
- Distributions. Act 170, provides two tests for measuring a distribution, and a distribution violates the law if after the distribution, the LLC fails either of the tests. One test is whether, after giving effect thereto, the LLC would be insolvent. The other test is the balance sheet test, whereby following the distribution, the LLC’s total assets would be less than the sum of its total liabilities, plus the amount that would be needed, if a company were to be dissolved at the time of the distribution, to satisfy preferential rights upon dissolution.
- Governance Interests and Transferable Interests. Absent language in the governing documents to the contrary, the only interest in an LLC or partnership which may be transferred is a “transferable interest”, which is an economic interest with the right to receive distributions, but no voting or management rights. A “governance interest” also encompasses the rights to receive or demand access to information, to vote for the election of governors and the right to receive notice of or vote on issues involving the affairs of the entity.
- Nonprofit and Benefit Entities. Act 170 authorizes the formation of nonprofit limited partnerships and limited liability companies. Act 170 also authorizes benefit limited liability companies.
- Charging Orders. Judgment creditors can only extract value from a debtor’s interest in a partnership or LLC via a “charging order”. Such charging order provides the creditor with the right to receive distributions, but does not give any voting or management rights. However, the entire interest of the sole member in a single member LLC may be subject to execution by a judgment creditor.
- Dissociation/Dissolution/Termination. Act 170 outlines procedures by which a partner or member may dissociate from an entity and also outlines procedures for dissolution or ultimately winding up and terminating an entity. An entity must file a Statement of Termination instead of a Certificate of Dissolution after all debts have been paid, discharged or provided for and all assets have been distributed. Another note is that Act 170 provides an exception to the tax clearance requirement on dissolution if such dissolving entity never transacted business.
- Full Shield Liability Protection. Act 170 now provides the same liability protection that is available to shareholders of a corporation and members of a limited liability company, and provides a full shield for general partners of an LLP or LLLP, with some exceptions including the negligent or wrongful acts or misconduct committed by such partner or for debts, obligations or liabilities that arose before February 21, 2017.
Please note that this is not a comprehensive summary of Act 170, but serves to highlight some of the most important changes. Since Act 170 applies to existing entities as of April 1, it may be prudent to revisit your governing documents. Please contact me should you seek clarification on these changes, desire to amend your governing documents or are looking to set up a new entity.