HIGHLIGHTS OF THE NORTH DAKOTA LIMITED LIABILITY COMPANY ACT. N.D.C.C. Ch Real Property, Probate & Trust Section Seminar

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1 HIGHLIGHTS OF THE NORTH DAKOTA LIMITED LIABILITY COMPANY ACT N.D.C.C. Ch Real Property, Probate & Trust Section Seminar State Bar Association of North Dakota William L. Guy III Fredrikson & Byron, P.A. 51 Broadway, Suite 400 Fargo, ND

2 HIGHLIGHTS OF THE NORTH DAKOTA LIMITED LIABILITY COMPANY ACT N.D.C.C. Ch Revised Uniform Limited Liability Company Act ( RULLCA ). a. The Uniform Limited Liability Company Act ( ULLCA ) was promulgated by the National Conference of Commissioners on Uniform State Laws ( Uniform Laws Commission ) in 1995 and was not well received. b. The RULLCA was promulgated in 2006 and has been adopted in Alabama, California, District of Columbia, Florida, Idaho, Iowa, Minnesota, Nebraska, New Jersey, North Dakota, South Dakota, Utah, Vermont, Washington, and Wyoming and is under consideration in Illinois, New Mexico, and South Carolina. 2. History of the North Dakota Limited Liability Company Act. a. N.D.C.C. Ch was enacted in 1993 and was patterned after Minnesota Statutes Ch. 322B. b. N.D.C.C. Ch : (1) Was been patterned after Minnesota Statutes Ch. 322C which in turn is based on the RULLCA; and (2) Was sponsored by Representative Lawrence Klemin (North Dakota s representative on the Uniform Laws Commission) and was supported by the offices of the Secretary of State and the Attorney General. c. In 2014, the Uniform Laws Commission promulgated some changes to the RULLCA. To the extent that other states adopt these changes, North Dakota will consider them also. 3. Reasons for adoption. a. Unique structures: (1) Ch and Minnesota Statutes Ch. 322B took a corporate approach to LLCs. (2) All other states followed a partnership model which is the default structure of the RULLCA. 1

3 b. Less formal rules: (1) Ch requires that all agreements among the members and the LLC (particularly the Member Control Agreement) be in writing and must be signed by all members of the LLC (regardless of voting power). (subsection 2 of section ). (2) Ch allows the Operating Agreement (which replaces the Member Control Agreement) whether or not referred to as an Operating Agreement to be oral, in a record, implied, or in any combination thereof as is the case with partnership agreements among partners (subsection 35 of section ). 4. Other noteworthy differences between Ch and Ch a. Again, the core agreement among the members and the LLC is the Operating Agreement regardless of what it is called and whether oral, in a record, implied, or any combination thereof b. Management structure : (1) Again, Ch uses a corporate approach to LLCs with members, governors and managers which are the counterparts to shareholders, directors, and officers. As such, Ch LLCs are considered to be board-managed. That concept was eliminated in the RULLCA but has been retained in subsection 4 of section Thus, the board-managed LLC style that we have used since 1993 can be continued in existing LLCs and in LLCs which are newly formed under Ch (2) However, under Ch , all LLCs will be deemed to be membermanaged unless the Operating Agreement expressly provides that it is to be manager-managed or board-managed. In a member-managed LLC (subsection 2 of section ): i. The management and conduct of the company are vested in the members. Each member has equal rights in the management and conduct of the activities of the company. 2

4 i iv. A difference arising among members as to a matter in the ordinary course of the activities of the company may be decided by a majority of the members. An act outside the ordinary course of the activities of the company may be undertaken only with the consent of all members. v. The Operating Agreement may be amended only by the consent of all members. In a manager-managed LLC (subsection 3 of section ): i. Except as otherwise expressly provided in this chapter, any manner relating to the activities of the company is decided exclusively by the managers. i iv. Each manager has equal rights in the management and conduct of the activities of the company. A difference arising among managers as to the ordinary course of activities of the company may be decided by a majority of the managers. The consent of all members is required to: A. sell, lease, exchange, or otherwise dispose of all, or substantially all, of the property of the company, with or without the good will, outside the ordinary course of activities of the company; B. approve a merger, conversion or domestication ; C. undertake any other act outside the ordinary course of the activities of the company; or, D. amend the operating agreement. v. A manager may be chosen at any time by the consent of the majority of the members and remains a manager until a successor is chosen, unless the manager at an earlier time resigns, is removed, or dies, or in the case of the manager who is not an individual, terminates. A manager may be removed at any time by the consent of a majority of the members without notice or cause. 3

5 vi. v A person need not be a member to be a manager, but dissociation of member who is also a manager removes the person as a manager. If a person that is both a manager and a member ceases to be a manager, that cessation does not by itself dissociate the person as a member. The ceasing of a person to be a manager does not discharge any debt obligation or other liability to the limited liability company or members which the person incurred while a manager. (c) In a board managed LLC (subsection 4 of section ): activities and affairs of the LLC are managed by and under the direction of a board of governors as determined by the members holding majority of the voting power of the members. i. In board managed LLCs: A. The board acts only through an act of the board; B. No individual governor has any right or power to act for the LLC; and C. Only officers and managers or other agents designated by the board have the right to act for the LLC and that right extends only to the extent consistent with the terms of the designation by the board. A governor must be an individual but need not be a member to be a governor. A. However, the dissociation of a member who is an individual and who is also a governor disqualifies the individual as a governor. B. If an individual who is both a governor and a member ceases to be a governor, that cessation does not by itself disassociate the individual as a member. C. The ceasing of an individual to be a governor does not discharge any debt, obligation or other liability to the LLC or to members which the individual incurred while a governor. 4

6 i iv. The method of election and any additional qualifications for the governors will be as determined by the members holding a majority of the voting power of the members. Subsection 4 of section sets forth the rules for meetings of governors and are nearly identical to their Ch counterparts. v. The job descriptions for persons designated as a chief manager, president, chief executive officer, treasurer, chief financial officer, or other titles of similar import are set forth as well. Both of these positions can filled by a person (i.e., either an individual or an entity) as opposed to requirement that they be filled by an individual under Ch (d) In our office, we are continuing to structure both our existing and our new formed LLCs as being board-managed. c. Default profits and losses and distribution rights: (1) In Ch , unless provided otherwise in the articles of organization or in the member control agreement, profits, losses, and distributions are allocated in proportion to the value of the contributions of the members as reflected in the required records. (2) In Ch , unless otherwise provided in the Operating Agreement: Distributions prior to dissolution and winding up are to be equal among the members (i.e. per capita). In dissolution and winding up, each member: i. first receives the value of any unreturned contributions; and, then an equal share of the residue. (c) No default provisions are made for allocation of profits and losses. The RULLCA, in its commentary, states that entities will choose to allocate profits and losses in order to comply with applicable tax, accounting and other regulatory requirements. Those requirements, rather than this Act, are the proper source of guidance for that profit and loss allocation. (3) In our office, we are providing in our Operating Agreements that profits, losses and distributions (except for the value of the unreturned contributions in dissolution and winding up) are allocated in proportion to 5

7 d. Default voting rights. the value of the contribution of the members as set forth in Schedule A to the Operating Agreement. (1) In Ch , unless otherwise provided in the articles or member control agreement, members have voting power in proportion to the value of their contributions as set forth in the required records (subsection 5 of section ). (2) In Ch , unless otherwise provided in the Operating Agreement, in a member-managed LLC each member has equal voting rights in the management and conduct of the LLC activities (i.e. per capita not per capital contributions). (Subsection 2 of section ). (3) Again, in our office we are providing in our Operating Agreements that voting rights among transferable interests that have voting rights are allocated and proportioned to the value of the contribution of the members as set forth in Schedule A to the Operating Agreement. e. Dissenters rights (1) In Ch , sections and , statutory dissenters voting rights and the procedure for asserting them are set out in great detail. (2) Under Ch : Any Ch dissenter rights that apply when a LLC becomes governed by Chapter (because members have not overridden the default rules through the LLC existing articles of organization or member control agreement) will continue to apply. Ch has no statutory dissenters rights. i. Thus, for any such rights to exist, they would need to be set forth in the Operating Agreement. If you are representing a minority investor in an LLC, then you may want to use the provisions in sections and as a pattern for the dissenters rights and procedures for the enforcement of those rights that you may wish to have included in the Operating Agreement. f. Statutory authority. (1) In Ch , the power to actively manage the LLC is given to the President (subsection 1 of section ). 6

8 (2) Under Ch , a member is not an agent of an LLC solely by reason of being a member. Agency issues are governed by the Operating Agreement and general agency law. Section and authorize the filing of statements of authority and statements of denial with the Secretary of State and effect only the power of a person to bind the LLC to persons who are not members. g. Fiduciary duties. (1) In Ch , sections and set forth the standard of conduct for governors and for managers, respectively. There is no provision for overriding these standards of conduct. (2) Section sets forth the standard of conduct for members, managers, and governors. However, subsection 4 of section allows the Operating Agreement to contain certain restrictions or the eliminations of certain aspects of the duty of loyalty so long as the restrictions or the elimination are not manifestly unreasonable. h. Shelf LLCs. (1) Shelf LLCs (i.e. an LLC with no members) were not permitted under Chapter (2) However, under subsections 2 and 3 of Section : Under subsection 2, until an LLC has (or has had) at least one member, the LLC lacks the capacity to do any act or carry on any activity except: i. Delivering to the secretary of state for filing: A. a statement of change under section ; B. an amendment to the certificate under section ; C. a statement of correction under section ; D. an annual report under section ; E. a notice of termination under section ; and 7

9 F. articles of dissolution and termination under section ; Admitting a member under section ; and i Dissolving under section Under subsection 3, a limited liability company that has (or has had) at least one member may ratify any act or activity that occurred when the company lacked the capacity under subsection 2. i. Governing Agreements: (1) In Ch the governing instrument was the Member Control Agreement. (2) In Ch the governing agreement is the Operating Agreement which is the agreement, whether or not referred to as an operating agreement and whether oral, in a record, implied or in any combination thereof, of all the members of a limited liability company, including a sole member, concerning matters described in subsection 1 of section which are: (c) (d) Relations among the members as members and between members and the limited liability company; The rights and duties under Ch of a person in the capacity of manager or governor; The activities of the company and the conduct of those activities; and The means and conditions for amending the Operating Agreement. To the extent the Operating Agreement does not otherwise provide for a matter described above, Ch governs the matter. j. Membership Interests: (1) In Ch : The membership interest meant the members ownership interest in the LLC which were divided into: i. Financial Rights meaning a member s right to share in profits, losses and distributions; 8

10 Governance Rights meaning all of the members rights as a member other than Financial Rights. Membership Interest is personal property and as such is a general intangible. i. The member has no interest in the specific property of the LLC; All property of the LLC is property of the entity. (c) Charging Orders: i. Section provides that a court may charge the Financial Rights of a member with the payment of an unsatisfied judgment and that, to the extent so charged, the judgment creditor has only the rights of an assignee of those Financial Rights as provided under section The section goes on to provide that it is the sole and exclusive remedy of a judgment creditor with respect to the membership interest of a judgment debtor. (2) In Ch : What had been referred to as a membership interest under Ch is now referred to as the transferable interest and is divided into: i. Economic rights; and Governance rights (including management rights, consent rights, information rights, etc.). (c) As was the case under Ch , a transferable interest is personal property. Charging Orders Ch expands the right of judgment creditors substantially as set forth in : i. Initially a judgment creditor has a charging order against the transferable interest of the debtor which requires the LLC to pay over to the creditor any distribution would otherwise have been paid to the debtor. If necessary, a receiver may be appointed. Upon a showing the distributions under a charging order will not pay the judgment debt within a reasonable time, 9

11 the court may foreclose the lien and order the sale of the transferable interest. The purchaser at the foreclosure sale obtains only the transferable interest and does not become a member. i At any time prior to the foreclosure sale: A. The member may extinguish the charging order by satisfying the judgment in full; or B. The limited liability company or any of its members may pay the judgment creditor in full and thereby succeed to the rights of the judgment creditor including the charging order. 5. The following aspects of Ch continue to be quite similar to its counterparts in Ch : a. Sections that involve the Office of the North Dakota Secretary of State; b. Sections that involve the Office of the North Dakota Attorney General; c. Sections that involve foreign limited liability companies; and d. Sections that involve mergers, exchanges, conversions and domestications; 6. The future a. As mentioned previously, in 2014 the Uniform Laws Commission promulgated some changes to the RULLCA. To the extent that other states (primarily Minnesota) adopt those changes North Dakota will consider them also. b. Depending upon the level of its acceptance by the states that have not yet adopted it, further changes seem likely to follow _2.docx 10