Limited Liability Companies (“LLCs”) have been part of the legal landscape in Pennsylvania since 1994. Since then, LLCs have offered small businesses an alternative to S-Corporations for pass-through taxation and protection from personal liability for the owners, while also allowing greater flexibility in governance. Because LLCs do not entail the same degree of formality in operations as corporations do, the LLC model is often preferred over an S Corporation for the organization of small, closely held businesses.
With that said, under the 1994 law, Pennsylvania LLCs still did not offer the same level of management flexibility as LLCs set up across the border in Delaware. The scene now changes with the Pennsylvania Limited Liability Company Law of 2017, effective April 1, 2017.
One of the overarching principles of the new law is the promotion of freedom of contract. That is, there are now fewer restrictions in governance structure, or in how the members of an LLC can organize its management and divide up rights and duties among its members. A multiple-member LLC can manage itself as a general partnership, with each member having a responsibility for day-to-day operating decisions and general policy decisions, or as a limited partnership, with one general partner having responsibility for major decisions and the other partners having more passive roles. An LLC can also govern itself as a corporation, governed by a board of managers. With few restrictions, a limited liability company may operate in whatever manner its operating agreement provides.
Another of the other more important changes in the LLC law is the expansion of the potential purposes for which an LLC may be formed. Under prior law, the purpose for which an LLC could be formed was essentially limited to for-profit businesses. Under the new law, non-profit groups can now organize as LLCs. Perhaps even more important, an LLC may now be organized as a “Benefit Company,” similar to the concept of a Benefit Corporation. Unlike the rule with for-profit corporations or for-profit LLCs, a benefit company can consider purposes beyond the financial bottom line of its members. Specifically, benefit companies can have a purpose that includes a material positive impact on society and the environment, and a duty to consider the interests of non-owner stakeholders, as well as a profit motivation.
Yet another significant change in the new law relates to the agency authority of the members of the LLC. Under the prior law, except to the extent that the operating agreement said otherwise, any member of a limited liability company had the legal power to act as an agent of that company.
Under the new law, members are no longer agents of the LLC simply by virtue of membership. That is, a member does not have statutory apparent authority to act for the company. Instead, authority is limited to those members or managers appointed as agents in the operating agreement or as designated by a “Certificate of Authority” to be filed with the Pennsylvania Department of State.
While it is not strictly necessary for limited liability company to file a certificate of authority with the Department of State, for some businesses this may be the best way of establishing the agency authority of a member or manager. Specifically, if a company does not wish to turn over its operating agreement to third parties in order to establish agency authority, the filing of a certificate of authority provides a less intrusive alternative. Also, in the case of LLCs that buy and sell real estate, the county recorder of deeds may require a filed certificate of authority in order to establish the agency of the signatory to the deed.
A further detail of the new law with significant potential implications is the law’s specific recognition of LLC operating agreements that exist in something other than paper form. Now, operating agreements can be in any “record form” – that is, “inscribed on a tangible medium or stored in an electronic or other medium and retrievable in perceivable form.” The new law also specifically allows for operating agreements to be “oral, implied, in record form or in any combination thereof…”.
The existence or terms of an oral operating agreement can be difficult to prove, making it an inherently bad idea for LLC members not to reduce their agreement to a signed writing or some other “perceivable form.” But it is at least theoretically possible for a member of an LLC to seek enforcement of agreed operating terms that were never reduced to writing.
Among the many other noteworthy provisions of the new law is its clarification of the duties of loyalty and care owed by members of the company to the company itself and to each other. As a general rule, members of member-managed LLCs owe these duties to the company and to each other. However, for manager-managed LLCs, these duties are owed only by the manager, such that other members are free to compete against the company, self-deal or otherwise divide their loyalties.
This allocation of the duty of loyalty is largely consistent with the judge-made law that developed under the prior LLC law. But in a departure from that prior law, and in keeping with the new focus on freedom of contract, the duties of members in member-managed LLCs and of managers in manager-managed LLCs are now subject to variation by agreement of the members. In very general terms, these duties can be altered or even eliminated so long as those alterations are not “manifestly unreasonable.”
What variations in duties are “manifestly unreasonable” remain to be seen. It will take years for the courts to work their way through this issue and through all of the many other provisions of this new law. Meanwhile, stay tuned, and consult with your lawyer for details.
Bruce L. Baldwin, Esquire is a partner in the law firm of Wolf, Baldwin and Associates, P.C. with offices in Pottstown, West Chester, and Reading, and has represented employers and employees in business matters and litigation for over 30 years. He may be reached by calling 610.323.7436, or by e-mail at BBaldwin@wolfbaldwin.com.