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General Information
The Ohio Revised Limited Liability Company Act (ORC Chapter 1706 – the “Revised Act”) will become applicable to all LLCs in Ohio as of February 11, 2022 (see §1706.83). After that date, the Revised Act will govern all LLCs formed (or qualified to do business as foreign LLCs) in Ohio, regardless of whether the LLC was formed or qualified before or after that date. As such, all KWGD operating agreements should contain the correct references to Chapter 1706 as opposed to the Chapter 1705 references- After February 11th, all references to 1705 will be a reference to a repealed statute.
While Chapter 1706 completely replaces Chapter 1705 (the “Current LLC Act”), and the Revised Act will govern all LLCs after February 11, 2022, it is not necessary that an LLC update its organizational documents and updating an LLCs operating agreement should be determined on a case by case basis.
The purpose of this Memo is to highlight a few of the more significant differences between the current LLC Act and the Revised Act.
Formation of Series LLCs
The Revised Act now allows for the formation of Series LLCs in order to establish one or more separate series of assets and liabilities through their operating agreement (See ORC §1706.76 – §1706.7613). Each series in a sense acts as its own LLC. Each series may, in its own name, enter into contracts; sue or be sued; hold and convey title to assets; grant liens and security interests in assets of the series. This structure provides liability protection to each series, as assets owned by one series are shielded from the risk of liability of others within the same Series LLC. This concept is practically similar to a parent LLC has one or more subsidiary LLCs, including with the same or different members holding an ownership interest in each series.
According to §1706.76(A)(1)-(2), an operating agreement may establish one or more designated series of assets under the same LLC that has both of the following: (1) Either or both (a) “Separate rights, powers, or duties with respect to specified property or obligations of the limited liability company or profits and losses associated with specified property or obligations,” and/or (b) a separate purpose or investment objective; and (2) At least one member must be associated with each series. Notably, according to §1706.76(B), a series established in accordance with subsection (A) may also carry on any activity, whether or not for profit.
According to §1706.761(A), the debts and liabilities with respect to a particular series are only enforceable against the assets and are not enforceable against the assets of the LLC generally or any other series of the LLC. Similarly, the debts and liabilities with respect to the LLC generally or any series thereof are not enforceable against the assets of another series. However, in order to take advantage of these limitations, the conditions of §1706.761(B) must be met: (i) the records maintained for a particular series must account for the assets of that series separately from the other assets; (ii) the LLC’s operating agreement must contain a statement to the effect of the limitations provided for in §1706.761(A), and (iii) the LLC’s articles of organization must contain a statement that the LLC may have one or more series of assets subject to the limitations provided for in §1706.761(A).
Management Structure and Authority – Fiduciary Duties
The Current LLC Act allows for an LLC to be structured as either member-managed or manager-managed (see, for example §1705.24 and §1705.25). However, the Revised Act eliminates the distinction between member-managed and manager-managed LLCs, and instead, simply allows the operating agreement to govern the management structure and provides that a person’s ability to act as an agent, and bind the LLC, can be authorized by either the operating agreement; decisions of members in accordance with the operating agreement; a Statement of Authority Form filed with the secretary of state’s office; or the Revised Act’s default rules.
Further, according to the Revised Act, the only non-waivable fiduciary duties for members and managers is the implied covenant of good faith and fair dealing (see §1705.08 and §1705.31). This provides additional flexibility when drafting the operating agreement and will allow parties to further provide for one or more members to be able to devote time to another, competitive business.
Cancellation for Failure to Maintain a Statutory Agent
Unlike the Current LLC Act, the Revised Act imposes statutory penalties on any LLC that fails to maintain their statutory agent. According to §1706.09(L), upon the failure of an LLC to continuously maintain a statutory agent or file a change of name or address of a statutory agent, and after providing the LLC with a 30-day opportunity remedy their mistake, the Secretary of State can cancel the articles or registration of the LLC without further notices or action. However, if an LLC has their articles or registration cancelled, that same LLC can file for reinstatement after the appointment of a new agent and paying a filing fee. The LLC must file for reinstatement on a form prescribed by the Secretary of State.
Transacting Business Without Registration
Under the Current LLC Act, an unregistered foreign LLC does not owe a penalty for failing to register with the State, but the LLC is prevented from maintaining a lawsuit in Ohio. The Revised Act now imposes a fine if the LLC fails to properly register with the Secretary of State (see §1706.515). Further, the Revised Act grants the Attorney General the authority to bring action against an LLC for failure to register and the action may result in an injunction, court costs, and interest due.
Penalties for Members’ Failure to Perform
Pursuant to §1706.08(B)(4) of the Revised Act, an operating agreement may provide either or both of the following: (a) that a member or assignee who fails to perform in accordance with, or to comply with the terms and conditions of, the operating agreement shall be subject to specified penalties or specified consequences; (b) that at the time or upon the happening of events specified in the operating agreement, a member or assignee may be subject to specified penalties or consequences. There was no such provision in the Current LLC Act.
The penalties and consequences that can be specified in the operating agreement pursuant to §1706.08(B)(4) are then described in §1706.08(B)(5). These penalties and consequences can include: (1) reducing or eliminating the defaulting member’s or assignee’s proportionate interest in a LLC, (2) subordinating the member’s or assignee’s membership interest to that of a non-defaulting member or assignee, (3) forcing a sale of the member’s or assignee’s membership interest, (4) forfeiting the defaulting member’s or assignee’s membership interest, (5) the lending by other members or assignees of the amount necessary to meet the defaulting member’s or assignee’s commitment, (6) a fixing of the value of the defaulting member’s or assignee’s membership interest by appraisal or by formula and redemption or sale of the membership interest at that value, or (7) any other penalty or consequence.
These do not appear to be mandatory provisions, but rather provisions which could be included in an operating agreement. That being said, given these provisions may be included in an operating agreement, we should be addressing them with clients and asking whether they would like any of these items to be covered in their operating agreements.
Default Rules
The Current LLC Act promotes the freedom of contract and the rights of the members of LLCs to construct their operating agreements as they see fit, notwithstanding the default rules of the Current LLC Act. For example, the Current LLC Act contains numerous phrases such as “except as otherwise modified by the LLC’s operating agreement” or “except as otherwise provided in the articles of organization”. The Revised Act doubles down on this and expressly provides that its provisions are generally default rules which will be applicable in the absence of contradicting terms in an LLCs operating agreement. Therefore, the Revised Act aims to allow for the same freedom of contract principles, while at the same time simplifying which default rules of the Revised Act can be modified and which cannot. The Revised Act provides, in one section (§1706.08(C)), a comprehensive list of provisions that cannot be modified by the LLC’s operating agreement, and that, to the extent that a certain provision is not included in §1706.08(C), an LLC is permitted to modify such a provision through its operating agreement.
NOTE: This general summary of the law should not be used to solve individual problems since slight changes in the fact situation may require a material variance in the applicable legal advice.