If you are a member (owner) of a Minnesota limited liability company (LLC), then you need to decide in the next few months whether it is necessary, or simply prudent, to adopt revised governance documents in light of changes in Minnesota law governing LLCs. This article provides a framework for evaluating whether a modification of your existing governance documents is necessary.
Minnesota’s former statutes governing LLCs were codified in chapter 322B. Thus, a “322B LLC” is a Minnesota LLC that remains subject to Minnesota statutes 322B, et seq. Any Minnesota LLC organized prior to August 1, 2015, was organized according to 322B. Some of those LLCs may have elected to be governed by the new LLC act, codified in chapter 322C, and referred to here as a “322C LLC.” To determine whether your LLC is governed by 322B or 322C, go to the Minnesota Secretary of State website, search for your LLC by name, and review the first page of the expanded report under the heading “MN Statute.”
322B vs. 322C
If you find that you have a 322C LLC, then your company was either (i) organized on or after August 1, 2015, or (ii) you elected to opt-in to have the LLC be governed by 322C. In either case, the organizational and governance documents for your LLC should be up-to-date. If you have any questions regarding whether this is the case, review the documents or contact your attorney for what should be a quick review.
If you find that you have a 322B LLC, then you will need to decide on how to proceed. That decision will be impacted by whether your company is a single member LLC, or has more than one member.
While a detailed analysis of the differences between 322B and 322C is beyond the scope of this article, the changes to the law governing Minnesota LLCs were substantive and cannot be ignored, especially for multi-member companies. A nonexclusive list of some of the new act’s key changes include the following:
- Members may contractually agree to reduce or eliminate the duty of loyalty and the duty of care, subject to such modifications not being “manifestly unreasonable.”
- Members may contractually agree to limit the grounds for judicial relief of oppressive member or manager conduct.
- The governing agreement among the members may be oral, written, implied by course of dealing, or a combination of all three.
- The LLC may be managed by its members, a board, or be “manager-managed.”
- Unlike 322B, which had a default provision providing for distribution of cash or other assets to be made in proportion to the value of each member’s contribution to the LLC, 322C provides for default distributions to be made in equal shares among the members.
- Each member has equal voting rights in the management and conduct of the activities of the LLC, in contrast to the proportional voting rights based on capital contributions under the old statute.
What to do next? A decision matrix for Minnesota LLCs
Single Member LLC – If you have a single member LLC, meaning there is only one owner, then your options are either to (i) do nothing, or (ii) adopt a revised operating agreement that formally recognizes 322C as the governing statute for the company, and modify any default provisions as necessary.
Because a single member LLC will typically be member-managed, and that solo member can govern all aspects of the company, there is no immediate risk for an owner electing to do nothing. However, there is a risk that if a new member were to join the company, then the default provisions of 322C would “fill the gap” between the existing governance documents and the new statute. This may have unintended consequences.
Our Recommendation – We recommend that a single member LLC adopt a revised operating agreement acknowledging the applicability of 322C and making clear any additional members will be subject to an operating agreement to be adopted by the existing member. This will be a relatively short document and inexpensive for the company to adopt.
Multi-Member LLC – If you are a member of a multi-member LLC, one option is also to do nothing. In that case, the LLC’s existing 322B governance documents will become the “operating agreement” for the LLC. For a number of reasons, we strongly discourage this approach.
First, 322C is an updated law that emphasizes flexibility in the contractually-negotiated business agreement among members. As such, it is different than 322B, which was based on a corporate framework.
Second, the mandatory effective date for 322C is an opportune time for a company to revisit its governance documents and the assumptions made in those documents. It is not unusual that organizational documents become “stale,” with an organization’s practices differing from the structure originally contemplated in previous years. Certain default provisions set out in 322B, such as indemnification of nonexecutive employees and agents of the company, may be ripe for limitation, which can be accomplished by updating the company’s governance document to a 322C operating agreement.
Third, and perhaps most importantly, there may be gaps that exist when a company subject to 322C continues to govern using documents originally drafted under 322B. For example, if your company’s existing governance documents do not address the allocation of distributions, then 322C’s default provision is that distributions will be made on a per member basis, not based on a member’s capital contributions or percentage ownership interest. This likely is contrary to the expectation of most business owners.
Similarly, the 322C Act’s default provision is that voting is on a per member basis, not based on the percentage of the company owned by the member. Accordingly, it is possible that a member owning a majority interest in an LLC could be outvoted by two or more members that together own a minority interest in the company. Again, this is likely to be contrary to the expectation of most business owners.
A final example is that 322C contemplates that oral agreements and course of conduct can inform or constitute the operating agreement. It is not difficult to conceive of a dispute whereby a company that continues to use documents drafted under 322B, without a clause disclaiming oral modification, finds itself in conflict with members over whether its operating agreement has been modified orally or by a course of conduct.
Our Recommendation – Because of the risks to operating under the old LLC act, we strongly recommend that a Minnesota multi-member LLC, prior to January 1, 2018, adopt an operating agreement to replace any existing member control agreement, operating agreement, bylaws, buy-sell agreement, and other governance documents.
In adopting a new operating agreement, a threshold question will be whether the LLC should be member-managed, board-managed, or manager-managed. A member-managed LLC would be directly managed by the members, each of whom would have an equal vote in the operation of the business. A board-managed LLC will likely operate much like a 322B LLC that is governed by a Board of Governors. A manager-managed LLC will be managed by one or more persons (or companies) with exclusive authority to act for the LLC.
The new Minnesota LLC act, codified at 322C, does not take a “one-size-fits-all” approach. To the contrary, the partnership-like structure is designed such that members can enter into a contract governing their expectations, and limiting or expanding owner rights as appropriate.
Any of the business attorneys of Trepanier MacGillis Battina P.A. would be happy to discuss your existing LLC governance structure and how adoption of an operating agreement that takes advantage of the new LLC act can benefit your organization. Contact Minnesota business attorney Jim MacGillis at 612-455-0503 for more information.