Big Changes Ahead for Minnesota LLCs: What you need to know—and do

Big changes are on the horizon for the thousands of limited liability companies (LLCs) organized under Minnesota law. The Minnesota Revised Uniform Limited Liability Company Act (codified in Chapter 322C of the Minnesota Statutes, which replaces the previous laws under Chapter 322B) will apply to all Minnesota LLCs effective as of January 1, 2018, and will functionally amend the governing documents of LLCs that do not take any action in anticipation of the change. While the new LLC Act ultimately gives LLCs greater flexibility, it’s important that all LLC owners understand the changes—and make preparations ahead of time—to ensure their LLCs are structured to reflect the way they want the businesses to operate.

Here’s what you need to know about Minnesota’s new LLC Act—and what you need to consider.

Why the new law?

It seems like LLCs have been around forever, so many people are surprised to learn that the first Minnesota LLC Act was adopted by the Legislature in 1992. Extremely popular within Minnesota’s business community, LLCs provide similar liability protections as do corporations but with greater flexibility, fewer requirements and the advantage of avoiding entity-level taxation. In essence, LLC members get the protection of shareholders of a corporation, while retaining the flexibility to operate their business like sole proprietorships or partnerships.

However, the fundamental structure and framework of the original Minnesota LLC statute was lifted directly from Minnesota’s Corporate statute. By contrast, most other states have adopted LLC statutes based on a partnership model and give more flexibility to the members to set their own governing structure in a negotiated operating agreement.

The adoption of the new LLC Act brings Minnesota LLC law into greater conformity with LLC statutes throughout the country. In particular, it gives members significant latitude in crafting an operating agreement that covers custom business arrangements, along with the freedom to adjust that agreement as the business and partnership evolves.

Do I need to worry about the LLC law change?

• LLCs formed on or after August 1, 2015: No—you’re covered.
  Newer LLCs have been subject to the new LLC act from their inception. The January 1, 2018 deadline has no implications for these LLCs.
• LLCs formed prior to August 1, 2015: Yes—unless you’ve proactively made changes already.
  Older LLCs have been allowed to continue operating under the original LLC Act. Seeing the January 2018 deadline approaching, some LLC owners have proactively elected to amend their agreements to take into account the new LLC Act. Most, however, have not made these changes, and should be aware of the fast-approaching January deadline.

What happens if I do nothing?

The new LLC Act includes “bridging language” to provide some level of continuity for LLCs that take no action. Certain default provisions from the original LLC Act will automatically carry over. These default provisions include provisions relating to distribution rights, voting rights and dissenters’ rights. The bridging language also contemplates that the existing LLC documents—including the articles of organization, bylaws and member control agreement—will be deemed automatically included in the “operating agreement” under the new LLC Act.

What are the big changes I should know about?

Here are some of the most important changes in the new LLC Act that LLC owners should be aware of:

• Management Structure and Framework: While the original LLC Act imported corporate concepts such as management by a board of governors, the new LLC Act is based on partnership statutes and allows for greater flexibility in governance matters. Under the new LLC Act, an LLC has three options for governance:
  1. Member-managed: Decision-making resides with the members, with each member having equal rights in management; this is the default management structure under the new LLC Act.
  2. Board-managed: Mirroring corporate structure, members elect a board of governors that manages the LLC and oversees the executive(s) of the LLC.
  3. Manager-managed: One or more persons or entities has authority and control over the operations of the LLC.
• Governing Documents: The new LLC Act limits governing documents to the articles of organization and an operating agreement. Almost all substantive terms are incorporated into the operating agreement, which typically includes the terms previously contained within the articles of organization, bylaws and member control agreement under the original LLC Act.
• Oral Governing Agreements: While the original LLC Act stipulated that a member control agreement must be in writing and signed by the members, the new LLC Act allows that the operating agreement may be written, oral or even implied.
• Distributions: Under the original LLC Act, the default rule provided for the distribution of cash or other assets to the members in proportion to their capital contributions. The new LLC Act changes the default rule to provide for the distribution of cash or other assets to the members per capita—i.e. in equal shares to each member.
• Voting Power: The default rule under the original LLC Act gave voting power to members in proportion to their capital contributions. The default rule under the new LLC Act provides that the members will have equal voting rights, regardless of the amount of their capital contributions.
• Corporate Formalities: The original LLC Act, closely mirroring Minnesota’s Corporate statute, incorporates corporate case law relating to piercing the corporate veil of limited liability protection. The new LLC Act limits the applicability of such corporate case law. Most importantly, the failure of an LLC to observe corporate formalities can no longer be used to impose liability on the members, managers or governors of an LLC.
• Fiduciary Duties: The new LLC Act provides greater flexibility to limit or modify fiduciary obligations of the members, managers and governors that are responsible for managing an LLC.

Why shouldn’t I wait to amend my LLC’s governing documents?

The LLC law change gives LLC owners a great reason to re-examine their LLC documents and agreements, as well as to amend these documents to better reflect how their businesses operate today. Moreover, waiting until the last minute is never a smart business practice. Taking a proactive approach to amending an LLC’s governing documents not only prevents unintended consequences—acting now yields several advantages:

• Increased Flexibility: Businesses thrive on flexibility. Under the new LLC Act, almost all statutory defaults can be modified in the operating agreement. For example, for some LLCs, it may make sense to adopt a different management structure (e.g. manager-managed or member-managed).
• Mitigate the Risk of Oral Amendment: As noted above, the new LLC Act allows that an LLC’s operating agreement may be oral, written or even implied. To avoid the risk of inadvertent, unintended or otherwise unwanted changes to an LLC’s governing documents, it’s important to add a provision to its governing documents expressly providing that all amendments must be in writing.
• Address New Statutory Defaults: While the new LLC Act allows an LLC significant latitude to change its default provisions by contract, for this flexibility to be useful, the LLC needs to ensure it has a comprehensive operating agreement that includes its preferred terms, and modifies the new statutory default provisions included in the new LLC Act, as desired.
• Maintain Existing Rights of Members: LLC owners need to pay special attention to ensure that the new LLC Act doesn’t deprive members from valuable rights that were provided by default in the original LLC Act. For example, the original LLC Act’s default rules provided members of an LLC with preemptive rights, meaning members would have the right to participate in future offerings of equity to prevent dilution. The new LLC Act includes no such statutory default. This means that if an LLC does nothing, its members will lose their preemptive rights by default. In order to preserve the existing rights of the members, preemptive rights would need to be incorporated into in the governing documents of the LLC.
• Filling in Gaps in New Act: The new LLC Act leaves certain gaps that the original LLC Act did not. To prevent unintended consequences, it may be useful to amend the governing documents of an LLC to address areas in which the new LLC Act is silent. For example, the original LLC Act includes detailed provisions on member meetings; the new LLC Act does not.
• Consolidation of Agreements: To simplify the transition and avoid future confusion or disputes, it’s a good idea to consolidate provisions previously spread throughout an LLC’s articles of organization, bylaws and member control agreement into a single comprehensive operating agreement.
• Limitation on Certain Remedies: To protect the business from the actions of a single member, it may be advisable to incorporate language limiting the availability of alternative remedies. For example, an operating agreement could contractually limit the availability of remedies such as a forced sale in cases in which a member brings legal action against an LLC.
• Nomenclature Changes: Small changes in statutory definitions may have significant implications for the meaning and interpretation of a legal agreement. Addressing changes in nomenclature between the original LLC Act and the new LLC Act enables business owners to mitigate risks arising from ambiguous defined terms. For example, while the original LLC Act referred to “membership interests” consisting of “financial rights” and “governance rights,” the new LLC Act contains the same general concepts—but defines them differently. The new LLC Act uses the term “transferable interest” to refer to financial rights and does not include an analogous defined term for “membership interests” or “governance rights.” Amending the governing documents of an LLC allows for greater precision by incorporating the new statutory defined terms.

Proactively address change

Ultimately, it’s better to address the changes of the new LLC Act proactively rather than passively relying on the bridging language contained in the new LLC Act to fill in the gaps left by the change in law. LLC owners have a natural opportunity to revisit governing documents that may not have been updated for many years, revise them to fit the way the company is operating today, and ensure it continues to operate smoothly for years to come.