New limited liability company (LLC) laws became effective in Minnesota and North Dakota earlier this year, ushering in a significantly different legal landscape relating to the rights and responsibilities of LLC members and management and third parties dealing with LLCs in those states. Although banks and bank holding companies are not typically structured as LLCs for regulatory reasons, banks and bank holding companies commonly establish LLC subsidiaries to engage in tangential activities such as insurance sales or holding other real estate (OREO). Therefore, it is important for banks to note the changes to the LLC laws. This article highlights some important aspects of Minnesota’s new LLC law (Minnesota’s New Act) and North Dakota’s new LLC law (North Dakota’s New Act) (or, the New Acts).
Effective Dates. Minnesota’s New Act became effective on August 1, 2015, and North Dakota’s New Act became effective on July 1, 2015. Therefore, all LLCs formed in Minnesota on or after August 1, 2015 are subject to Minnesota’s New Act, and all LLCs formed in North Dakota on or after July 1, 2015 are subject to North Dakota’s New Act. LLCs organized in Minnesota or North Dakota prior to the New Acts’ respective effective dates remain subject to the LLC laws that existed prior to the New Acts (collectively, the Prior Acts), unless the members take action to elect early into a New Act. LLCs may want to opt-in and take early advantage of some of the changes in a New Act, such as non-board governance structures. In any event, all Minnesota LLCs will be subject to Minnesota’s New Act on January 1, 2018, and all North Dakota LLCs will be subject to North Dakota’s New Act on January 1, 2016.
Will Prior Act-Organized LLCs Change Once Subject to the New Acts? Once Prior Act-organized LLCs become subject to the New Acts, the LLCs’ economic and governance structures will not necessarily change. First, if a Prior Act-organized LLC has a governing agreement called a “member control agreement,” the member control agreement’s provisions will be respected under the New Acts (with very few exceptions). Also, if a member control agreement for a Prior Act-organized LLC does not discuss a particular aspect of the LLC’s owners’ agreement, the New Acts “grandfather in” various concepts from the Prior Acts and apply those concepts to Prior Act-organized LLCs even after all LLCs are subject to the New Acts. Further, under the New Acts, oral and implied agreements may be considered to supplement or amend a written member control agreement. Therefore, even if the New Acts are different from the Prior Acts in some respect, oral or implied agreements may be assumed to be part of a written member control agreement and supersede provisions of the New Acts.
General Difference Between the Prior Acts and the New Acts. Generally, the Prior Acts were based on corporate laws and included corporate concepts such as board and officer management structures. The New Acts are generally modeled after partnership laws. Therefore, many of the differences between the Prior Acts and the New Acts are due to the differences between corporate law and partnership law concepts.
Governing Agreement. Under the New Acts, an LLC’s governing agreement is called an “operating agreement” (regardless of what the agreement is actually titled). An operating agreement is an agreement among all the members (owners) of the LLC and can be in various formats including written, oral, implied, and a combination thereof. The Prior Acts required an LLC’s member control agreement to be in writing and signed by all the LLC’s members.
Given that the New Acts provide that an operating agreement can take many forms, it is important to have an operating agreement in writing (to avoid confusion over the operating agreement’s terms), and also to have a clause in the written operating agreement that clarifies that the written operating agreement is the only operating agreement, that it can be amended only in writing, and that the members understand and adhere to its terms.
Flexible Governance Structures. Under the Prior Acts, LLCs were required to have boards of governors (which are similar to boards of directors in a corporation) and managers (which are similar to officers). Under the New Acts, three different governance structures are explicitly permissible: member-managed, manager-managed, and board-managed. For example, if your bank partners with another bank on an LLC service company, you would likely prefer member or board management. For wholly-owned OREO subsidiaries, the streamlined manager-managed choice may be more appropriate. If the members wish to have the LLC be manager-managed or board-managed, that choice must be set forth in the LLC’s operating agreement. Otherwise, the LLC will be member-managed, which is the default governance structure for LLCs organized under the New Acts.
Note that if an LLC is member-managed, the default voting power of the members under the New Acts is per capita – i.e., one vote per member. In practice, member voting is typically based on percentage ownership in an LLC, and therefore, member voting provisions in an operating agreement need to deviate from what the New Acts provide as default.
If an LLC is manager-managed or board-managed, most of the decision-making power for the LLC rests in the manager(s) or board. However, the New Acts provide for a short list of major decisions for the LLC that will require unanimous member consent, including sale of all or substantially all of the LLC’s assets, mergers, and acts outside of the LLC’s ordinary course of business. The operating agreement may contain overriding provisions relating to these and other decisions.
Relations of Members/Managers/ Board to Third Parties. A member of an LLC cannot act on behalf of the LLC simply because he or she is a member. Rather, the LLC’s operating agreement or state law determines who can act on behalf of an LLC. Under the Prior Acts, the power to actively manage and sign documents on behalf of an LLC was explicitly granted to the chief manager. However, third parties cannot similarly rely on the New Acts to determine who has authority to bind the LLC. To assist third parties, the New Acts permit filings of statements of authority with the Secretary of State’s Office that indicate who has the authority to bind the LLC.
Modifying and Eliminating Fiduciary Duties. Like the Prior Acts, the New Acts impose on an LLC’s members and management the fiduciary duties of loyalty and care. Unlike the Prior Acts, the New Acts allow for greater flexibility in fiduciary duties through an LLC’s operating agreement.
Dissenters’ Rights. The New Acts eliminate dissenters’ rights as a default right. (“Dissenters’ rights” are, in general, the right of shareholders to receive a cash payment for the fair value of their shares in the event of a share-for-share merger or acquisition to which the shareholders do not consent.) Therefore, members of an LLC do not have statutory dissenter or appraisal rights. However, an operating agreement may be drafted to include those rights. With regard to Prior Act-organized LLCs that have dissenters’ rights for their members (i.e., that did not waive dissenters’ rights), those dissenters’ rights continue to apply even after all Prior Act-organized LLCs become subject to the New Acts, unless the members agree to eliminate them.
The new Minnesota and North Dakota limited liability company laws significantly change many of the underlying statutory rules for LLCs from what existed under prior law, and make it critical that LLCs have proper operating agreements in place to define the agreements of the members. If a bank or bank holding company chooses to form an LLC as a subsidiary, it is imperative that the LLC have an up-to-date, written operating agreement that reflects all of the agreements of the members and contains a clause that clarifies that the written operating agreement is the only operating agreement that exists and that it cannot be modified except by a written amendment. Further, when establishing an LLC subsidiary of a bank or bank holding company, bankers need to take into consideration not only the New Acts, but applicable banking laws, regulations and guidance.