letting the statute be the deal: the delaware statutory …€¦ · the question for practitioners...

LETTING THE STATUTE BE THE DEAL: THE DELAWARE STATUTORY LLC DEFAULT RULES

Steven A. Waters Haynes and Boone, LLP,

112 E. Pecan, Suite 1600, San Antonio, Texas

Robert R. Nix II Kerr, Russell and Weber, PLC,

500 Woodward Avenue, Suite 2500, Detroit, Michigan


I. INTRODUCTION Delaware has led the nation in creating legislation favorable to the formation,

management and operation of businesses. One example, the progressive Delaware limited liability company act, as amended through June, 2003, 74 Del. Laws, C191 (the "Act"), is becoming the jurisdiction of choice for the formation of limited liability companies, particularly those conducting business in multiple states. One attractive aspect of the Act is found in its policy of maximizing the principle of "freedom of contract.” Section 18-1101(b) provides that "it is the policy of this chapter to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements. This principle of letting parties control their business arrangements via the limited liability company agreement (the "LLC Agreement") is further enhanced by the part of Section 18-01(a) that provides that "the rule that statutes in derogation of common law are to be strictly construed shall have no application to this chapter." Thus, the Act provides a framework within which parties are free to establish the precise perimeters of their business relationship through the vehicle of the LLC Agreement.

The question for practitioners is whether the LLC Agreement should address everything? The Act contains statutory "defaults" or "fall back" rules that will govern the limited liability company (the "LLC") if there is no LLC Agreement or if the LLC Agreement is silent on the matter. Some of these "default rules" may be deemed advantageous and others may produce unwanted results, depending on the nature of the LLC, its business operations or the parties’ expectations. Consequently, this analysis of the "default rules" is offered to assist lawyers drafting LLC Agreements for Delaware LLCs. A summary, bullet-point checklist, and a more complete chart summarizing the default "default rules," are attached for reference. This analysis also identifies certain optional provisions in the Act that provide "drafting opportunities" (i.e. that are enabled by the statute, if adopted by the parties), and other controlling provisions that should be considered.

II. STATUTORY "DEFAULT RULES"

The Act establishes the "default rules" through its use of qualifying language like "except as otherwise provided in an LLC Agreement", or "if the LLC Agreement does not otherwise provide", or "except to the extent limited by the LLC Agreement." Lack of coverage by the LLC Agreement results in the following "default rules" becoming applicable (i.e., by default). Sections 18-106(a), (b) and (c) provide an LLC with broad and expansive powers and privileges to conduct business, except the businesses of insurance and banking. Absent a limitation in the LLC Agreement, the LLC has the power and authority to make contracts of guaranty and suretyship, and to enter into interest rate basis, currency, hedge or other swap agreements, or cap, floor, put, call, option, exchange or collar agreements, derivative agreements or other similar agreements. Many of these powers would not be suitable for certain LLCs and should be restricted, as appropriate, in the LLC Agreement.

Following is a brief discussion of some of the more important default rules:

A. Self-Dealing. Section 18-107 permits both managers and members to enter into

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business transactions with the LLC to the same extent as third parties. Presumably, the phrase "to the same extent as third parties" means that the terms of the business transaction will be controlled by the agreement of the parties, which could be oral or written. Because third parties owe no particular fiduciary duties to the LLC or its members, the statute may be construed to permit managers or members (like third parties) to negotiate terms favorable to their own interest free from the fiduciary duties of loyalty, care, etc. Thus, a well-drafted LLC Agreement will specifically address this subject and impose appropriate standards and limitations. The standards and limitations to be developed likely will be different for developer members and investor members.

B. Indemnification. Section 18-108 provides that an LLC may indemnify members, managers and others from "any and all claims and demands whatsoever". As a permissive rather than mandatory provision, the standards and restrictions "upon the indemnity are to be set forth in the LLC Agreement." An LLC Agreement is not required, and an oral agreement can exist among the members that includes indemnification. In this case, the indemnification would be extremely broad and would have to be interpreted in the context of governing case law (as well as be subject to a more difficult proof burden than a written one). This is an extremely important subject that should be addressed in the LLC Agreement.

C. Agency and Delegation of Authority. Section 18-204(b) permits the LLC Agreement and other documents to be executed by an agent for a party. The authorization, including a power of attorney, need not be in writing, sworn to or verified. If the authorization is in writing, the LLC must retain a copy in the LLC records. This provision, which permits authorization or an agency relationship to be created by oral agreements, is subject to the risk of verification by adequate testimony or evidence. That problem is compounded by Section 18-407, which provides that both managers and members have full authority to delegate their rights and powers to manage and control business and affairs of the LLC. This grant of authority should be documented and restricted by the LLC Agreement or specific agreements establishing the delegation. However, the delegation does not cause the delegee to become a member or manager, or cause the member or manager delegating powers to lose any rights.

D. Voting and Management. Section 18-402 places management in its members (unless the members designate a manager) in proportion to their percentages of ownership, and a vote of more than 50% establishes control. Unless otherwise provided in the LLC Agreement, each member and each manager (if any) has the authority to bind the LLC. Section 18-403 permits a person to be both a manager and member with the respective rights and powers of each category. This "default provision" gives extremely broad authority to act on behalf of and to bind the LLC, which often is not appropriate. Thus, an LLC Agreement should be drafted appropriately to restrict or limit the powers and authority of the various members or managers of the LLC. Other "default rules" of the Act place voting control in more than 50% of the members (including more than 50% vote of each class if there are classes). That same voting requirement applies to a merger pursuant to Section 18-209(b), a change of state organization pursuant to Section 18-213(b) and a conversion (unless there is a provision addressing merger, which then controls) pursuant to Section 18-216. However, Section 18-301(b) requires the consent of all members for the admission of members after formation of the LLC. In view of the significance of voting control and management rights, most sophisticated transactions will require an LLC Agreement that specifically covers these subjects.

E. Series LLCs. The Act contains an innovative provision generally not found in

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limited liability company statutes of other states, permitting one or more series within the LLC. Section 18-215 permits the LLC to establish one or more designated series of members, managers or limited liability company interests having separate rights, powers or duties, with respect to specific property or obligations of the LLC or profits and losses associated with specific property or obligations. Importantly, each series may have a separate business purpose or investment objective. This provision provides useful flexibility to create, under the umbrella of a single LLC, different business ventures composed of different members or managers with different percentage interests. The tax issues associated with series LLCs are complex, and ventures that use them are not yet commonplace. One advantage of a series LLC is that the assets of the particular series can be insulated from the general debts and liabilities of the LLC and the debts and liabilities of each other series within the LLC. Subsections (b), (f), (g), (i), (j), (k), and (m) create specific "default rules" that should be carefully reviewed when creating a series LLC. The statutory advantage of limiting debts and liabilities to the assets of a particular series LLC is simply obtained by a Delaware LLC’s making a statement in its certificate of formation that the debts and liabilities of a particular series is limited to its assets. Importantly, the series LLCs need not be created at that time, and they automatically obtain the benefit of the limitation of liability when subsequently created. Subsection 215(m) provides the same rules for a foreign LLC, but the application for registration must state whether the LLC Agreement establishes one or more series. The series default rules include the following:

1. Subsection 215(f) provides that management of the series is vested in the members, with a vote of more than 50% controlling, unless the members have elected a manager. A manager who ceases to manage one series does not automatically cease to be the manager of any other series.

2. Subsection 215(g) provides that the members entitled to receive distributions have the same status and rights as creditors of the LLC.

3. Subsection 215(i) provides that an assignment by a member of an interest in one series does not cause the member to cease to be the member in any other series, terminate the member's membership interest in the LLC or cause a termination of the series involving the assignments.

4. Subsection 215(j) provides that a series can be terminated without causing a dissolution of the LLC. This subsection further provides that a series cannot be terminated without a 2/3 vote.

5. Subsection 215(k) provides that the manager(s) (if any) or members approved by more than a 50% vote are charged with the responsibility for winding up the affairs of a terminated series.

F. Non-economic Members; Preemptive Rights. Section 18-301(d) contains an extraordinary provision that permits a member to be admitted into an LLC without acquiring an LLC interest and without making or being obligated to make a contribution. This non-economic member can provide a vehicle for the continuation of the LLC on the sale or assignment, dissolution, bankruptcy, etc. of other members or managers of the LLC. The non-economic members also can be designated as the member to hold certain voting control of preemptive rights, etc. However, because LLCs can be created without a LLC Agreement, oral agreements on this subject should be avoided. If there is no LLC Agreement, then another written agreement should cover this important issue. The use of non-economic members is frequently found in

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transactions involving securitized loans, where the non-economic member is selected by the lender and is granted voting rights in connection with specified matters, such as bankruptcy filings. This use of non-economic members raises issues involving conflicts of interest and fiduciary duties that are beyond the scope of this paper.

Section 18-301(e) provides that a member has no preemptive rights to subscribe to any additional issues or interests in the LLC or in any other company. Many transactions do give members with rights to participate in additional ventures or to avoid dilution; to exist, those rights must be addressed in the LLC Agreement.

G. Member and Manager Actions. Sections 18-302(d) and 404(d) provide "members and managers with the ability to take action without meetings, prior notice or a formal vote, so long as the action is verified by subsequent written consent. While the flexibility of this provision is advantageous, attorneys representing minority members will want to limit the majority from taking action without providing prior notice to the minority.

H. Bankruptcy. Section 18-304 provides that a member ceases to be a member of an LLC on the occurrence of certain bankruptcy or insolvency events or the making of an assignment for the benefit of creditors. This default rule results in the member’s losing membership status (but not the economic entitlements), which include applicable voting and management rights. This provision can be enormously helpful in avoiding the interference in the LLC business activities caused by the bankruptcy of a member having significant voting and management rights. The LLC Agreement could enhance this provision by providing for a delegation or a transfer of management and voting rights to another member or manager, as appropriate.

I. Member's Right to Information. Section 18-305 gives members a statutory right to obtain certain information from the LLC, on reasonable demand. This default rule subjects the right to reasonable standards either set forth in the LLC Agreement or established by the managers (or if no managers, by the members). Thus, in the absence of a formal LLC Agreement, reasonable standards can still be imposed in connection with the release of information from the LLC. The right to information is broad and includes information for “any purposes reasonably related to the member's interest as a member in the LLC,” specifically including, financial information, tax returns, and a list of members and managers. Managers, however, may keep trade secrets and other confidential business information from the members "if the managers believe in good faith that keeping the information from the members is in the LLC's best interests". Each manager has similar rights to access LLC information to the extent related to the performance of its duties as a manager.

J. Contributions, Allocations of Profits and Losses and Distributions. The default rules for these subjects are consistent with normal expectations. A member’s obligation to contribute cash or property or to perform services is not affected by that member's inability to perform, and it survives death or disability (Section 18-502(a). The consent of all members is required to compromise any member's obligation to make a contribution or return a distribution in violation of the LLC Act (Section 18-502(b)). Section 18-504 provides that distributions are made on the basis of the agreed value of contributions made by each member as shown on the LLC records. Complex transactions that include special allocations, priority returns, shifting of percentage interests on special events, etc. should be addressed by an appropriate LLC Agreement. Section 18-601 provides the default rule that permits members to receive

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distributions on withdrawal from or dissolution of the LLC. This right to receive distributions upon withdrawal (which could include sale and assignment of the membership interest) is generally disfavored and almost always “drafted away” by the LLC Agreement. Section 18-606 provides that a member becomes a creditor of the LLC when the member is entitled to receive a distribution and can pursue the distribution with the full rights of a creditor. Absent a formal LLC Agreement, it may be difficult to establish when a member is entitled to receive a distribution. Finally, Section 18-604 provides that a resigning member is entitled to receive the fair value of the member's LLC interest as of the date of resignation, to be paid within a reasonable time after resignation. This companion to subsection 601 will apply unless excluded in the LLC Agreement. Section 18-605 does not permit a member to demand an "in-kind" distribution. However, the LLC is permitted to force a member to accept a distribution of assets "in-kind" so long as the percentage of the asset distribution equals the member's percentage share of distributions. But a distribution of real property assets "in-kind" will vest ownership in the members as tenants-in-common, creating problems of control, management, sale, financing, etc. This default rule should be avoided by an LLC Agreement that properly addresses the sale and disposition of the property through appropriate buy/sell and liquidation provisions.

K. Member and Manager Resignation. The default rule in Section 18-602 permits a manager to resign by giving written notice to the members and other managers, even if restricted by an LLC Agreement. However, if the resignation violates the LLC Agreement, then it may give rise to liability for damages. Section 18-603 prevents a member from resigning before the dissolution or winding up of the LLC. This provision does not apply to any LLC formed on or before July 31, 1996 and the previous version of Subsection 603 applies to any such LLC. The withdrawal, assignment and transfer rights of members and LLCs are critical to the formation, management and operation of LLCs and should be not left to the default rules. In the absence of an LLC Agreement, those subjects should at least be covered by a separate agreement.

L. Transfers and Assignments. The default rule in Section 18-702(a) permits a membership interest to be assignable, in whole or part, but the assignee does not have a right to participate in management without the consent of all other members. The assignment is essentially limited to an assignment of the economic benefits of profits, losses and distributions. If the entire membership interest is assigned, then the assigning member ceases to be a member of the LLC and ceases to have the power to exercise any management and voting rights previously held by the member. Under the default rule, the assignee cannot exercise those voting and management rights unless admitted as a successor member with the consent of all members, which could result in an unanticipated change of control in the LLC. This uncertainty should be avoided by coverage in an LLC Agreement. A pledge or encumbrance of the membership interest does not create the same risk because subsection 702 provides that an assignment for security does not cause a member to cease to be a member or give the pledgee the power to exercise voting and management rights. Consistent with the approach taken by this default rule, the assignee does not have liability as a member of the LLC. Subsection 702(e) permits the LLC to purchase and redeem any interest of a member or a manager, and the acquisition results in cancellation of the interest acquired unless there is an LLC Agreement that provides otherwise. While the default rule preserves an important right to the LLC, the terms and conditions for such acquisitions will be governed by the ad hoc actions of the LLC in the absence of an LLC Agreement, which could have provided greater certainty. Section 18-704(b) provides that an assignee who becomes a member is liable for the obligations of the assignor to make

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contributions, but not the assignor's obligation to return prior distributions. This default rule applies only if the obligations to make those contributions are known to the assignee at the time it became a member, or could be ascertained from the LLC Agreement.

M. Dissolution Events. Section 18-801(a) provides that an LLC is dissolved either at the time specified in an LLC Agreement or on the happening of event specified in the LLC Agreement. In the absence of an LLC Agreement, the LLC has a perpetual existence and is dissolved on the affirmative vote or written consent of the members (by class, if more than one class) who own more than two-thirds of the then current percentage interests in the profits of the LLC. Subsection 801(a) (4) provides that the LLC is not dissolved if, within 90 days after the occurrence of the event that terminated the membership of the last remaining member, the personal representative of that member agrees to continue the LLC and to the admission of the personal representative or its nominee or designee as a member, or a new member is admitted in the manner provided in the LLC Agreement. This default rule is advantageous and similar to that provided in many LLC Agreements.

III. OPTIONAL STATUTORY RULES THAT MAY BE INVOKED ONLY BY INCLUSION OF RELEVANT PROVISIONS IN THE LLC AGREEMENT The Act specifically enables an LLC to have certain features, but only if relevant

provisions are included in the LLC Agreement. Consequently, the matters allowed by the Act can only be obtained by appropriate inclusion in an LLC Agreement – if the LLC Agreement is silent and fails to take advantage of a statutorily-permitted item, then there is no controlling “default” provision in the statute to fill the gap. (Given the strong “freedom of contract” principle discussed above, however, it is not the case that none of these could effectively be included absent statutory authorization. But they still must be included in the LLC Agreement to be effective for the particular LLC.)

A. Jurisdiction. Section 18-109(d) permits managers or members to consent to be subject to the jurisdiction of Delaware or any other state, and the LLC Agreement may specify the manner in which service of process occurs.

B. Contractual Appraisal Rights of Members. Section 18-210 permits a merger agreement and an LLC Agreement to provide for contractual appraisal rights for any class or group of members or LLC interests in the event of a merger or consolidation involving the LLC or a sale of substantially all of the assets of the LLC. However, it is more common for LLC Agreements to include specific buy/sell provisions that establish the rights of the members to acquire membership interests of other members, cause the LLC assets to be sold to third parties and provide for the method of establishing the value of the membership interests being sold or acquired. Such provisions often include "tag along rights" that permit minority members to sell their membership interests on the same terms as controlling members, and "come along rights" or “drag along rights” in which the majority members can force minority members to sell their membership interests on the same terms governing the sale of the membership interests of the majority members or on alternative valuation methods.

C. Series LLCs. Section 18-215 permits an LLC Agreement to create a series of members, managers or LLC interests and to establish separate rights and obligations in connection with each series. Importantly, the debts, liabilities, obligations and expenses of each series can be limited to the assets of the series. Although this provision of the Act offers great flexibility, the associated complexities and tax issues have discouraged its use.

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D. Remedies. Section 18-306 permits an LLC Agreement to provide remedies and penalties for a member's breach of its obligations under the LLC Agreement. Similarly, Section 18-405 permits an LLC Agreement to provide for remedies and penalties for a manager's breach of its obligations under the LLC Agreement. These sections permit the LLC Agreement to be tailored to the transaction, limited only by the imagination of the lawyers drafting the agreements. Section 18-502(c) permits an LLC Agreement to provide penalties for a member's failure to make required contributions, including dilution of a member's membership interest, subordination of the interest and a forced sale of the member's interest. This appears to be a codification of current practice. These provisions support the policy of the Act to give maximum effect to the principle of freedom of contract.

IV. CONCLUSION The Act provides a number of significant "default rules" that will control an LLC in the

absence of an LLC Agreement. Careful practitioners should become familiar with these rules in drafting LLC Agreements to ensure the desired outcome. Most LLCs involving complex real estate transactions will be governed by detailed LLC Agreements. However, the "default rules" may be advantageous to resolve ambiguities, or they may serve as a starting point for more detailed provisions. The optional provisions of the Act also provide additional drafting opportunities to fit the LLC Agreement to the needs of the parties. The policy of the Act to give maximum effect to the freedom of contract and evolving interpretive case law will encourage practitioners to form Delaware LLCs.

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Bullet Point Summary

Quick Summary Of What You Get, And Can’t Have, If You Rely On The Statute Alone

If you default to the Act, YOU Get:

• Members and managers – like 3rd third parties – may do business w/ LLC. (18-107)

• To merge or consolidate on approval of greater than 50% of membership interests (by class, if applicable). (-209(b))

• Management of separate series by vote of greater than 50% of members of the series. (-215(f))

• Creditor status, if member entitled to a distribution (by series). (-215(g))

• Ability to terminate series w/out dissolving LLC, on 2/3 vote of series members. (-215(j))

• Ability to authorize conversion (by class, if appropriate) on greater than› 50% membership interest vote (unless the LLC Agreement specifies manner to authorize merger or consolidation, which would also apply to conversions). (-216)

• To admit person to LLC as a member w/out its acquiring an LLC interest or making, or being obligated to make, a contribution. (-301(d))

• To have member action w/out a meeting, w/out prior notice, and w/out a formal vote, if action is consented to in writing by members w/ required voting strength; may be done by electronic transmission. (-302(d))

• Freedom (as member or manager) from personal liability for debts of LLC. (-303)

• Member right to obtain, on reasonable demand for purpose reasonably related to member’s interest as member, info re LLC’s affairs, including financial, tax returns, list and contact info for members and managers. (Managers may keep trade secrets and other confidential business info from members if in best interest of the LLC.) (-305)

• Management by members in proportion to % ownership, w/ greater than 50% vote controlling. Each member and manager has authority to bind the LLC. (-402)

• Full authority of members and managers to delegate rights/ powers to manage/control business and affairs of LLC. (-407)

• Allocate profits and losses based on agreed value of contributions made by members. (-503)

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• Distributions on basis of agreed value of contributions made by each member. (-504)

• Entitlement to receive distributions on w/drawal from, and dissolution of, LLC. (-601)

• Authority of manager to resign by giving written notice to members and other managers (although, can be wrongful, creating possible liability for damages). (-602)

• Ability of resigning member to receive, w/in a reasonable time after resignation, fair value of LLC interest, based on distribution right. (-604)

• The right to assign the membership interest (but not, without agreement, management rights). (-702(a))

• As assignee that becomes a member, obligation of assignor to make contributions, if known to assignee (or determinable from LLC Agreement) when assignee becomes member. (-704(b))

• To dissolve LLC on affirmative vote or written consent of members (by class, if applicable) w/ greater than 2/3 of % interests in profits. (-801(a)(1), (a)(3))

• The right of the personal representative of a member to vote to avoid dissolution and winding up, on the termination of the membership interest of the last remaining member. (-801(a)(4))

• The right to wind up after dissolution, by a manager who has not wrongfully dissolved, or if none, by a vote of more than 50% of membership interests (subj. to Chancery Court right to appoint liquidating trustee). (-803(a))

• After creditors paid, right as resigning or w/drawing member to be paid before continuing members. (-804(a))

If you default to the Act YOU CAN’T HAVE:

[Note: GENERALLY – MAY not be able to get the benefit of any provision that enables something to be included in the LLC Agreement, but that is not otherwise permitted.]

• Specify means to merge or convert that is different from means to amend or adopt new LLC Agreement to achieve a merger or

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consolidation. (-209(f))

• Make available contractual appraisal rights regarding an LLC interest to any class or group of members or LLC interests, pertaining to an amendment, merger or consolidation, or sale of substantially all of the LLC’s assets. (-210)

• Creation of classes or groups of members, w/ different rights and voting procedures. (-302)

• Provision of remedies and penalties for a member’s breach of its obligations under the LLC Agreement. (-306)

• Creation of classes or groups of managers, w/ different rights and voting procedures. (-404)

• Provision of remedies and penalties for a manager’s breach of its obligations under the LLC Agreement. (-405)

• Provision of penalties for a member’s failure to make required contributions (including, but not limited to, reducing or eliminating the member’s membership interest, subordinating the member’s interest to those of nondefaulting members, or fixing a forced sale value). (-502(c))

• Establishment of conditions and procedures in connection w/ the admission as a member or an assignee of a member’s membership interest. (-603)

• Define the “standards and restrictions” relating to an LLC’s indemnity of members, managers and others. (-108)

• Provide for 1 or more series and that the debts, liabilities, obligations and expenses of each series of membership interests are enforceable only against the assets of that series, and that none of the debts, etc. of the LLC generally, or of any other series, are enforceable against that series. (-215(b))

• Prohibit conversions, or specify a manner of authorizing a conversion that is different from the manner of authorizing a merger or a consolidation. (-216)

• The right to impose pre-emptive rights to describe to any additional issue of interests. (-301(e))

• The imposition reasonable standards governing a member’s obtaining information regarding the LLC’s affairs. (-305)

• Imposition of voting requirements different from majority percentage interests. (-402)

• Providing that a member’s obligation to perform a promise to contribute cash or property, or to perform services is discharged or otherwise affected by the member’s inability to perform, including death or disability. (-502(a))

• Providing that a member’s obligation to make a contribution or to return money or other property to the LLC may be compromised by less than all members. (-502(b))

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• Allowing a member to demand and receive a distribution in a form other than cash, or forcing a member to accept an in kind distribution that is not pro rata. (-605)

• Affecting the right of members and former members who are owed distributions under Sections 601 and 604, to be paid before other members. (-804(a))

• Freeing an assignee its member/transferor’s obligations to make contributions. (-704(b))

• Allowing a member to resign from an LLC before dissolution and winding up. (-603)

• Allow an assignee to exercise one or more rights or powers of a member. (-702(b))


Detailed Summary

DELAWARE

LIMITED LIABILITY COMPANY ACT

SECTION TOPIC ISSUE COMMENTS

§18-1101(b) Freedom of Contract

“It is the policy of this chapter to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements.”

Clearly, the parties have the statutory ability in most cases to override the statutory result. (This is not an unfettered right. For example, in Gotham Partners L.P. v. Hallwood Realty Partners, L.P., a 2002 Delaware Chancery Court decision involving a limited partnership, the court indicated (albeit in dicta) that it would not accept a complete elimination of fiduciary duties.) Gotham Partners, L.P. v. Hallwood Realty Partners, C.A. No. 15754, 2000 Del. Ch. LEXIS 146 (Del. Ch. Sept. 27, 2000)

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DELAWARE



FALLBACK / DEFAULT PROVISIONS

(These apply if the LLC Agreement is silent; with limited exceptions that are noted (where appropriate), LLC Act has qualifying language like “except as otherwise provided in an LLC Agreement” or “if the LLC Agreement does not otherwise provide” or “except to the extent limited in the LLC Agreement”)

§18-106 (b), (c)

Power of Company

An LLC has all powers and privileges granted by the Act or otherwise by law, except the businesses of insurance and banking. An LLC has the power and authority to make contracts of guaranty and suretyship, and to enter into interest rate, basis, currency, hedge or other swap agreements, or cap, floor, put, call, option, exchange or collar agreements, derivative agreements or other agreements similar to any of the foregoing.

This section was substantially expanded in August, 2002.

§18-107

Related Party Transactions

Members and managers are permitted, to the same extent as third parties, to enter into business transactions with the LLC.

The parties often impose limitations or standards, such as that all dealings and contracts with affiliates be “market” or “arm’s length.”

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DELAWARE



§18-108 Indemnification An LLC may indemnify members, managers and others from “any and all claims and demands whatsoever.”

The “standards and restrictions” on the indemnity are to be set forth in the LLC Agreement. So, the failure to include that in the LLC Agreement could result in an extremely broad indemnity that would have to be interpreted in the context of governing case law.

The “others” concept would be useful for those situations where the LLC has officers or an executive committee (and would serve as statutory authority for an indemnification of officers and executive committee members.)

§18-204(b) Document Execution

Parties may execute the LLC Agreement and other documents via an agent.

The authorization, including a power of attorney, need not be in writing, sworn to or verified. If written, a copy must be retained by the LLC.

§18-209 (b)

Approval of Merger

A merger or consolidation involving an LLC must be approved by members who own more than 50% of the membership interests (if classes are established, the 50% approval applies by class).

§18-213(b) Change of State of Organization

Transfer to or domestication in another state must be approved in writing by all members and all managers.

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DELAWARE



§18-215 (b)

Separate series of Members, Managers, or LLC Interests

If the LLC Agreement establishes one or more series of membership interests, and separate records are maintained for each series, and if the LLC Agreement so provides (and the Certificate of Formation gives notice of the limitation of liabilities), then the debts, liabilities, obligations and expenses of each series are enforceable only against the assets of the series, and none of the debts, etc. of the LLC generally, or of any other series, are enforceable against that series.

§18-215 (f)

Management of a Given Series

Management of a separate series is vested in members associated with it, in proportion to ownership percentages, with more than 50% controlling. A manager who manages more than one series, and who ceases to be a manager of one of the series, does not automatically cease to be a manager of any other series or of the LLC generally.

§18-215 (g)

Member Status as Creditor of a Series

When a member associated with a series becomes entitled to receive a distribution with respect to that series, it has the status of a creditor of the series with respect to that distribution.

§18-215 (i)

Effect of Assignment of All Interests in a Series

A member who assigns its entire interest in a series ceases to be associated with that series, but not any other series with which it is associated.

Such an assignment does not terminate the member’s membership in the LLC or cause a termination of the series.

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DELAWARE



§18-215 (j)

Termination of a Series

A series may be terminated without causing the dissolution of the LLC. A series is terminated and its affairs required to be wound up on the affirmative vote or written consent of members associated with that series (voting by class if there is more than one), with a 2/3 vote.

§18-215 (k)

Winding up of a Series

Winding up of a series is conducted by a manager associated with the series who has not wrongfully terminated it or, if there is no such manager, then by members associated with the series approved by a more than 50% vote of those members.

§18-215 (m)

Foreign LLC Series

The same rules apply to a series established for a foreign LLC, except that the application for registration must state whether the LLC Agreement establishes one or more series.

§18-216

Procedure and Required Approval for Organizational Conversion

If an LLC Agreement does not specify the manner of authorizing a conversion of the LLC, and does not prohibit conversions, then conversion is authorized in the same manner that the LLC Agreement authorizes a merger or consolidation. If there is no merger or consolidation procedure, then the conversion must be authorized by a vote, by class (if more than one), of members who hold more than 50% of the percentage ownership interests.

§18-301 (a)

Timing of Admission as Member – Formation

A person is admitted as a member of an LLC on the later of (a) formation or (b) when the person’s admission is reflected in the records of the LLC.

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DELAWARE



§18-301 (b) Timing of Admission as Member – Post-Formation

A person is admitted as a member of an LLC on the consent of all members and when the person’s admission is reflected in the records of the LLC. In the case of merger or consolidation, a person is admitted as a member at the time provided for in the LLC Agreement of the surviving LLC.

§18-301 (d) Member Admission Requirements

A person may be admitted to an LLC as a member without acquiring an LLC interest and without making, or being obligated to make, a contribution.

Because LLC Agreements are not required, such a non-economic member can be admitted without limitations or restrictions (other than oral understandings or agreements that must be proven), which normally would be contained in the LLC Agreement. This has been used in the securitization context where a non-economic “independent” member has the rights of a so-called “independent director.”

§18-301 (e) Member Pre-Emptive Rights

A member has no pre-emptive rights to subscribe to any additional issue of interests in the LLC or in any other company.

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§18-302 (d) Member Action by Written Consent

Member action may be taken without a meeting, without prior notice, and without a formal vote, so long as the action is consented to in writing and signed by the members having the required voting strength. The written consent of a member may be given by electronic transmission.

Members may vote or participate in a written consent personally or by proxy granted in writing or by electronic transmission.

Flexible, but consider due process effect on minority if it learns about actions for the first time after they’re taken. (So far, the LLC Act has not abrogated fiduciary duties and the duty of good faith and fair dealing. That will serve as some protection for the minority.)

§18-303 Member and Manager Liability

No member or manager of an LLC is personally liable for the debts of the LLC. Of course, this is one of THE

reasons for using an LLC. Obviously, this does not override some environmental liabilities, criminal liabilities, tort liabilities, fraudulent conveyance laws, etc. Note, also, the Hobby case from Conn., where the court pierced the veil. Stone v. Frederick Hobby Associates II, LLC, 2001 Conn. Super. LEXIS 1853, Superior Court, judicial district of Stamford-Norwalk, at Stamford, Docket No. CV000181620S (July 10, 2001) (Mintz, J.)

§18-304

Effect of Member’s Bankruptcy

A person ceases to be a member of an LLC on the occurrence of certain bankruptcy or insolvency events, or the making by the member of assignments for the benefit of creditors.

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§18-305 Member’s Right to Information about the Company

Each member of an LLC has the right, subject to such reasonable standards set forth in the LLC Agreement or established by the managers (or if no managers, by the members), to obtain from the LLC from time to time, on reasonable demand for any purpose reasonably related to the member's interest as a member of the LLC, a broad range of information regarding the LLC’s affairs, including financial information, tax returns, and a list of members and managers and their contact information. However, the managers may keep trade secrets and other confidential business information from the members if the managers believe in good faith that keeping that information from the members is in the LLC’s best interests. Each manager has similar rights to access LLC information to the extent related to the performance of its duties as a manager.

JV-type venture agreements typically spell this out in detail. Consider differences with a general partner’s right to information and a shareholder’s right to information.

§18-402 Action by Members

An LLC is managed by its members in proportion to their percentage of ownership, with a greater than 50% vote controlling. Each member and each manager (if any) has the authority to bind the LLC.

This often will be overridden by the actual document. Note that the parties usually will want to eliminate the apparent authority of all members.

§18-403 Managers who are Members

A person who is both manager and member has the rights and powers, and is subject to the restrictions and liabilities, applicable to both.

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§18-404 (d) Manager Action by Written Consent

Manager action may be taken without a meeting, without prior notice, and without a formal vote, so long as the action is consented to in writing and signed by the managers having the required voting strength. A manager’s written consent may be given by electronic transmission.

Managers may vote or participate in a written consent personally or by proxy that is granted in writing or by electronic transmission.

See comments to 18-302(d), above.

§18-407 Delegation of Management Rights

Members and managers have full authority to delegate their rights and powers to manage and control the business and affairs of the LLC, and that delegation will neither cause the delegating party to lose any rights, nor cause the delegee to become a member or manager.

This likely is too broad a grant for many situations. This allows the LLC to appoint officers, which is often a very useful thing.

§18-502 (a) Member Contribution Obligations

A member’s obligation to an LLC to perform any promise to contribute cash or property or to perform services is not affected by that member’s inability to perform, even if caused by death or disability.

This might be helpful in those situations where the LLC is utilizing subscription line financing.

The member can be required to contribute cash equal to the agreed value of the contribution shown in the LLC’s records.

§18-502 (b) Compromise of Member Contribution Obligations

Any member’s obligation to make a contribution or to return money or other property paid or distributed in violation of the LLC Act may be compromised only by the consent of all members.

Unanimous consent may be an impossible hurdle.

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§18-503 Allocation of Profit and Loss

Profits and losses are allocated on the basis of the agreed value of contributions made by members, as shown in the LLC’s records, to the extent received and not returned.

Normal, but there are many other ways to handle.

§18-504 Distributions Distributions are made on the basis of the agreed value of contributions made by each member, as shown in the LLC’s records, to the extent received and not returned.

Normal, but there are many other ways to handle. Typically, LLC Agreements specify in detail how profits, losses and distributions are shared.

§18-601 Timing of Distributions

Except as otherwise provided in the Act, each member is entitled to receive distributions on its withdrawal from the LLC and on dissolution of the LLC.

The “on withdrawal” right is almost always drafted away.

§18-602 Manager Resignation

Regardless whether an LLC Agreement states that a manager may not resign, a manager may resign by giving written notice to the members and other managers. However, a wrongful resignation may give rise to liability for damages.

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§18-603 Member Resignation

A member may not resign from an LLC before the dissolution and winding up of the LLC.1

Presumably, this protects an LLC against an unwanted dissolution.

Normally, and LLC Agreement addresses assignment and transfer rights and limitations, tailored to the transaction.

§18-604 Distribution to Resigning Member

A resigning member is entitled to receive, within a reasonable time after resignation, the fair value of the member’s LLC interest as of the date of resignation based on the member’s right to share in distributions.

As with 18-601, this is usually drafted away.

§18-605 Distribution in Kind

A member has no right to demand and receive any distribution from an LLC in any form other than cash. Furthermore, the LLC may not force a member to accept a distribution in kind that is not pro rata. However, the LLC may force a member to accept a distribution of any asset in kind so long as the percentage of the asset distributed equals the member’s percentage share of distributions from the LLC.

§18-606 Member as Creditor

When a member becomes entitled to receive a distribution, it becomes a creditor of the LLC, with full rights as such.

The LLC Agreement may provide a record date for distributions.

1 Note that this version of Section 18-603 does not apply to any LLC whose original certificate of formation was filed with the Secretary of State and effective

on or before July 31, 1996 – the previous version of the section applies to those LLCs.

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§18-702 (a) Assignment of LLC Interest

An LLC interest is assignable in whole or in part, but an assignee of an LLC interest has no right to participate in management (absent approval of all of the other members and compliance with the LLC agreement).

The parties may well want to circumscribe this result. If the parties want to limit transfers of interests within a member, then the LLC Agreement must specifically address this.

§18-702 (b) Rights of Assignee of LLC Interest

An assignee of an LLC interest does not become or have authority to exercise the rights or powers of a member. The assignee shares in profits and losses, receives distributions and an allocation of tax incidents to which the assignor was entitled. Furthermore, the assignor of an LLC interest ceases to be a member at the time of the assignment of its entire LLC interest. However, the mere pledge of an LLC interest does not result in loss of membership status.

Members have rights, and (absent agreement) assignees/interest holders have fewer rights (e.g. access to certain information). Such an assignment may effect a change in voting control because the assignee has no voting rights – the LLC Agreement should cover that.

§18-702 (c) LLC Certificate An LLC interest may be evidenced by a certificate. Mezzanine lenders should consider whether they want the LLC agreement to “opt into” Article 8. of the UCC. Mezzanine lenders should consider whether they want an express provision precluding issuance of certificates and opting into Article 8 in the event the LLC agreement does not contemplate such circumstances at the time of origination of the mezzanine loan.

§18-702 (d) Liability of Assignee of LLC Interest

An assignee of an LLC interest who does not become a member of the LLC does not have the liability of a member solely because of the assignment.

The LLC Agreement could impose liability.

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§18-702 (e) Redemption by LLC of LLC Interest

An LLC has the power to acquire, by purchase, redemption or otherwise, any LLC interest or other interest of a member or manager in the LLC; any such interest acquired by the LLC is deemed cancelled.

§18-703 (c) Redemption by Creditor of Member

An LLC interest that is subject to a charging order may be redeemed by the judgment creditor, by one or more members, or by the LLC with the consent of all other members whose interests are not so charged.

A creditor’s rights under Sec. 703 are subject to the member’s rights under exemption laws. The Act provides the exclusive remedy for the creditor, which has no rights in the LLC’s property.

§18-704 (b) Contribution Obligations of Assignee who Becomes a Member

An assignee who becomes a member is liable for the obligations of the assignor to make contributions (but not the assignor’s obligation to return prior distributions), so long as the obligations of the assignor to make contributions are known to the assignee, or could have been ascertained from the LLC Agreement, when the assignee becomes a member.

Perhaps, the members should include a provision obligating the LLC to provide an estoppel certificate (or analogous document) upon request which would be binding on the LLC.

§18-801 (a)(1), (a)(3)

Dissolution Events

The LLC has perpetual existence. However, dissolution will occur on the affirmative vote or written consent of the members (by class, if more than one) who hold more than 2/3rd of the percentage interests in profits.

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§18-801 (a)(4)

Continuation after Dissolution under Certain Conditions

An LLC is not dissolved and is not required to be wound up if, within 90 days after the occurrence of the event that terminated the membership of the last remaining member, the personal representative of that member agrees in writing to continue the LLC and to admit the personal representative of the member or its nominee or designee into the LLC as a member to be effective as of the date on which the termination event occurred, or another new member is admitted within that period.

This is an important consideration for securitizations.

§18-801 (b) Effect of Withdrawal of Member from LLC

The death, retirement, resignation, expulsion, bankruptcy or dissolution of a member, or the occurrence of any other event that terminates the continued membership of that member, does not necessarily cause the LLC to be dissolved or require that its affairs be wound up.

It’s ironic that this is the opposite of what was typical in the pre-“check-the-box” era. In a JV-type arrangement among a small group of parties, the parties might consider choosing different arrangements.

§18-803 (a) Winding up of LLC’s Affairs after Dissolution

A manager who has not wrongfully dissolved an LLC may wind up the LLC’s affairs, or if there is no such manager, then the members or person approved by the members (by a vote of each class, if more than one), who own more than 50% of the then current percentage ownership of profits may wind up the LLC’s affairs, subject to the right of the Court of Chancery to appoint a liquidating trustee on the application of an interested party.

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§18-804 (a), (c)

Distribution of Assets to Members

After assets are distributed to creditors to discharge the LLC’s obligations to them, assets next are distributed to members and former members in satisfaction of liabilities for distributions owed to the member under §§601 and 604 of the Act (members who resign or withdraw). Any remaining assets then are distributed to members in return of their contributions and then with respect to their LLC interests, pro rata. There is a 3-year “clawback” right in subsection (c) for distributions received in violation of the order specified in subsection (a).

§18-1101 (c) Duties of Managers, Members and Others in Connection with LLC

To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) and related liabilities relating thereto to an LLC or to another member or manager or to another person that is a party to or is otherwise bound by a particular LLC Agreement, the party acting pursuant to the LLC Agreement is not liable to the LLC or to any such other member or manager or other person for the member's or manager's or other person's good faith reliance on the provisions of the LLC Agreement.

See above discussion on the Gotham Partners decision. Unlike the Uniform Limited Liability Company Act and the LLC acts of some states, the Delaware LLC Act does not enumerate fiduciary duties.

Can the LLC Agreement eliminate liability for any reason, including for breach of duty of loyalty, duty of care, etc.?

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OPTIONAL PROVISIONS

(Enabling language in Act, but the LLC Agreement must contain them for them to apply to a particular LLC. Frequently presented in the Act with “may”.) To take advantage of them requires affirmative action.

§18-109(d) Consent to Delaware Jurisdiction

In an LLC Agreement, a manager or member may consent to be subject to the nonexclusive jurisdiction of the courts of, or arbitration in, a specified jurisdiction, including Delaware, and to be served with legal process in the manner prescribed in the LLC Agreement.

§18-209 (f)

Merger/ Consolidation

An agreement of merger or consolidation may effect any amendment to LLC Agreement or the adoption of a new LLC Agreement. But an LLC Agreement may specify a different means to achieve these things.

§18-210 Contractual Appraisal Rights of Members

A merger agreement and an LLC Agreement may provide that contractual appraisal rights with respect to an LLC interest are available for any class or group of members or LLC interests, in connection with any amendment of an LLC Agreement, any merger or consolidation in which the LLC is a party, or on the sale of all or substantially all of the LLC’s assets.

§18-215 Creation of Series of Interests

If the LLC Agreement creates a series of members, managers or LLC interests, then this section governs all of the various associated permissible rights and obligations.

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§18-301(c) Admission of Members Upon Organizational Conversion

On the conversion of an entity into a Delaware LLC, the LLC Agreement will govern how and when members are admitted.

§18-302 Classes of Members

An LLC Agreement may create classes or groups of members, granting different rights to those classes or groups, as well as establishing voting procedures when there is more than one class or group.

§18-306 Penalties for Breach of Member’s Obligations

An LLC Agreement may provide remedies and penalties for a member’s breach of its obligations under the LLC Agreement.

§18-404 Classes of Managers

An LLC Agreement may create classes or groups of managers, granting different rights to those classes or groups, and may establish voting procedures when there is more than one class or group.

§18-405 Penalties for Breach of Manager’s Obligations

An LLC Agreement may provide remedies and penalties for a manager’s breach of its obligations under the LLC Agreement.

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§18-502(c) Penalties for Failure to Make Contributions

An LLC Agreement may provide penalties for a member’s failure to make required contributions to the LLC, including, without limitation, the reduction or elimination of that member’s membership interest, subordination of that member’s interest to the interests of non-defaulting members or fixing a forced sale value for the member’s interest.

These provisions provide statutory authority for typical remedial provisions in JV type arrangements.

§18-704(a) Admission of Assignee as Member

An LLC Agreement may set forth conditions and procedures in connection with the admission as a member of an assignee of a member’s interest.

CONTROLLING PROVISIONS

The following provisions of the Act apply and are not subject to the LLC Agreement

§18-505 Usury A manager or member is precluded from raising usury as a defense to any Obligation in the LLC Agreement or separate agreement or writing.

Although the LLC Agreement could not expressly permit usury as defense, the Agreement could impose limitations upon the amount of interest a member was obligated to pay.

§18-607(a) Limitation Upon Distributions

The LLC is prohibited from making distributions to members if the distributions exceed the fair value of the assets of the LLC.

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§180607(b) Member’s Liability for Distributions

Members receiving distributions with knowledge that the distributions violates the Act are liable for the amount of the distribution. Members without such knowledge are not liable for distributions in violation of the Act.

§18-607(b) Limitation of Liability

A member’s liability for a distribution in violation of the Act expires three years after the date of the distribution.

§18-703 Judgment Creditor Charging Order

A judgment creditor of a member’s assignee may obtain a charging order and the appointment of a receiver from a court having jurisdiction to satisfy the judgment.

§18-110 and 111

Actions in Chancery Court

Upon application of any member or manager, the Court of Chancery may determine the validity of any admission, election, appointment, removal or resignation of a manager. Any action to interpret or enforce the provisions of the LLC Agreement or the duties and obligations of members or managers may be brought in the Court of Chancery.

The Chancery Court does not have exclusive jurisdiction for such actions.

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