Introduction and Overview of the New Tennessee Revised Limited Liability Company Act - 2006   printer  

I. INTRODUCTION AND OVERVIEW OF THE NEW TENNESSEE REVISED LIMITED LIABILITY COMPANY ACT.

A. Introduction.

 

As Yogi Berra would have said if he had been asked: "If you didn’t know what was in the old law, you wouldn’t think there were many changes in the new law."

1. Background. The Tennessee Revised Limited Liability Company Act is now officially Public Chapter 286 and is codified in the Tennessee Code as Sections 48-249-101, et seq. We will refer to the new statute as the "Revised Act" and the current law as the "Current Act."

The Revised Act represents a major rewriting and revision of the Current Act. Just as the Current Act represented the very useful product of very considerable work by a group of Tennessee lawyers, the Revised Act modernizes, shortens and, in many ways, simplifies the LLC statute in Tennessee.

The Current Act was adopted in 1994 when the LLC statutes were in their infancy in the United States and when practitioners were still struggling for federal income tax classification purposes with the concept of associations taxable as a corporation. The advent of the "check the box" rules by the IRS have mooted the need for many of the more lengthy and confusing provisions in the Current Act. Likewise, the experience practitioners have had with the various different versions of LLC statutes around the country allows the more successful provisions from these other states to be incorporated into the Revised Act for Tennessee.

One of the most helpful features of what the drafters of the Revised Act have done is to collect similar provisions in one place, such as collecting all (or most) of the provisions which are mandatory and cannot be waived in the LLC’s documents in the new §48-249-205. The Current Act requires a scavenger hunt through some 120 pages of the Tennessee Code Annotated. In a helpful sign, the number of chapters in the Revised Act is reduced to 11 from the 46 which are found in the Current Act. An initial estimate indicated that there are 208 different Sections in the Current Act. The Revised Act would reduce those to 136. These are both cheerful signs for those of us who have spent untold hours flipping back and forth through the Current Act while attempting to keep our fingers stuck in the pages containing the various related, but well-spaced provisions.

However, as a trade-off, the Revised Act adopts many new technical provisions which, although possibly simpler in totality than the Current Act, will have to be learned by a practitioner. The good news is that many of these provisions may be waived by proper wording in the LLC documents. However, in many instances, the failure to do so creates more serious concerns than may arise from a lack of understanding under the Current Act. The new Act generally goes into effect as of January 1, 2006. LLC’s existing up to that time may either opt to be under the Revised Act or may continue under the Current Act, which will be the default result if an option to be bound under the Revised Act is not elected.

2. Overall. The Revised Act is shorter and better organized than the Current Act. It adopts words and concepts which are consistent with the present law in Delaware and other states. It changes a number of mandatory provisions to optional. It adds a new type of traditional LLC called the director-managed LLC which is more analogous to a corporation. It adds one entirely new concept, the Family LLC, which has much greater restrictions and is more similar to the Family Limited Partnership.

Generally, you can do the same things with an LLC under either statute, but it is simpler to do so under the new statute, and the provisions allowing various complexities are more explicit.

3. What You Have to Know.

a. Your clients’ existing articles of organization and operating agreements do not have to be changed.

b. Ultimately, a majority of your clients will probably elect to be governed by the Revised Act, since that will be the law everyone knows. Although this is simple to do, existing documents should be reviewed at that time or a new operating agreement adopted, if possible.

c. Your existing routine forms and checklists will need to be updated. You will want to become acquainted with the new nomenclature for major defined terms under the Revised Act.

d. Once your existing forms and checklists are updated, there will be little practical difference when forming or administering LLC’s.

e. For the exceptional transaction, the possibilities are practically unlimited.

4. Effect on Existing Documents. The effective date is January 1, 2006. LLC’s existing prior to that time can either file a simple form opting to be governed under the Revised Act or continue under the old law as it was before the amendment. For most LLC’s, it is probably advisable to opt under the new law so that it will not be necessary to go back and find the old statute book if a legal question arises. The statute makes it simple to opt to be under the Revised Act, but existing documents should be reviewed at that time, if possible, and likely restated documents in the new forms adopted. Proceeding under the new law may facilitate resolution of some disputes, since court decisions in Delaware and other states with similar provisions may be helpful in interpreting Tennessee’s Revised Act. There are very few Tennessee cases construing the existing LLC statute, which has been a source of some concern.

B. Overview.

The purpose of this article is to outline the structure of the Revised Act and to summarize some of the more important provisions. The Public Chapter as passed containing the Revised Act is some 96 pages long (with another 12 pages on professional limited liability companies) and thus there is much in the Revised Act which is not mentioned in these materials.

In reading this Overview, recall that any of the provisions can be waived or varied in the LLC’s documents, except those specifically collected and set out in §48-249-205.

 

CHAPTER 1. General Provisions.

Sections 48-249-101 through 116 are an initial Chapter containing general provisions. Many of these provisions are similar to the Current Act, but there are enough differences to make reading and comparing them worthwhile.

One of the new definitions in §48-249-102(9) relates to the "Family LLC" which is an LLC in which two or more members of the same family hold in the aggregate at least 50% of the financial rights in the LLC. This introduces a new concept for family entities to be used to obtain discounts for transfer tax purposes.

There is a redefinition of "financial rights" §48-249-102(10), of "governance rights" §48-249-102(12), and of "Member" §48-249-102(19). At §48-249-102(13), there is a new definition of "Holder of financial rights".

Section 48-249-102(16) defines the term "Majority vote" as to a vote of members, managers or directors as applicable so that this would be the default provision. If voting is on a per capita basis, then it is a majority in number of the applicable voters. If the voting is determined otherwise under the LLC documents, a majority of the voting interests of such voters would be the majority vote. This is a point to be carefully addressed in drafting.

In §48-249-102(35), the term "Transfer" is defined broadly to include an assignment, conveyance, deed, bill of sale, lease, mortgage, security interest, encumbrance, gift and transfer by operation of law.

Section 48-249-103 contains detailed notice provisions which are similar to those in the Current Act.

Section 48-249-104 provides that an LLC has as its purpose engaging in any lawful business, unless a more limited purpose is set forth in the LLC documents. As noted below, such a limitation may be useful. An LLC engaging in business subject to regulation may be formed under the Revised Act only to the extent permitted by such other provisions.

Section 48-249-104 also has a detailed series of some 16 specific types of actions that the LLC would be empowered to take as well as a general statement that the LLC would have and exercise all other powers necessary or convenient to effect any and all of the business purposes for which the LLC is formed. These are consistent with the Current Act.

Section 48-249-106 contains more detailed provisions as to name than does the Current Act, but, generally, the LLC can still have either the words "limited liability company", or an abbreviation such as LLC as a part of the name. The provisions for a new LLC to use a name similar to an existing entity are broadened so that only filing of the permission of the other entity is necessary to allow it. This avoids the cumbersome provisions of the Current Act.

Section 48-249-106(d) still provides for use of an assumed name by the LLC.

This Chapter contains provisions for requirement of maintenance of an office and an agent, and for service on the Secretary of State as appropriate. The provisions are more detailed than the Current Act.

Section 48-249-114 deals with the personal liability of members and others involved with the LLC. This follows the Current Act. Generally, a member, holder of rights, director, manager, officer, employee or other agent of an LLC does not have a personal obligation for the acts of the LLC whether such arise in contract, tort, or otherwise.

The Revised Act continues the specific provision that each person, member, or employee required to collect and pay over to the "department of revenue" taxes collected from the customers of an LLC shall be personally liable for such taxes in the same manner as responsible persons for a corporation. This is slightly revised to include the words "domestic or foreign" LLC. This could simply be a clarification, or this provision could be a sleeper where there are disputes as to taxes due on sales involving out of state entities.

This Section also provides that a member, holder, etc. of an LLC does not have any personal obligation for the acts and omissions of any other member, holder, manager, officer, director, employer, or other agent of the LLC. However, such a person may still become personally liable by reason of such person’s own acts and conduct.

There are still provisions for having voluntary unlimited personal liability for one or more members. The LLC articles must name any member that is personally liable and that member must sign the articles.

Section 48-249-114(e) recites the existing rule that the failure of an LLC to observe the usual LLC formalities or requirements is not a ground for imposing personal liability on members, holders of rights, directors, managers, officers, employees or other agents of an LLC.

Section 48-249-115 pertains to indemnity and in essence continues the existing broad indemnity provisions. There is a subsection which explicitly states that the provisions in the Act are non-exclusive and allows for other indemnity as provided by law or in the LLC documents.

 

CHAPTER 2. Formation, Articles and Operating Agreements.

Sections 48-249-201, et seq., deals with the formation of the LLC and other administrative procedures. It continues to allow for a single member LLC to be organized. The articles of organization can still allow for (up to 90 days) a delayed effective date or for the existence to await the occurrence of a future event. A certificate of formation can still be filed.

Section 48-249-202 contains very simple mandatory provisions for what must be contained in the articles of organization which are filed with the State. The articles are allowed to have any other provisions not inconsistent with the law. The mandatory provisions are slightly changed from Current Law. If the LLC will have more than six members at the date of filing, the articles must state the number of members as of such filing. Otherwise, the number of members need not be stated. This allows a greater level of anonymity than under the Current Act, since the Current Act requires that the number of members be publicly filed as a part of the LLC articles. The annual report form is consistent and, under the Revised Act, does not require a statement of the number of members where that number is six or less.

The specific mandatory provisions under §48-249-202 for what must be contained in the articles of organization are as follows:

§48-249-202. Articles of Organization

(a) Mandatory Contents. The articles must set forth:

(1) A name for the LLC that satisfies the requirements of §48-249-106;

(2) The street address and zip code of the initial registered office of the LLC, the county in which the office is located, and the name of its initial registered agent at that office;

(3) The street address and zip code of the principal executive office of the LLC, and the county in which the office is located;

(4) A statement as to whether the LLC will be member-managed, manager-managed, or director-managed;

(5) If the LLC will have more that six (6) members at the date of filing of the articles, a statement of the number of members at the date of the filing of the articles;

(6) If, under §48-249-114(f), one (1) or more members are personally liable for all of the debts, obligations and liabilities of the LLC, the information required in §48-249-114(f);

(7) If the existence of the LLC is to begin upon a future date, or the occurrence of a specific event, the future date or a description of the specific event; except that in no event may the future date, or the actual occurrence of the specific event, be more than ninety (90) days after the filing of the articles in compliance with §48-249-201;

(8) If the LLC, while being formed under Tennessee law, is not to engage in business in Tennessee, a statement that the LLC is prohibited from engaging in business in Tennessee; and

(9) If the duration of the LLC is to be limited to a specific period of time or term of years, such limitation and the future date on which dissolution is to occur or the term of years shall be stated in the articles.

Section 48-249-202(b)(1)(C) sets out some provisions allowing for fairly broad limitations of personal liability for a director, acting in a capacity as director, in a director-managed LLC.

Section 48-249-202(b)(2)(d) states that if there is a conflict between the articles and the operating agreement, the articles control, which is consistent with the Current Act.

Note that the Current Act requires that a power to expel a member must be contained in the articles. This is not required in the Revised Act.

Section 48-249-203 provides that the all members of an LLC may enter into an operating agreement either before, after, or at the time of filing of the articles of organization. However, an operating agreement is not required. The Current Act required a board-managed LLC, but not a member-managed LLC, to have an operating agreement.

In a major change, unless the articles of organization or a written operating agreement specifically requires otherwise, an operating agreement need not be in writing. The Current Act required any operating agreement to be in writing. This change should be addressed in the forms.

There is a useful clarification which provides that the operating agreement may be entered into before filing the articles.

Section 48-249-203(b), consistent with the Current Act, provides that a Court of Equity may enforce an operating agreement by injunction or by other equitable relief and, as an alternative where applicable, may conduct or continue the dissolution or winding up.

Section 48-249-203(c) provides that an LLC with a single member may adopt an operating agreement between the member and the LLC. Under the Current Act, there is some question as to the validity of an agreement between an individual and an LLC, which is disregarded as an entity for federal income tax purposes.

The LLC is bound by a properly adopted operating agreement, even if it is not a signatory.

Section 48-249-204 contains certain provisions as to amendment of articles and operating agreement. An amendment to the articles must generally be approved by all of the members. However, this is not listed in the mandatory provision so it appears it could be waived.

An amendment to the operating agreement must be approved in the manner provided in the LLC documents and, if the documents do not otherwise provide, then the operating agreement can only be amended by the agreement of all members. The wording is somewhat different from the Current Act.

Section 48-249-205 collects all of the provisions which are mandatory and cannot be waived in the LLC’s documents, and provides that the articles and operating agreement may modify, alter, or waive provisions of the Act except for certain specific mandatory provisions set out therein. However, as a practical matter, we suggest that §48-249-202(a) as to the mandatory contents of the articles should also be followed, whether or not technically listed in §48-249-205. The specific language is that "It is the express intent of the legislature of this state that members of an LLC may modify, alter or waive any provisions of this Act in the LLC documents except as otherwise set forth in" § 48-249-205(b). The exceptions in that subsection are generally what one would expect.

The specific mandatory provisions under §48-249-205 for what cannot be waived in the LLC documents are as follows:

§48-249-205(b) Nonwaivable Provision of Act. The LLC documents may not:

(1) Vary the requirement under §48-249-102(5) that a director be an individual;

(2) Vary the notice requirements under §48-249-103, or under the other provisions of this Act, in a manner that is manifestly unreasonable;

(3) Vary the requirements with respect to the LLC’s name under §48-249-106;

(4) Vary the requirements with respect under §48-249-112(c) regarding the Workers’ Compensation Law;

(5) Eliminate or vary the potential for personal liability under §48-249-114(a)(2) or under §48-249-114(d);

(6) Eliminate or vary the restrictions on indemnification in §§48-249-115(i)(1)(A), (B) or (C);

(7) Eliminate or vary any restrictions in §§48-249-202(b)(1)(C)(i), (ii) or (iii), on the elimination or limitation of the personal liability of a director under §48-249-202(b)(1)(C);

(8) Eliminate or vary this section;

(9) Eliminate or vary the restrictions on distributions in §48-249-306;

(10) Eliminate or vary the liability for unlawful distributions in §48-249-307;

(11) Authorize a director to appoint a proxy;

(12) Unreasonably restrict a right to information or access to the records under §48-249-308;

(13) Eliminate the duty of loyalty under §§48-249-403(b)(1) or (2), but the LLC documents may:

(A) Identify specific types or categories of activities that do not violate the duty of loyalty under §§48-249-403(b)(1) or (2), if not manifestly unreasonable; and

(B) Specify the number or percentage of members, disinterested managers or disinterested directors, which may be greater of lesser that the number or percentage required under §48-249-404, if applicable, that may authorize or ratify, after full disclosure of all material facts, a specific act or transaction that otherwise would violate the duty of loyalty;

(14) Unreasonably reduce the duty of care under §48-249-403(c), §48-249-403(i)(4)(B), §48-249-403(i)(4)(C), §48-249-403(j)(2) or §48-249-403(j)(3);

(15) Eliminate the obligation of good faith and fair dealing under §§48-249-403(d), but the LLC documents may determine the standards by which performance of the obligation is to be measured, if the standards are not manifestly unreasonable;

(16) Eliminate the obligation of good faith under §48-249-403(i)(4)(A) or §48-249-403(j)(1), but the LLC documents may determine standards by which the performance of the obligation is to be measured, if the standards are not manifestly unreasonable;

(17) Vary the right to expel a member in an event specified in §§48-249-503(a)(6);

(18) Vary the requirement to wind up the LLC’s business in an event specified in §48-249-601(a)(5); 

(19) Eliminate or vary the provisions of part 11 of this Chapter;

(20) Vary any requirements relating to documents required to be filed with the secretary of state or any register of deeds, or otherwise vary or restrict any other rights of the secretary of state or any register of deeds; or

(21) Otherwise vary or restrict any rights of any other person under this Chapter, other than the rights of a manager, director, officer, employee, agent, member or holder of financial rights.

Anyone drafting under the Revised Act should keep a copy of the mandatory provisions of §48-249-202(a) and §48-249-205 near at hand.

 

CHAPTER 3. Finance Provisions.

Sections 48-249-301, et seq., deals with the finance provisions of the Revised Act.

Under §48-249-301, a contribution to the LLC may consist of tangible or intangible property or other benefit to the LLC which can include a note or services, or an obligation or agreement to contribute money or property, or to perform services in the future. The addition of a provision explicitly allowing future services is new in the Revised Act.

The decision as to how to record a contribution consisting of a promise to perform future services will require some creative accounting. The Section provides that the value "of the consideration to an LLC for each contribution shall be determined by the members in the case of a member-managed LLC or by both the members and the managers in the case of a manager-managed LLC or by both the members and the directors in the case of a director-managed LLC." If the member does not contribute the services (or property) as agreed, the LLC can require that money be paid instead in the value as stated in the LLC documents or the LLC records. Note that this applies even if the member is unable, disabled or deceased, unless the documents excuse performance. This is a new area for dispute where care appears advised for all parties.

A contribution agreement, whether made before or after the formation of the LLC, is not enforceable against the prospective contributor unless it is in writing and signed by the prospective contributor. This statute of frauds type requirement is in the Current Act.

Subsection 48-249-301(c) states that neither a purported contribution nor an offer of consideration to make a contribution shall be treated as a contribution to the LLC until it is properly accepted by the LLC and the amount and value are recorded in the LLC documents. This is consistent with the Current Act and an operating agreement under the Revised Act should have specific language as to the procedure for the acceptance of a contribution and for notation of the amount and value of any such contribution.

Section 48-249-302 confirms that a person who has agreed in writing to make a contribution to the LLC is obligated to do such even if unable to perform because of death, disability, or other reason. This is consistent with the Current Act.

Section 48-249-302 (c) gives creditors certain rights where they extend credit or otherwise act in reliance upon a written contribution agreement. This appears to be new.

The LLC documents may provide that any member or other person who fails to make a contribution that they are obligated to make can be subject to various remedies including eliminating their interest, a sale of the interest and the like. This is consistent with the Current Act.

Section 48-249-303 makes it explicit that the LLC documents may provide for classes or groups of directors, managers, members, or holders of financial rights having various rights, preferences, limitations, powers and duties. These documents may provide for the taking of an action, including the amendment of the LLC documents, without the vote or approval of any director, manager, member or holder of financial rights or of any specific class of them. The Revised Act gathers various existing provisions in one place and adds to the scope.

 

The LLC documents may denominate membership interests as units, shares, percentages, participation, distribution interests, ownership or economic interest, with or without governance rights and with or without fixed or variable rights to participate in distributions, assets, properties, or allocations. These explicit provisions are new.

It is worth reading §48-249-303 to understand its breadth.

Section 48-249-304 provides that profits and losses shall be allocated in the manner provided in the LLC documents and, in the absence of such provisions, they will be allocated among the members and holders of financial rights in equal shares. The same applies to distributions. This is consistent with the Current Act.

Section 48-249-305 contains important provisions as to distributions. First, it clarifies that neither a member nor a holder of financial rights has a right to demand or receive, and may not be required to accept (if not pro rata), distribution in kind regardless of the contribution of such person. This is slightly different from the Current Act.

If a member or holder of financial rights becomes entitled to receive a distribution, the member or holder has the status of, and is entitled to all remedies available to, a general unsecured creditor of the LLC with respect to the distribution.

A member or holder of financial rights is entitled to receive distributions before dissolution only as provided in the LLC documents or by a majority vote of the members of a member-managed LLC, the managers of a manager-managed LLC, or the directors of a director managed LLC, as applicable. This is consistent with the Current Act.

Section 48-249-306 contains a number of restrictions upon distributions such as where the LLC would not be able to pay its debts as they become due in the ordinary course of business or that its total assets would be less than the sum of its total liabilities, plus the amount that would be needed, if the LLC were to be dissolved, to satisfy preferential rights, etc. The LLC may base a determination that a distribution is not prohibited on financial statements prepared on the basis of accounting practices and principles that are reasonable in the circumstances or on a fair valuation or other reasonable method. While consistent with the Current Act, there are additional provisions. Note that the requirements of this Section are mandatory.

An indebtedness of an LLC to a member or holder of financial rights, including one incurred by reason of a distribution made in accordance with this Section, is at parity with the LLC’s indebtedness to its general unsecured creditors except as otherwise provided. This is consistent with the Current Act.

Section 48-249-307 provides for personal liability of those involved with an LLC for a violation of the distribution provisions. This is consistent with the Current Act.

Section 48-249-308 is the records section. This sets out the records that must be maintained by the LLC and the rights to view such records. This goes beyond the provisions of the Current Act. The mandatory section provides that the LLC documents may not "unreasonably restrict a right to information or access to records" under this Section. Holders of financial rights have a new, limited, right of access to obtain information reasonably necessary to comply with federal or state tax laws.

Section 48-249-309 allows the LLC to establish one or more designated series of members, holders, membership interests, or financial rights with separate rights, powers, and duties, and these can be different as to differing businesses or properties. In other words, each series may have a separate business purpose or investment objective. For example, if properly done, liabilities of a specific series are enforceable against the assets of that series only and not the assets of the LLC generally or those of another series. This appears to allow almost unlimited flexibility and expands upon what is provided in the Current Act. Again, it is necessary to read this Section to appreciate its breadth. There is no way to predict whether these forms of entities, which we have seen formed in Delaware, will indeed be formed under Tennessee law. If so, however, this Section provides enormous opportunity and a plethora of interesting questions.

 

CHAPTER 4. Management of LLC’s.

Sections 48-249-401, et seq. deals with management issues. Although the ultimate results are not that different, the wording is different from the Current Act and the names and descriptions of the management models are revised. We go from the two management models under the Current Act to three under the Revised Act. It is necessary to review this Chapter in detail because of the changes from the Current Act.

In reading this Chapter, recall that the mandatory provisions only apply to portions of Sections 48-249-403 and 48-249-404, so the remainder are subject to the provisions of the LLC documents.

 

First, the Revised Act provides for a member-managed format which would be comparable to the member-managed LLC under the Current Act. This is closer to a general partnership governance model.

Second, the Revised Act allows a manager-managed format, which is closer to a limited partnership governance model.

Third, there can be a director-managed LLC which is similar to the corporate governance model in the existing Tennessee Business Corporation Act.

Under Subsection 48-249-401(a), in a member-managed LLC, each member has equal rights in the management and conduct of the LLC’s business and except as provided by other provisions of the statute, matters are to be decided by a majority vote of the members.

Subsection 48-249-401(b) provides that in a manager-managed LLC, each manager has equal rights in the management and conduct of the business and except as provided in the other sections, any matter is decided by a majority vote of the managers. A manager must be designated by a majority vote of the members and holds office until a successor has been designated. A manager need not be a member.

Subsection 48-249-401(c) provides that in a director-managed LLC, all powers are exercised under the authority of and the business is managed by the board of directors. Again, except as provided in certain subsections, any matter relating to the business of the LLC should be exclusively decided by a majority vote of the directors. A director must be designated by a majority vote of the members and holds office until such person resigns or is removed. A director-managed LLC must have a president appointed or elected by a majority vote of the directors who is authorized to act as the agent of the LLC.

Historians will be saddened to hear that the eccentric provision of the Current Act to the effect that a governor had to be a natural person unless a member and, if a member, an entity could be a governor, is no longer included. Section 48-249-101(5) now defines "Director" as an "individual."

There is an additional complexity in §48-249-401 under subparagraphs (e) and (f). Subparagraph 48-249-401(e) allows for a delegation of rights and powers to manage and control the business of the LLC to one or more officers, agents, or employees, provided that such delegation is reasonable under the circumstances and made in good faith. Unless one is interested in enriching litigation attorneys, LLC members should be very careful when delegating to officers. Questions concerning reasonableness and good faith in the delegation to officers may be able to be addressed in the LLC documents, since the Section is not among those that are mandatory under §48-249-205.

Subparagraph 48-249-401(f) lists six different items that require the consent of all of the members. These include the amendment of the operating agreement if the documents do not provide for a method by which the operating agreement may be amended, the use of the LLC’s property to redeem an interest subject to a charging order, or, very importantly, the admission of a new member, including without limitation, the transfer of any of a member’s governance rights to a person who is not a member. At least some of these represent an important departure from the Current Act, if not addressed in the LLC documents.

The specific provisions and requirements requiring a consent of all members make the LLC operating under the default provisions of the Revised Act a less flexible vehicle. However, they are not listed among the non-waivable provisions of §48-249-205, so proper drafting can avoid the problems.

Subparagraph 48-249-401(g) provides for a written proxy by a member or manager, but provides no details as to the scope or term of such proxy and whether, for example, such could simply be a permanent proxy allowing someone else to vote the member’s right to vote as to admission of a new member. A director cannot name a proxy.

Section 48-249-402 deals with authority. First, subject to certain limitations, in a member-managed LLC, each member is an agent of the LLC for the purpose of its business and an act of that member, including the signing of an instrument in the LLC’s name, for apparently carrying on the ordinary business of the LLC or business of the kind carried on by the LLC, binds the LLC unless the person has no authority to act for the LLC in the particular matter and the person with whom the member was dealing knew or had notice that the person lacked authority.

Any other act of a member which is not apparently for carrying on the ordinary course of the business of the kind binds the LLC only if the action was authorized by the other members.

From a drafting standpoint, this reminds us that both the statutory provisions and the doctrine of apparent agency require careful drafting of the articles. A recital in the recorded articles would establish some limitation as to type of business and as to the authority of individual members, and, under the Revised Act, provides notice to third parties.

In the manager-managed LLC, again subject to certain exceptions, a member is not an agent of the LLC by reason of being a member but each manager is an agent under similar actual and apparent authority as set forth for a member-managed LLC. The same drafting considerations arise.

In a director-managed LLC, no member or director is an agent of the LLC solely by reason of such membership or directorship. The president and other authorized officers are the agents of the LLC under similar actual or apparent authority rules.

Further, in a director-managed LLC or any other LLC with a president or other authorized officers, the president and each other authorized officer of the LLC is an agent for its business with similar or apparent authority rules.

In addition, the articles may grant an authority to one or more members, managers, directors, or officers to execute instruments for the transfer of real property and have restrictions or conditions with respect to such authority. Unless the designation states that it is exclusive, it does not override the above provisions as to actual or apparent authority.

This Section also has a Subsection setting out knowledge and notice rules which are new. These clarify that a filing of record of the articles constitutes notice.

The provisions of §48-249-402 are new and, at least on initial reading, raise a number of issues to consider. Actual and apparent authority issues are always fact specific and are difficult to advise upon. However, the Revised Act provides us guidance that restrictions of record in the Secretary of State’s Office in the articles provide "notice" as required by the Revised Act to third parties, whether they have seen them or not. The articles continue to be critical documents requiring far more thought than, say, a corporate charter. Clients forming their own LLC with documents downloaded from the internet now have more of a concern.

Section 48-249-403 sets forth the fiduciary duties of a member to the LLC. These are a complicated set of new provisions setting out differing fiduciary duties for member-managed, manager-managed, and director-managed LLC’s. These are a complex set of provisions that will require careful study in advising clients in the future. The wording varies from the Current Act. Various parts of this Section are subject to the non-waivability provisions of 48-249-205.

Subsection 48-249-403(a) provides that the only fiduciary duties a member in a member-managed LLC owes to a member-managed LLC and its other members and holders are a duty of loyalty and a duty of care as defined in the Section. This appears to revise a fiduciary duty of a majority owner established by a 2003 Tennessee Court of Appeals decision.

The duty of loyalty in §48-249-403(b) is limited to a duty to account, a duty not to deal with the LLC while having an adverse interest, and a duty to refrain from competing with the LLC before its termination. This non-competition provision needs to be considered in drafting the LLC documents.

The duty of care in §48-249-403(c) is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law.

However, litigators can relax. There is an obligation of "good faith and fair dealing" provided in §48-249-403(d).

Subsection 48-249-403(h) provides that in a manager-managed LLC, a member owes no duty to the LLC or to the other members or holders solely by reason of being a member. A manager is held to the same standards of conduct as a member in a member-managed LLC.

Subsection 48-249-403(i) similarly provides that in a director-managed LLC, a member owes no duty to the LLC or to the other members or holders solely by reason of being a member.

Reliance on financial statements, data, information, opinions, etc., is a defense as to discharge of duties, if the accountant, counsel or other are providing information as to matters the member, manager or director "reasonably believes are within the person’s professional or expert competence."

Section 48-249-404 deals with conflict of interest and has some fairly detailed provisions. The Section allows the single member of a single member LLC to ratify a transaction in which the member has a conflict of interest.

Section 48-249-405 begins by saying that each member, manager, or director of an LLC shall have equal voting power per capita with each other member, manager, or director. There are also provisions for notice and other formalities and for actions by written consent. Recall that all of these are default provisions and the LLC documents can control.

Section 48-249-406 details a listing of records which an LLC is required to maintain.

 

CHAPTER 5. Membership Issues.

Section 48-249-501 deals with the admission of a member. After an LLC is formed, all members must approve the admission of a new person as a member, the interest of such member, and the contribution of such member. All consents under this subsection may be unreasonably withheld and are in the sole discretion of the members. This appears to be consistent with the Current Act, but there are differences in wording.

Section 48-249-502 confirms, as under the Current Act, that a membership interest in an LLC is personal property and that a member has no interest in specific LLC property. At the request of a holder of a membership interest or financial rights, the LLC shall state in writing the particular membership interests or financial rights owned by such person. The statement must describe rights to vote, shares in profits and losses, and shares in distributions, as well as any assignment of the rights then in effect. The statute goes on to say that this shall not be a security, a negotiable instrument, or a stock or a bond as those terms are generally defined in other statutes, and shall not be a vehicle by which a transfer of the member interests or financial rights may be effected. This is consistent with the Current Act.

Section 48-249-503 provides for methods of termination of a membership interest in the LLC. This includes receipt of a written notice of withdrawal from a member, an event specified in the LLC documents as causing termination, a transfer of all of the member’s financial rights (unless it is merely for security purposes and has not been foreclosed or is pursuant to a court order charging the member’s financial interest), the member’s expulsion pursuant to the LLC document, the member’s bankruptcy, the member’s death, appointment of a conservator for the member and a variety of other provisions.

Many of the provisions in §48-249-503 are consistent with the Current Act, but some are new and many are substantially rewritten. This Section should be studied carefully, given the importance of these provisions.

Subsection 48-249-503(b)(1) provides that, except as provided for a Family LLC (mentioned below), or under §48-249-504, a member has the power and right to terminate such member’s membership interest at any time, including upon withdrawal. The Family LLC concept and provisions are new in the Revised Act.

However, under §48-249-503(b)(2), a member of a Family LLC does not have the power to terminate the membership interest of such member in the Family LLC and the Section is specific that a variety of the termination methods otherwise applying would not apply to a Family LLC. Any transfer contrary to these provisions is void. The effect of this restriction is to make the "default" provisions of state law more consistent with using an LLC as the form of entity in Tennessee for discounting value for transfer tax purposes. Many practitioners had felt that the limited partnership was a more appropriate vehicle in Tennessee for such purposes because of the more onerous restrictions on withdrawal. The Family LLC provisions create a special class of LLC for this purpose.

Section 48-249-504 says that if a membership interest of a member is terminated in contravention of the LLC documents, then the member forfeits governance rights in the winding up or the continued business and the member is liable for damages incurred by the other members and the LLC due to the wrongful termination. This is consistent with the Current Act.

Section 48-249-505 generally deals with the effect on the LLC of the termination of a membership. Generally, the LLC can be continued by the remaining members. However, there are detailed provisions dealing with different circumstances including the purchase of the terminated member’s membership interest at "fair value." The fair value provisions are not in the Current Act, but also are not among the mandatory provisions, and thus can be changed in the LLC documents.

If the membership is terminated due to the member’s death or incompetence, then the affected member’s personal representative has the option for 60 days to have the LLC buy him out at the "fair value" under Section 48-249-506, and, if not exercised, the LLC has the option for 60 days to buy at fair value. If neither occurs, the personal representative automatically becomes a member. This should be considered in conjunction with §48-249-601 as to a 90 day notice of dissolution period.

Section 48-249-506 sets forth a procedure for determining fair value where the LLC is required or elects to purchase a membership interest at fair value pursuant to §48-249-505. This Section consists of several pages of detail on the process.

In the absence of other provisions in the LLC documents, the court considers the going concern value, and a number of other factors, including legal or financial constraints on the ability of the LLC to purchase the membership interest. TCA §48-216-101 of the Current Act, to the contrary, provides that the terminating member receives the "lesser of the fair market value of the withdrawing or terminating member’s interest determined on a going concern basis or the fair market value of the withdrawing member’s interest determined on a liquidation basis." The Revised Act makes careful drafting of the LLC documents more important.

Section 48-249-507 provides that with the limitations set forth, the financial rights of a member or a holder of financial rights are transferrable in whole or in part. Such an assignment of financial rights entitles the assignee to receive only the share of profits and losses and distributions to which the assignor would otherwise be entitled. Such an assignment does not dissolve the LLC and does not entitle the assignee to become a member or to exercise any governance rights. Oddly, the Revised Act appears to have deleted the existing provision in TCA §48-218-101 that an assignment may not include a provision allowing the assignee to control the assignor’s exercise of assignor’s governance rights. It seems unlikely that the Revised Act would be interpreted to allow that, however.

A restriction on assignment of financial rights may be imposed by the LLC documents or by a written agreement. Such a restriction is enforceable, if it is set forth in the LLC documents, against a successor or transferee including a pledgee or legal representative whether or not they had notice. Except for a written restriction contained in the LLC documents, a restriction is ineffective against a person without knowledge of the restriction. While reworded, these provisions are consistent with the Current Act.

Section 48-249-508 provides that a member may assign the member’s full membership interest only by assigning all of the governance rights coupled with an assignment of all of the financial rights. Governance rights can only be assigned under this Section. There are certain exceptions.

A member may without the consent of any other member assign governance rights to another member. If it is a single member LLC, the single member may freely assign governance rights or membership interests to any other person. This last provision appears to be new.

Any other assignment of any governance rights is effective only if all of the members, other than the member seeking to make the assignment, approve the assignment by unanimous consent. Any foreclosure of rights is subject to all of these restrictions.

This Section clarifies that the pledge of, or granting of a security interest in, any portion of a membership interest is not a transfer and does not affect the member’s rights. However, the foreclosure of such is a transfer.

Section 48-249-509 deals with rights of a judgment creditor. A court may charge the debtor’s financial rights with payment of an unsatisfied judgment with interest, giving the creditor only financial rights and no governance rights. This is also the "exclusive remedy of a judgment creditor with respect to the judgment debtor’s membership interest or financial rights." This tracks the Current Act.

 

CHAPTER 6. Dissolution and Winding Up.

Sections 48-249-601, et seq. deals with dissolution or winding up of the LLC. Generally, the LLC would have a perpetual existence unless a period is fixed in the LLC documents for its duration. The LLC would be dissolved likewise by an event as specified in the documents and by certain other provisions set out in the statute. The occurrence of any event that terminates the continued membership of any member shall not cause the LLC to be dissolved. The dissolution and winding up provisions are substantially rewritten and thus have some differences. However, the practical effect seems to be consistent with the Current Act.

There is an interesting addition where there are no remaining members and the LLC documents do not mandate dissolution in such event. The LLC can file a notice of dissolution within 90 days, and, if it does not, then the personal representative is automatically substituted as a member as of the date that the last member’s interest was terminated. This should be considered in conjunction with §48-249-505 as to a 60 day option period.

Section 48-249-603 sets out the provisions for dissolution of an LLC by the members.

Section 48-249-604 provides the circumstances in which the Secretary of State may administratively dissolve the LLC which includes not filing the reports within two months after due. Subsequent sections deal with reinstatement or other procedures after administrative dissolution.

An LLC that has been administratively dissolved continues its existence but may not carry on any business except that necessary to wind up and liquidate its affairs.

Section 48-249-610 outlines what must be done once the LLC has filed a notice of dissolution with the Secretary of State, if the LLC is to be wound up and not continued in a successor entity.

Section 48-249-611 sets out procedures for dealing with the LLC’s creditors where the LLC is to be wound up and not continued in a successor organization. This includes a provision for notice to bind unknown creditors who do not file within 2 years after the notice.

This Section also provides additional protection for members of a dissolved LLC in that, even if there is not compliance with the Section, creditors can only reach undistributed assets of the dissolved LLC or recover amounts distributed to the member. These provisions are consistent with the Current Act.

Section 48-249-612 provides for articles of termination to be filed with the Secretary of State and subsequent sections deal with procedural matters for termination. When the articles of termination are filed with the State, the existence of the LLC is terminated, but Section 48-249-614 emphasizes that termination does not take away any remedy of or against the LLC, for any matter incurred prior to termination.

Sections 48-246-615 and 48-249-616 provide for court intervention and dissolution or other winding up. The Court has rather broad discretion under the statute.

Section 48-249-620 sets out the order of distribution of the assets upon the winding up of an LLC. Subsequent Sections in this Chapter deal with various aspects of such dissolution and winding up.

Section 48-249-622 provides that after the LLC has been terminated, any of its former managers, directors or members may assert or defend in the name of the LLC any claim by or against the LLC.

 

CHAPTER 7. Mergers, Conversions of Entities and Transfer of Assets.

The provisions in the Revised Act as to merger and conversion are substantially new. They are designed to provide simplified procedures for these steps. However, §48-249-702(l) notes that the merger provisions are not exclusive and a Tennessee LLC may be merged in any other manner provided by law. The conversion Sections contain similar provisions. Because of the specialized nature of these Sections, they are not considered in detail in this Overview.

Sections 48-249-701, et seq., deals with mergers and other conversions or transfer or assets.

Section 48-249-702 provides for mergers of an LLC into another LLC or other form of entity. Note that there are no automatic dissenter’s rights under this and subsequent Sections.

Section 48-249-703 contains provisions for other entities to convert to a Tennessee LLC.

Section 48-249-704 provides for a Tennessee LLC to convert to another entity.

Section 48-249-705 provides that the sale, lease or transfer or other disposition by an LLC of substantially all of its properties and assets, not in the usual and regular course of business, must be approved by: (i) a majority vote of the managers, if the LLC is member-managed, or a majority vote of the directors, if the LLC is director-managed; and (ii) by a majority vote of the members, whether the LLC is member-managed, manager-managed or director-managed.

The Section goes on to provide that the transferee of the assets is liable for the debts, obligations, and liabilities of the transferor only to the extent provided in the contract or as provided by this Act or other applicable law.

Section 48-249-706 provides that the LLC documents or the plan of merger may provide for contractual appraisal rights with respect to a membership interest, financial rights, or other interests in the LLC which would apply upon a merger, conversion, or disposition of assets.

Note that the provisions of the Current Act (TCA § 48-231-101, et seq.) as to dissenter’s rights upon a merger or sale, lease, transfer or other disposition of all or substantially all of the property and assets of an LLC not made in the usual or regular course of its business are not contained in the Revised Act and these now become matters for the LLC documents or contract.

CHAPTER 8. Various Derivative Actions.

Sections 48-249-801, et seq., contains five rather detailed Sections covering derivative actions. These are consistent with the Current Act.

 

CHAPTER 9. Non-Tennessee Limited Liability Companies.

Sections 48-249-901, et seq., deals with provisions for foreign (non-Tennessee) LLC’s.

Section 48-249-902 as to the activities which do not constitute the transacting of business so as to require qualification under the Revised Act is similar to the Current Act.

 

CHAPTER 10. Miscellaneous Provisions, Transition Rules and Effective Dates.

Sections 48-249-1001, et seq., are general provisions of a miscellaneous nature.

Section 48-249-1002 provides generally that the provisions of the Revised Act apply to every Tennessee LLC formed on January 1, 2006 or thereafter. After January 1, 2006, a Tennessee LLC formed prior to that date may voluntarily elect to be governed by the Revised Act by amending its articles to state such. The statute states that this can be done by adding a sentence such as "This LLC elects to be governed by the Tennessee Revised Limited Liability Company Act." Any LLC formed prior to January 1, 2006 that does not so voluntarily elect to be governed by the Revised Act continues to be governed by the Current Act.

Section 48-249-1003 provides that for the purposes of all state and local Tennessee taxes, an LLC shall be treated as a partnership, or as an association taxable as a corporation, as such classification is determined for federal income tax purposes. This is similar to the Current Act.

Section 48-249-1004 is designed to allow the Revised Act to apply, to the extent constitutionally permissible, upon a conflict with another act in another state as to liability issues for members, holders, managers, directors and such.

Section 48-249-1005 contains various filing provisions, including that the document be in English.

Section 48-249-1007 provides for fees, including the existing $300 minimum per year. This means that LLC’s continue to be more expensive than corporations for purposes of annual minimum filing fees with the Secretary of State.

 

CHAPTER 11. Professional Limited Liability Companies.

Sections 48-249-1101, et seq., provide special provisions for professional limited liability companies, in addition to the provisions of the first 10 chapters discussed above which likewise apply.

 

© Dodson Parker & Behm, P.C. 2005