Last year, Ohio revised its Revised Code (“ORC”) to update many provisions concerning the Limited Liability Company Act (the “Act”). The Act replaces the Chapter 1705 of the ORC with Chapter 1706. The new provisions will apply to both new and old LLCs and it will govern domestic and foreign LLCs formed before and after the effective date. The Act was expected to be effective this week, but the Secretary of State had a lot of work to go to adapt its forms to take in consideration the changes, so the Act will be applicable on February 11, 2022 and filing forms should be ready to be accepted by then.
This post will highlight some key aspects, but does not mention all items changed nor all changes.
The new Act generally allows more freedoms to what LLCs can do; it does not necessarily require changes to operating agreements but increases freedom of contract. Ohio law is certainly trying to catch up with other more flexible states. For example, section 1706.08 lists the few provisions that cannot be changed, which is shorter than the previous version. To this end, the legislator cleaned up language to make it clear that the statute provides for fall back provisions, and except for 1706.08 matters, the parties can contract as they please (e.g. eliminating some fiduciary duties).
The new Act codifies two principles: it allows a person to become a member without any contribution and allow a member to have no economic interests (1706.27(C)). It also allows the operating agreement to give enforceable rights to someone who is not a party to the agreement (1706.082(B)), for example, if the party wants to give rights to a financing institution, or once could see an LLC cooperative scenario where a third party Is given rights to enforce the values and principles adopted by the coop through veto power.
The new act streamlines situations where the members have fiduciary duties to each other and to the LLC. Traditional OH case law establishes that LLC members owe each other fiduciary duties similar to those of partners in a general partnership. Under the previous law, the members fiduciary duties of loyalty and care had minimum thresholds that could not be eliminated by the operating agreement. Under the new law, the only duty that cannot be modified in an LLC with managers is the implied covenant of good faith and fair dealing (1706.31(A)), but can otherwise eliminate the fiduciary duties of members or managers. Also, the members may not eliminate liability for any act or omission that constitutes bad faith violation of the implied covenant of good faith and fair dealing (1706.08(B)). If the LLC has a manager, the only duty the members have to each other and to the LLC is the implied covenant of good faith and fair dealing. If the LLC doesn’t have managers, the members owe a duty of loyalty and a duty of care as defined in the Act.
Regarding management structures, the new act deploys the concept of manager differently as well: managers are now just another type of an agent that the LLC can adopt – without special statutory role, giving the LLC more flexibility to specify how members and managers are allocated authority and responsibility, eliminating the dichotomy of member-managed vs. manager-managed models.
The new law also made it clear the binding effect of the operating agreement on members and assignees, supporting the enforceability of restrictions on transfers. Moreover, the Act relating to inapplicability of certain UCC provisions supports that the restrictions are applicable, absent other controlling law. Specifically, UCC 9-406 and 9-408 (ORC 1309.406 and 1309.408) which typically allows a third party to acquire a security interest despite contractual restrictions will not apply to a membership interest in an OH LLC (1706.06(D)); it is uncertain whether the UCC provisions from another state would be overridden or not.
For security regulatory purposes, LLC membership interests are always securities under the OH securities law and would generally be securities under federal securities laws. However, for purposes of the UCC transfer restrictions and perfecting security interests, Art. 8 of the UCC provides that membership interest in an LLC is not a security within the meaning of Art. 8, unless the LLC expressly opts to have its interests treated as securities under UCC Art. 8. If the LLC does elect to be treated as such, then restrictions on transfer in the operating agreement may not be enforced against a purchaser without knowledge unless either (i) security is certified and restriction is noted conspicuously on the securities certificate, or (ii) security is uncertified and registered owner has been notified of the restriction. The implication of this provision will impact perfection of the security interests: if the interest in not an Art. 8 security, then the only way to perfect is by filing in the location of the debtor, but if it is a certificated security, then the security can be perfected by filing or by control, and control trumps filing without regard to order in time.
While the previous law did not have express remedies the LLC could exercise for breaches of the operating agreement by a member, the new law expressly permits an operating agreement to:
- Reduce or eliminate defaulting member’s interest
- Subordinate defaulting person’s interest to those of others
- Force a sale of defaulting person’s interest
- Forfeit the defaulting person’s membership interest
- Allow loans by other members or assignees to meet defaulting member’s commitment
- Fix the value of defaulting member’s or assignee’s membership interest by appraisal or formula and redeem or sell the membership interest at that value
- Apply any other penalty or consequence.
Moreover, the new Act also now allow for series LLCs to be formed within the LLC, to have its own assets, liabilities, obligations, and members; hold and convey title to assets held by the series, enter into contracts, etc. Debts, liabilities, obligations, and expenses for a series are only enforceable against the assets of the debtor LLC, and not the company generally or any other series; the same is true of the debts of the company generally, which is solely responsible for its own obligations. According to the Act, the operating agreement must state its ability to have one or more series of assets and include the limitations provided in the Act for them to be applicable (1706.761(B)(2), and must maintain records of the accounts for the assets of each series separately from the others.
Other noteworthy changes are:
- The LLC registration may now be cancelled by the OH Secretary of State for failure to maintain a statutory agent in the state;
- LLCs who are not registered will owe a fine for lack of registration with the Secretary of state.
- Most if not all LLC forms were updated and old ones will no longer be accepted starting on February 11, included.
Remember, this is not a comprehensive summary of the changes to the Ohio LLC law; you will want to reach out to an attorney to make sure your operating agreement does not need to be modified to protect the LLC’s members interests.