COMMENTS ON ULLCA Copyright 1995 Larry E. Ribstein Larry E. Ribstein The following are comments on the Uniform Limited Liability Company Act. Unless otherwise noted, references are to the version of February 28, 1995. References to "Comments" are to these Comments. References to "Drafters' Comments" are to the official comments published with ULLCA. A longer version of these Comments will appear as part of Larry E. Ribstein, A Critique of the Uniform Limited Liability Company Act, forthcoming 1995 Stetson Law Review. For criticism of the drafting process which produced ULLCA, see Larry E. Ribstein & Bruce H. Kobayashi, Uniform Laws, Model Laws and Limited Liability Companies, forthcoming 1995 Colorado Law Review. 101(13), 103: THE OPERATING AGREEMENT Section 103 provides for the effect of the "operating agreement," which is defined in §101(14). 1. What is an operating agreement? ULLCA must address the basic policy question of what kinds of agreements should be deemed to waive the statutory provisions. The answer, arguably, is any agreement (or, perhaps, as discussed below, any written agreement) that is (1) agreed to by all of the members; and (2) that relates to the LLC. This is the definition provided for in the Prototype Act. 1 An immediate problem with the ULLCA provisions on the operating agreement is that they make conflicting statements about the nature of the operating agreement. Section 101(13) defines the operating agreement as "concerning the relations among the members, managers, and the limited liability company. . . " However, §103 says more broadly that the operating agreement may "provide for the regulation of the affairs of the company, the conduct of its business, and governing the relations among the members, managers, and the limited liability company." These sections suggest that a provision concerning relations with third parties, such as member liability, may or may not be part of what ULLCA defines as an "operating agreement." The ULLCA provisions on the operating agreement are also incomplete because they do not explicitly answer several questions which have arisen under state statutory definitions of the operating agreement, including whether the definition includes several agreements on specific points made at different times, or agreements made by fewer than all of the members. 2 2. Should The Act Be Waivable By Oral Operating Agreements? ULLCA §103 provides that the operating agreement "need not be in writing." In the informal type of firm for which LLC statutes should be drafted a requirement of a written operating agreement might often frustrate the members' legitimate expectations. But there is also much to be said for reducing potential litigation by providing that at least some important statutory defaults, including allocation of financial rights, voting requirements, and dissolution causes, can be varied only by written agreement. Note in this respect that an "oral operating agreement" could include something as ephemeral as a course of conduct.3 Whatever the best default rule as to the enforceability of oral operating agreements, the parties to an LLC should be able to agree that the agreement cannot be amended except by a writing. This approach would avoid frustrating members' expectations in informal firms, while allowing more formal firms to minimize the potential uncertainty and litigation expense of oral operating agreements. ULLCA §103 apparently would permit waivers of the default provisions on operating agreements by not listing itself as a provision which cannot be waived. 4 3. Are The Limits On Contracting In §103 Justified? Section 103 provides that the operating agreement rather than the act controls except for the matters listed in subsection (b), which include certain fiduciary duties. Mandatory rules are criticized in more detail below. 5 One type of mandatory rule in ULLCA §103(b) is worth discussing separately -- waivers relating to third parties. LLCs clearly ought to be able to make enforceable agreements with third parties, even if these agreements waive the default provisions of the Act. The relevant ULLCA provisions are not as straightforward as this proposition. ULLCA provides that an operating agreement cannot "restrict rights of third parties under this [Act]." 6 It is not clear what the Act means either by "restrict," or by "third parties." Any definition of rights is a restriction. Presumably, however, "restrict" means to take away rights that "third parties" would have under the act unmodified by the operating agreement. "Third parties" is also unclear. Does it mean that an operating agreement is not enforceable against anyone who is not a party to it? In that case, the provision adds nothing. Does it mean that it is not enforceable against one who is not a manager or member even if that person is a party to the agreement? If so, this is wrong. 7 Perhaps this provision means only that an "operating agreement" cannot restrict third parties' rights, but that an agreement that is not an "operating agreement" may do so. Since the Act defines "operating agreement" to include only agreements "concerning the relations among the members, managers, and the limited liability company," 8 maybe an agreement which concerns third parties may waive their rights. Yet that is wrong, too, since there is no reason why an agreement should not be an "operating agreement" merely because it affects third parties as well as members. The Act should have defined the operating agreement according to its parties -- i.e., as one "among" the members -- rather than solely according to its subject matter. 104 SUPPLEMENTAL PRINCIPLES This provision says that, "[u]nless displaced by particular provisions of this [Act], the principles of law and equity supplement this [Act]." The Comment says such principles "include, but are not limited to" those listed in UCC §1-103, including fraud and agency, and §1-205 on course of dealing and usage of trade. But course of dealing and usage of trade are part of the contract rather than "supplemental principles." At the same time, "law" could be interpreted to include other statutory law, including partnership and corporate statutes. Thus, the "black letter" creates a potentially open-ended linkage with other law which may not be suitable for LLCs. It is not clear whether the Comment should be interpreted to close such linkages since it does not expressly preclude them and, if so, whether it would be effective to limit the "black letter." 105 NAME This provision requires the LLC's name to include certain terms which indicate that it is an LLC, and, except in certain circumstances, to be "distinguishable upon the records of the Secretary of State" (or other equivalent agency). This provision is unclear in several important respects. First, the "name" of the LLC is not defined. If "name" includes only what is set forth in the articles of organization, then it is not clear why the terms identifying the firm as an LLC are necessary. If the term includes what the firm calls itself in advertising, correspondence and other contexts, what is the firm's "name" under the statute when this varies in different uses? Second, what is the penalty for violation of the section? If "name" includes advertising and other uses, and if a violation includes any use of a name different from that in the articles, is the penalty loss of LLC status, damages to anyone who deals with the LLC under the non-complying name, damages to a relying creditor, or none of the above? 201 LLC AS ENTITY This section says that "[a] limited liability company is a legal entity distinct from its members." But whether a firm is an "entity" depends on whether a court or legislature chooses to endow it with the legal characteristics of an entity, not on whether it is one in some Platonic sense. Thus, even a partnership, the archtypical non-"entity," often is treated like one in many contexts. 9 For an example of this confusion between causes and consequences it is necessary to look no further than the Comment to this section, which says: A limited liability company is legally distinct from its members who are not normally liable for the debts, obligations, and liabilities of the company. See Section 303. Accordingly, members are not proper parties to suits against the company unless an object of the proceeding is to enforce members’ rights against the company or to enforce their liability to the company. In fact, ULLCA §303 provides that members may be liable to third parties for LLC debts when they so agree. 10 It is not clear whether the Comment means that, because an LLC is an "entity," members are never proper parties to suits against the LLC, even when their agreed liability would contradict "entity" status. ULLCA might have usefully reduced the potential confusion created by the entity and aggregate concepts if it had simply provided that an LLC is an "entity" unless the context otherwise requires. 202 ORGANIZATION This section provides that one or more persons may form an LLC by filing articles of organization. This raises two issues: (1) whether one-person LLCs should be permitted; and, (2) what are the consequences of failing to file articles. 1. Should one-member LLCs be permitted? Partnerships must have two members, 11 and this requirement has been carried over to many LLC statutes. 12 This makes sense, since LLC statutes typically include many partnership-type rules, including concerning allocation of management rights, allocation of financial rights, transfer of interests, and the consequences of member dissociation. As in the partnership statute, these rules assume the existence of two or more members. Accordingly, one-member LLCs may raise problems in interpreting and applying the statute. On the other hand, the Comment says the one-member rule gives "flexibility. . . to enable sole proprietors to obtain the benefit of a liability shield." Indeed, it makes sense to give sole proprietorships the same access to LLCs that they have to the corporate form. Moreover, a rule requiring two members could cause problems for unwary firms if a member dies or if contractual or formality questions are raised about the status of purported members. But this "flexibility" comes at a cost. One-member firms may not be characterized as partnerships for tax purposes, 13 and may have difficulty seeking the protection of the bankruptcy law. 14 In general, drafting a statute so that it complies with the tax characterization factors may present a poor balance of tax considerations against non-tax transaction cost considerations, particularly since firms do not need to comply with all of the tax characterization factors to be taxed as partnerships. But, as discussed immediately above, transaction cost considerations weigh against one-member firms. Moreover, ULLCA's drafters are inconsistent regarding tax-compliant terms, since they adopt rules on continuity of the LLC solely for tax reasons. 15 In any event, even if ULLCA's rule permitting one-member LLCs is not clearly wrong, reasonable legislators could reach a contrary conclusion. Accordingly, there is no reason why this rule should be uniform, or why states should use it as a model. 2. Effect of Failing to file Articles ULLCA §202(b) provides that "the existence of a limited liability company begins when the articles of organization are filed." But there is no reason why, before filing, the members and third parties should not be bound by any agreements they have made, including an express or implied agreement to be governed by the Act. 16 This is the rule in limited partnerships. 17 The Comment to this Section says that "[u]ntil the articles are filed, a firm is not organized under this Act and is not a “limited liability company” as defined in Section 101(8)." However, it also says that members may nevertheless agree to be bound by the act, and that third parties may express "a contractual intent to extend a limited liability shield to the members of the would-be limited liability company." Indeed, there is nothing in the ULLCA, as there is in several statutes, that imposes liability on members who assume or purport to be acting as an LLC without complying with formalities. 18 Under this approach, the filing is important only if there is no contract among members or third parties that accomplishes the effect of the filing. 19 203 ARTICLES OF ORGANIZATION This section provides for the contents and effect of the articles of organization. While most of the required contents of the articles are similar to requirements in most other LLC statutes, ULLCA includes idiosyncratic provisions on term and the effect of the articles. 1. Specifying a term ULLCA requires the LLC to state in the articles "whether the company is to be a term company and, if so, the term specified." 21 The specification of a "term" is significant, since a "term company" may not dissolve on dissociation of a member, 21 and may or may not dissolve on expiration of a term. 22 Yet it may not be clear whether, or for what purposes, an LLC is a "term company." A "term company" is defined as one whose "members have agreed to remain members until the expiration of a term specified in the articles of organization." 23 Otherwise the LLC is an "at-will company." 24 The Comments say that specifying an "undertaking of an uncertain business duration is not sufficient" unless the undertaking is one that may extend beyond a specified term. This surprising qualification has no basis either the 'black letter," or in partnership law, which equates time period and undertaking durations. 25 Nor does it make any sense, since the members may know the firm's mission without knowing how long it will take. 26 Nevertheless, if the members forget to include the magic words of an arbitrary period of years, their term may not be enforced by a court which applies the Comment rather than the black letter. This is hardly the "flexibility" for "small entrepreneurs" the drafters promised in their Prefatory Note. 27 2. What Is The Effect Of The Articles? ULLCA provides that, where the articles and operating agreement are inconsistent, the operating agreement controls as to "managers, members and their transferees" 28while the articles control as to other types of persons "who reasonably rely on the articles to their detriment." 29 These provisions are questionable from a policy standpoint. The provision on managers, members and transferees oddly seems to say that an oral operating agreement, or even course of conduct that is construed as an operating agreement, would control over formal, written filed articles. Most parties to LLCs probably would not expect this result. The provision on third parties 30 is also dubious in several respects. First, it is not clear whether ULLCA would enforce articles on which third parties rely despite knowing of contrary provisions in a more recent written operating agreement. This may not be reasonable reliance. Yet if the "reasonableness" qualification makes the operating agreement enforceable, this would seem to negate the express provision to make the articles control as to third parties. Moreover, it is not clear how third parties can "reasonably rely" on the operating agreement under a statute that makes the articles control. Second, ULLCA provides that the articles may not "vary the nonwaivable provisions of Section 103(b)." 31 The latter section does not "have" any unwaivable provisions, but rather provides that the operating agreement may not waive or vary certain provisions of the act, or "restrict rights of third parties." 32 It is not clear whether and to what extent this latter constraint applies to the articles. Ignoring for the moment the mismatched language, ULLCA may be saying that the articles cannot do what the operating agreement cannot do. If so, it raises the same questions about the meaning of "restrict" as does the provision on the effect of the operating agreement. 33 If not, why restrict third parties' rights by articles they do not see, but not by written agreements they do see? Finally, ULLCA provides that the articles have other effects, including liability for false statements discussed next, and binding the firm in real property transactions. 34 In sum, the complexity of this section could trap the informal firms for which the statute should be designed. 209 LIABILITY FOR FALSE STATEMENTS This section provides that one who suffers loss in reliance on a false statement in a filed document can recover damages from one who signed the document knowing it was false. This provision is confusing because it is not clear when there can be a false statement in a filed document. Most statements in filed documents are necessarily "true" by reason of having been stated in the document. For example, the name of an LLC is probably what is set forth in the articles. If the firm transacts business under a different name, the misrepresentation, if any, is that name, and not the one in the articles. Also, as discussed immediately above, ULLCA provides that the articles control as to third parties where there is an inconsistency between the articles and the operating agreement. Again, the articles are true for such statements even if they are contradicted by other evidence. Where the articles are not controlling -- as where the articles neither "restrict" third parties' rights nor are inconsistent with the operating agreement -- the special statutory liability for such falsity is excessive because LLCs and their members are in any event liable for fraud, including fraud in filed documents. The section may go beyond fraud in giving a remedy to third parties for immaterial misstatements on which they unreasonably relied. In other words, a third party could recover on proving a false statement which she believed and acted on -- a contention that may be impossible to disprove. But there is no apparent justification for relaxing the usual elements of a fraud cause of action for misstatements in a filed document. Also, this open-ended damage remedy could have the perverse effect of discouraging LLCs from using the articles to provide information about the firm to third parties. A final problem with the liability for false statements is the way it relates to the effect of the articles in ULLCA §203. In some cases, as where the articles are inconsistent with the operating agreement, §203 makes the articles, in effect, controlling and, therefore, not false. In other situations the articles may be "false" and trigger an open-ended action for damages. There is no apparent reason why these similar actions have such different consequences. 301 AGENCY POWER This section provides for the authority of members and managers in LLCs that are (subsection (b)) and are not (subsection (a)) managed by managers, as well for the authority to bind in real property transfers (subsection (c)). 1. When Is A Manager's Act Binding? ULLCA §301(b)(1) says that only managers, and not members, are agents of a manager-managed LLC. Unfortunately, there is no precise guidance on who is a "manager." While this is generally a problem in LLC statutes, 35ULLCA does not help solve the problem by defining a "manager" as simply one who is authorized under §301 36 without explaining further when that authorization is deemed to take place. It is also not clear whether the operating agreement can restrict a manager's authority to act without member consent. This would seem to be the case, since §301(b)(2) cross-references the members' voting rights under §404 which are, in turn, not among the non- waivable rights listed in ULLCA §103(b). Yet this would contradict §103(b)(7), which provides that the operating agreement cannot restrict third party rights. 2. When Does A Member Effectively Transfer Real Property? ULLCA §301(c) provides that a member may sign and deliver a real property conveyance which is conclusive against a bona fide purchaser without knowledge of the lack of authority, unless the articles restrict the member's authority. This raises several questions. First, if the articles do restrict the member's authority, this could restrict a relying third party's rights contrary to ULLCA §203. 37 Second, it is not clear when a third party is deemed to have "knowledge" of the lack of authority. ULLCA unhelpfully defines "knowledge" as "actual knowledge." Does a third party have such "knowledge" if she knows of a restriction on authority in the operating agreement? Apparently not, in light of prohibitions on restricting third party rights. 38 Does a third party have such knowledge when the member's act is not "apparently. . . ordinary" within the meaning of §301(a), as where the member is transferring all of the LLC's property? Apart from these questions, the rule on real property conveyances is questionable policy. ULLCA §301(a) is explicitly subject to §301(c), which implies that the ordinary rules of authority do not apply to real property transfers, most of which would be outside a member's usual authority. If this is the rule, it differs from the rule which applies to other business associations. As such, it would surprise any informal LLC -- the sort of firm for which the statute should be designed -- that did not receive competent legal advice about the terms of ULLCA. The possibility of surprise is increased by the fact that §203, which tells LLC members what to put in the articles, does not cross-reference authority limitations under §301(c). 303 LIABILITY OF MEMBERS This section provides that LLC members and managers are not liable solely by reason of being or acting as such. This is similar to provisions in virtually all LLC statutes. However, the section includes other unusual and questionable rules regarding the effect of failure to observe formalities and of member consent to liability. 1. Significance Of Failure To Follow Formalities ULLCA §303(b) provides that "[t]he failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business is not a ground for imposing personal liability on the members or managers for liabilities of the company." This provision poses more questions than it answers. What are "usual" formalities and requirements? Are they different from "unusual" formalities? If the LLC's failure to follow formalities is not "a ground" for imposing liability, does that nevertheless mean it can still be taken into account in piercing the veil? If the failure to comply with statutory requirements has no effect at all, what is the purpose of including such requirements in the statute? The simpler and more direct way to protect firms from veil-piercing liability based on failure to comply with formalities is to eliminate useless requirements from the statute and to specify the consequences of failing to comply with included requirements. 2. What Is The Effect Of The Filing Requirement For Personal Liability? ULLCA §303(c) provides that members may be liable “in their capacity as members for all or specified” LLC debts if the articles so provide with the members' consent. This provision is arguably useful to the extent that helps some members contract for liability without having to contract separately with each creditor, and to avoid the corporate tax characteristic of limited liability. 39Such an LLC would be similar to a limited partnership, except that the guaranteeing members would not necessarily be managers and would not necessarily be liable for all of the firm's debts. The main problem with §303(c) is that it might inappropriately extend beyond this situation to impose constraints on member guarantees. An analogous New York provision 40 differs in explicitly providing that it does not apply to member guarantees. ULLCA does not include this qualification. Because ULLCA §303(c) applies to any liability of members "in their capacity as members" it could be interpreted as applying to members’ guarantees of the LLC’s liabilities. Significantly, this language is broader than that in subsection (a), which relieves members from liability "solely by reason of" being members. 41 To the extent that this subsection applies to member guarantees it is unnecessary and perverse. Authorizing guarantees is unnecessary because subsection (a) only removes members' liabilities that are imposed "solely by reason of" their acting as or being members -- that is, not including liability imposed by contract or otherwise. The provision is perverse if it conditions effectiveness of member guarantees on a certificate disclosure. While guarantees may be relevant credit information, any such benefit from requiring disclosure is outweighed by the costs to unwary creditors, who may be out-maneuvered by members or more sophisticated creditors who know about ULLCA’s idiosyncratic disclosure requirement. 402 LIABILITY FOR CONTRIBUTIONS This section provides for members' liability for contribution obligations and for compromise of these obligations. 1. Enforceability of oral contribution obligations This section permits enforcement of oral contribution obligations. The Comment explains: "Given the informality of some limited liability companies, a writing requirement may frustrate reasonable expectations of members based on a clear oral agreement." Yet the drafters also should have considered the litigation costs that might result from claims that members had orally agreed to make contributions. Although the appropriate balance between enforcing expectations and minimizing litigation may not be clear, the fact that the vast majority of the states require a writing is evidence of the appropriate rule. 42 In any event, rejecting the clear majority rule is not the simplest path to the uniformity NCCUSL supposedly seeks. 2. Compromise of contribution obligations ULLCA §402(b) provides that members can vote to compromise member contribution obligations, but that compromised contributions can be enforced by creditors who relied on the initial obligation. While many LLC acts also so provide, 43in this case they are wrong. To be sure, creditors may rely on contribution obligations, but it is more likely that they will rely either on general assets or profitability or obtain guarantees. Creditor reliance is particularly unlikely since ULLCA does not require contributions to be disclosed in the articles, 44 requires no records of contributions to be kept, 45and permits contributions to be made in any form, including by obligations to perform services 46which provide no security to creditors of insolvent LLCs. In the unusual case in which creditors do rely on a particular contribution obligation, they can contract for the protection this section would unnecessarily provide to all creditors. This rule costs LLCs financial flexibility with very little offsetting benefit to most creditors. Moreover, ULLCA apparently does not even let LLCs contract with its creditors to avoid the rule. 47 This type of provision is borrowed from limited partnership statutes 48 where it is a holdover from the early days of limited partnership in which limited liability was exceptional and mistrusted, and when it was surrounded by other provisions which bolstered creditor reliance on contributions by restricting their form and requiring certificate disclosure. There is no justification for continuing to include such provisions in LLC statutes. 403 INDEMNIFICATION This section provides, among other things, for reimbursement of members or managers by the LLC "for liabilities incurred by the member or manager in the ordinary course of the business of the company or for the preservation of its business or property." 49 Although the black letter is straightforward, the Comment adds an unsatisfactory gloss that the member or manager is not entitled to indemnification for "tortious conduct against a third party." 50 This Comment leaves unclear whether, for example, a non- negligent act, such as an act for which a statute imposes strict liability, which is in the "ordinary course" is non-indemnifiable merely because it might be classified as "tortious." 404 MANAGEMENT Subsections (a) and (b) provide, subject to subsection (c), for management by member-managed and manager-managed LLCs by majority vote of the members and managers, respectively. Subsection (c) provides that certain matters, including amendments to the operating agreement and articles, must be decided by unanimous vote of the members. 1. Is A Unanimity Rule For Certain Matters Appropriate? The unanimity rule empowers each partner not only to protect herself from harmful transactions, but also to insist on a large share of the gain from beneficial transactions. Even if members do not behave opportunistically, the cost of obtaining unanimous consent rises rapidly with the number of members. Moreover, a unanimity rule may not be very important in protecting members from harm where, as in a partnership or LLC, a member who disagrees with the firm's policies can dissociate. Perhaps the costs of dissociating combined with the potential for harm to individual members from extraordinary new transactions justifies a veto power in partnerships, where the members are subject to personal liability. But the potentially serious problems caused by a unanimity rule may not be warranted where members have limited liability, as in an LLC. 51 The strongest argument for a unanimity rule in an LLC is that the default rule should be designed for the more intimate, informal firm in which partnership-like management rules have the greatest benefits for members and impose the lowest decisionmaking costs. But even if this argument is persuasive, the unanimity rule would not necessarily be appropriate in manager- managed firms. The members' decision to centralize management decisions indicates that the firm is not the sort of intimate firm in which the veto power is appropriate, and that the costs of obtaining unanimity may be high. The most that could be said for the ULLCA approach is that, because reasonable minds could disagree on this issue, the ULLCA approach should not be uniform. Even if some matters should be decided unanimously, not everybody will agree about subsection (c)'s list of matters that must be approved unanimously. Matters such as compromise of contribution obligations, interim distributions and redemption of property subject to a charging order could be considered ordinary financing decisions best entrusted to the managers and a majority of members. To be sure, as discussed immediately below, members could vary the rules in their operating agreement. But default rules are important because of the costs of negotiating and drafting detailed agreements. Indeed, that is why business association statutes are necessary in the first place. 2. When Are These Rules Varied By Contrary Agreement The rules prescribed by this section can be waived by an oral operating agreement. 52 A strong argument can be made that a default rule of this importance should be waived only by written agreement. Although the statutory default rules should be designed for informal firms, it does not necessarily follow that rules regarding waiver of defaults also should accommodate informality. The drafters should consider the potential litigation costs of oral agreements about matters where disputes are sure to arise. 405 SHARING OF AND RIGHT TO PRE-DISSOLUTION DISTRIBUTIONS This section provides that any distributions prior to dissolution shall be made equally, and that members have no right to receive or obligation to accept distributions in kind. The section raises issues about the appropriate default sharing ratio and about how the default provision can be waived. 1. Should Distributions Be Shared Per Capita Or Pro Rata? There are good arguments both for and against a default rule allocating financial rights equally among the members rather than pro rata according to members' financial contributions as is the rule for corporate shareholders. The argument for the per capita approach is that informal firms may not have sufficient records from which members' current financial shares readily can be determined. As a result, such firms risk litigation concerning the validity of every distribution. On the other hand, a per capita rule is probably inconsistent with the parties' expectations in a limited liability firm, in which the members' contributions are mostly financial. Thus, while the ULLCA rule is not wrong, it is not so clearly right that it ought to be the uniform rule. 2. Should The Default Rule Be Waivable By Oral Agreement? The distributions rule can be waived by oral operating agreement. This raises the same concerns and potential problems as waivers of management and voting rules under ULLCA §404 -- i.e., the appropriate balance between accommodating the expectations of members of informal firms and avoiding excessive litigation costs. Thus, both the Prototype Act 53and the Revised Uniform Limited Partnership Act 54require written waivers of this default. ULLCA creates some confusion concerning waivers of the equal distribution rule. The Comment points out that the members must unanimously consent to interim distributions under ULLCA §404(c), and therefore could block equal distributions where this inappropriately reflects members' contributions. While §404 requires vote at a meeting or a "record," amendment by oral operating agreement may be more informal. 406-407 LIMITS ON AND LIABILITY FOR DISTRIBUTIONS These sections provide, respectively for limitations on distributions and for liability for wrongful distributions. Such provisions give little more to creditors than they would get under fraudulent conveyance law. For this small benefit, these provisions impose a costly extra level of legality on LLCs. ULLCA §406 requires firms to make determinations, on the basis of "reasonable" accounting practices that the distribution meets both "balance sheet" "equity insolvency" tests, with special rules for purchase or redemption of member interests. Such formalities ensure that even small, informal LLCs will need legal and accounting advice in arranging day-to-day finances. These provisions were not included in the Prototype Act. 55 Moreover, the fact that they have not been included in most limited liability partnership statutes 56 suggests that state legislatures are now ready to accept limited liability without these restrictions. 408 INFORMATION RIGHT This section provides for access to the LLC's books and for other member information rights. As discussed in the following subsections, ULLCA's open-ended language invites extensive litigation on disclosure, an issue that can be raised in connection with any dispute. Even worse, ULLCA does not give the parties adequate freedom to fashion their own agreements on this important issue. 1. Books and records ULLCA §408(a) provides for access to, but not the keeping of, records. This is consistent with both the UPA57 and RUPA 58 rule. As noted by the Comment, such a rule arguably fits the most informal firms for which the act should be designed because such firms may be caught by surprise by a recordkeeping requirement. Moreover, where the statute requires the firm to keep books, it is not clear what the penalty for failing to keep required books is, or should be. However, because "default" LLCs may be centrally managed, the partnership analogy may not be appropriate for LLCs. In a manager- managed LLC, unlike the "standard form" partnership, members who do not directly participate in management normally would want a way to monitor managers' performance. Indeed, records are so basic to managers' disclosure duties that courts are likely to imply an agreement or statutory requirement of recordkeeping obligations by managers. Accordingly, the statute should delineate the default recordkeeping duty in order to minimize the cost of litigating the issue. 2. Where Do Members Have Access To Books And Records? ULLCA §408(a) gives members access to books and records "at the company's principal office or other reasonable locations specified in the operating agreement." This raises several issues. First, since operating agreements may be oral, members may not easily be able to determine where the records are supposed to be kept under the operating agreement. Indeed, simply putting the records in a particular place might constitute the operating agreement provision on location if no one objects. Once again, the potential litigation costs of oral agreements may outweigh the benefits even for informal firms. Second, it is not clear when an operating agreement provision on location will be enforced. ULLCA § 408(a) provides that the location must be "reasonable." While it is easy to see how managers who are free to decide could put the records in an inconvenient place, how can a place to which the members have agreed be "unreasonable?" This requirement is particularly confusing in light of other ULLCA provisions. Does "reasonable" differ from the obligation to discharge duties in "good faith" under ULLCA §409(d), or from the rule that the operating agreement cannot "unreasonably" restrict access to records? 59 Can the agreement "reasonably" restrict access to an "unreasonable" place? 3. What Information Does The LLC Have To Provide Without Demand ULLCA §408(b)(1) provides that the LLC must furnish "without demand, information concerning the company's business or affairs reasonably required for the proper exercise of the member's rights and duties under the operating agreement or this [Act]." Once again, the Act has provided an openended standard rather than a clear default rule. Does the "reasonably required" standard mean all information that is "relevant" to the members' financial or management rights, only such "relevant" information that is also "material," or something else? There is no case law on this issue because the law generally does not impose open-ended disclosure duties for the sound reason that such a rule would invite litigation and protective overdisclosure by managers. 60 For all of these reasons, it is curious that the ULLCA drafters did not follow the UPA and RUPA approach of requiring demand. 61 4. What Information Can Members Demand? ULLCA §408((b)(2) entitles members "on demand, [to] other information concerning the company's business or affairs, except to the extent the demand or the information demanded is unreasonable or otherwise improper under the circumstances." Once again, ULLCA adopts a vague standard. When is information "unreasonable"? Does "unreasonable" differ from "otherwise improper?" From the bad faith conduct proscribed by ULLCA §409(d)? Also, if the information is "reasonable," how could the demand be "unreasonable?" Although a demand might be unreasonable if the member insists on having the information in the middle of the night, the section seems to refer to what may be demanded rather than when it must be provided. Moreover, any victory based solely on when a member demanded "reasonable" information is bound to be pyrrhic. In addition to being inherently unclear, this provision also relates uncertainly to members' rights to information without demand. How can "reasonable" information not be "reasonably required" under §408(b)(1)? When should members "demand" information instead of suing because it has not already been disclosed? 5. What Are A Member's Rights To Production Of The Operating Agreement? ULLCA §408(c) provides that "[a] member has the right upon signed record given to the limited liability company to obtain at the company's expense a copy of any operating agreement in record form." Although the section could be read to say that a member has the right to have an oral agreement reduced to writing, it probably means only that a member has a right to a copy of any operating agreement that is already a "record." 6. When Can Disclosure Duties Be Waived? The above questions are made particularly serious by the fact that that the members have only a limited right to contract around ULLCA §408. ULLCA §103(b)(1) provides that the operating agreement may not "unreasonably restrict a member's or former member's right of access to books and records under Section 408." Not only is "unreasonably" inherently unclear but it is confusing in conjunction with the reasonableness requirement for location provided for in §408 and the good faith requirement in §409(d). More fundamentally, it is not clear why the parties cannot make any agreement they want on this issue, subject to usual good faith rules of construction. Surely some LLCs would want to escape the potential litigation that is inherent in ULLCA's open-ended "reasonableness" default rules on disclosure. But if they try to do so, they only get tangled further in the additional issue of whether their agreement was "unreasonable." 409 FIDUCIARY DUTIES This section provides for rules similar to those in RUPA defining the fiduciary duties in an LLC as the duties of loyalty and due care. These rules apply to members of member-managed firms and to managers and managing members of manager-managed firms. In general, this section is an invitation to extensive litigation because of its vague standards and because it attempts the impossible -- the full specification of duties that inevitably vary from case to case. As discussed in subsection (1), this was equally a problem in RUPA. Subsections (2) and (3) show that the attempt to transplant these duties to ULLCA creates even more problems. 1. Adoption of RUPA rules My criticisms elsewhere of the RUPA fiduciary duty rules 62 apply equally to same rules in ULLCA. Like RUPA, ULLCA §409 (b) confusingly provides for separate duties of loyalty in addition to the general duty of which these are a part; Subsection (d) wrongly provides for the basic contract good faith rule in the fiduciary duty section; and subsection (e) casts doubt on the rest of the section by letting members act selfishly. 63 Most importantly, like its RUPA counterpart, ULLCA §103 severely limits firms' ability to contract around these highly questionable default rules. One aspect of the RUPA rules adopted in ULLCA deserves special mention because of the way it interrelates with other ULLCA rules. ULLCA §103(b)(2) provides that the operating agreement may identify specific types or categories of activities that do not violate the duty of loyalty, if not manifestly unreasonable, and that the operating agreement may "specify the number or percentage of members or disinterested managers 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." There is, however, no provision elsewhere in ULLCA explicitly permitting member authorization of self-dealing transactions. The Comment to ULLCA §103 says that "Section 103(b)(2)(ii) preserves the common law right of the members to authorize future or ratify past violations of the duty of loyalty provided there has been a full disclosure of all material facts." Yet this "common law right" is far from clear. The LLC is not a "common law" organization. By contrast, the UPA requires partners to account for only those benefits derived "without the consent" of the other partners. 64 ULLCA §409(b)(1) uses almost the same language as the UPA, but deletes the language about consent. This strongly implies that ULLCA requires authorization in the operating agreement rather than by member vote. If the members cannot authorize a specific transaction that would otherwise constitute self-dealing, this would be a real hardship for the typical informal firms -- for which the act should be designed -- that do not include such detail in their operating agreements. Indeed, members of such firms may be surprised by the existence of the rule only after the issue is litigated. This is particularly a problem since it may be difficult to determine whether the conduct in fact would violate the duty of loyalty in the absence of consent. In the end, courts probably will resolve this issue by holding that member consent removes any fiduciary breach regardless of what the Act says. The Act should make this clear. 2. Erroneous linkage with RUPA Even if the RUPA rules applied in ULLCA were fine for partnerships, they would not necessarily suit LLCs. For example, the limited liability of LLC members suggests that the extra incentive of a duty of care may be appropriate to protect against improvident transactions. Although the RUPA duty of care as set forth in ULLCA §409(c) may be appropriate for LLCs, the use of the same language in both statutes erroneously suggests that the courts should apply this duty the same way in both contexts. This may cause the creation of inappropriate precedents for both LLCs and partnerships. 3. What Are Members' Duties In A Manager-Managed Firm? ULLCA §409 provides for several rules that adapt the RUPA fiduciary duty rules to the special circumstances of manager-managed LLCs. ULLCA provides that a member in a manager-managed LLC has no duties "solely by reason of being a member." 65 Assuming it is clear who is a "member" and who a "manager," there is a question whether the members as a group should be freed from fiduciary duties to the minority. Although ULLCA apparently provides for judicial dissolution in this situation, 66 members arguably should have some remedy short of dissolution. More seriously, because the relationship between members and managers in LLCs is an evolving concept, it is even more difficult to make precise statements about fiduciary duties in LLCs than in the relatively simply partnership context. When is a person a "member" and when a "manager" for fiduciary duty purposes, particularly in informal LLCs where functions may be blurred? ULLCA defines "manager" unhelpfully as one who is "vested with authority under §301." 67 But §301 simply vests with authority one who is a "manager." Moreover, ULLCA §409(h)(3) provides that even a non-managing member "who pursuant to the operating agreement exercises some or all of the rights of a manager in the management and conduct of the company business is held to the standards of conduct in subsections (b) through (f) to the extent that the member exercises the managerial authority vested in a manager by this [Act]." But when is a "member" who is not a "manager" under §301 nevertheless exercising the rights of a manager under §409? And when is she doing so "pursuant to the operating agreement" if the agreement is oral or does not explicitly forbid the action? Does the member's fiduciary duty turn on whether she is usurping authority? 68 Finally, ULLCA §409(h)(4) relieves a manager of liability "to the extent of the managerial authority delegated to the members by the operating agreement." Does this mean that managers are relieved of liability when they act as long as the operating agreement has delegated authority to the members? 410 REMEDIES This section provides that a member may maintain an action to enforce the member's rights against the LLC or another member with or without an accounting. This section's main problems concern its interrelation with the members' management rights and the derivative remedy. ULLCA §410 apparently allows individual member suits for breach of fiduciary duty to the LLC without either co-member consent or demand on managers. ULLCA Article 11 permits derivative suits only if members or managers with authority refuse to do so. 69 Courts will have to determine when a member is suing derivatively under Article 11 and when under §410. That may be impossible. Although the Comment to §410 provides that under the section a "member pursues only that member’s claim," the member's rights which are enforceable under this section would include fiduciary rights under §409. This would permit members to sue individually on derivative-type claims for damage to the LLC. 411 CONTINUATION OF TERM LLC This section provides that if a term LLC is continued after expiration of its term, it does so as an at-will LLC, and that if an LLC’s business is continued without winding up, it continues as an at-will LLC. 70 This section raises several questions which are discussed below in connection with ULLCA §§801, 802 and 809. 71 501-504 TRANSFEREES AND CREDITORS OF MEMBERS These sections provide for transfer of LLC interests 72 in terms similar to those which apply to partnership interests. This application of partnership law generally makes sense from an organizational standpoint, and helps ensure that LLCs have the partnership tax characterization feature of restricted transferability. The sections are also generally similar to those in most LLC statutes. 73 Indeed, the existing uniformity of these provisions is one reason why ULLCA is unnecessary. 601 DISSOCIATION EVENTS. This section specifies the events that cause a member’s dissociation. The dissociation triggers either a buyout or dissolution and winding. 74 Most notably, this section provides that a member dissociates on transfer of all of her distributional interest 75 and that a member who transfers "substantially all" of her interest may be expelled. 76 This appears to be a compromise between providing for expulsion or providing for automatic termination as a result of transfer. However, it is an unsatisfactory compromise, since it will inevitably trigger litigation over whether the member has transferred "substantially all" of the interest. In the closely held firm for which the statute should be drafted, members might be concerned about any dilution of the incentives of a co- manager, and so arguably should have at least a default expulsion power in this situation. On the other hand, giving such a power to the majority could invite opportunistic expulsions. In any event, the rule should be clear-cut. NORMAL.DOT 1/5/94 12 Content-Type: TEXT/PLAIN; name="ullcom2b.txt" Content-ID: Content-Description: 602 POWER TO DISSOCIATE This section provides that a member has a power to dissociate at any time, although the dissociation may be wrongful. 1. Should There Be A Default Power To Dissociate The most important question concerning the member's power to dissociate is whether the statute should provide for this default right. Since the main consequence of the power to dissociate is the member's buyout right, this issue is discussed below with respect to the provision concerning that right, ULLCA §603. 77 2. Should Dissociation Be Wrongful If Not In Breach Of Operating Agreement But Prior To Expiration Of A Term? ULLCA §602 provides that a member's dissociation is wrongful if it is in breach of the operating agreement or prior to expiration of the duration of a term LLC. 78 A wrongfully dissociating member is liable for damages caused by the dissociation. 79This default damage remedy is a mistake. Unlike in a partnership, on which this rule is based, 80 the member's premature departure does not necessarily impose significant burdens on the other members -- it does not generally cause dissolution, 81 does not generally require the firm to find other debt guarantees because the members have limited liability and, at least in a manager-managed LLC, does not generally require replacement of the member's services. 82 Moreover, any risk that prematurely buying out the member will disrupt the firm's business is minimized by the fact that a term LLC can delay buyout until completion of its term 83 and has the option to prohibit dissociation altogether. 84 Thus, there will probably be no real damage from the member's departure. Yet this section invites the firm and the court to search for damages. 3. Should dissociation by member bankruptcy be wrongful? ULLCA §602 provides that dissociation is wrongful if "the member is dissociated by becoming a debtor in bankruptcy." 85 Even if damages ought to be imposed on some wrongfully dissociating members, such damages should not be imposed on the creditors of a bankrupt member. 603 EFFECT OF DISSOCIATION This section is partly a switching provision: On dissociation, the firm either dissolves under §801, in which case Article 8 applies; or the firm continues and purchases the member's interest under Article 7. In a term LLC, the purchase occurs only on expiration of the stated duration. The section also specifies the effect of dissociation on members' management and fiduciary rights and obligations. 1. Should Members Have A Default Put? One of the more controversial aspects of this section is that a member has a default right at any time to be cashed out of the firm. The obligation to buy out members could impose significant burdens on the sort of closely held firm for which the statute should be designed. Perhaps such a right is justifiable in a partnership, since it relieves partners of having to continue to expose their personal wealth to business risk in order to keep their financial interest in the firm. But LLC members do not have this problem. Accordingly, it is worth asking whether the statute should assume that LLC members would want to provide for a buyout right. The strongest justification for the buyout right is that, even in an LLC, illiquid minority members may be subject to potential oppression by majority members. Such problems have given rise to special remedies in close corporations which have triggered much litigation and unsatisfactory judicial lawmaking. The basic problem with this remedy is that courts must guess that close corporation shareholders want to be treated like partners, while their decision to incorporate indicates that that is not the case. 86 The same problems would arise under LLC statutes that do not provide for a default buyout right. If the statute provides for such a right by default, the majority would have to make the absence of a buyout right clear to the minority by specifying it in the operating agreement. This would eliminate judicial guesswork about whether or not the members agreed to the absence of a buyout. 2. Other Consequences of Dissociation ULLCA §603(b) necessitates separating out the sub-parts of the duty of loyalty, determining when duties relate to pre-dissociation matters and which post-dissociation matters relate to winding up. 87 These difficulties are added to the difficulties of interpreting the fiduciary duty provision. 88 This is another respect in which ULLCA is a litigator's dream. 701 PURCHASE RIGHT ULLCA §701 provides rules for the purchase of a dissociating member's "distributional interest." Although, as discussed in connection with §603, 89 a default buyout right arguably makes sense for informal LLCs, this section's rules governing the buyout provide the sort of detailed formality that is appropriate for a more sophisticated firm. If the firm is operated informally there is a strong possibility that members and managers will miss the 30-day and 120-day deadlines specified in this section. These rules are appropriate only for a formal, heavily lawyered, corporate appraisal proceeding, not the informal 702 COURT ACTION TO FIX PRICE This section provides rules for the court determination of the buyout price -- i.e., "fair value" -- provided for under §701. Most importantly, it provides that the court should consider "among other relevant evidence the going concern value of the company, any agreement among some or all of the members fixing the price or specifying a formula for determining value of company interests for any purpose, the recommendations of any appraiser appointed by the court, and any legal constraints on the company's ability to purchase the interest." 90 1. Vagueness of "Fair Value" Standard The Comment to §702 emphasizes the openendedness of the "fair value" standard used for determining the buyout price: Under this broad standard, a court is free to determine the fair value of a distributional interest on a fair market, liquidation, or any other method deemed appropriate under the circumstances. A fair market value standard is not used because it is too narrow, often inappropriate, and assumes a fact not contemplated by this section -- a willing buyer and a willing seller. While any judicially determined buyout price is bound to involve some uncertainty, there is no reason to maximize the need for costly lawyering as ULLCA does. The fact that there is no actual willing buyer and willing seller is no reason why the court cannot be instructed to determine a hypothetical market price based on a willing buyer/willing seller standard. Indeed, RUPA requires just such a determination. 91If there is some policy reason why this would not be appropriate, the statute should clarify deviations from the market standard. For example, the statute could explicitly eliminate any "minority discount" by providing that value should be determined on the basis of the member's pro rata share of the value of the firm, as is provided in RUPA. 92This would help deter oppression of minority holders, thereby eliminating the need for open-ended special remedies to deal with the problem. 93 As phrased, the section creates unnecessary potential for litigation on many issues, as indicated in the following subsections. 2. What factors may the court consider ULLCA §702 provides that "the court shall . . . determine the fair value of the interest, considering among other relevant evidence . . . . " This sets no limit on the factors the court may consider, exacerbating the openendedness problem discussed immediately above. Also, "the court shall" language implies that the court must consider at least the factors set forth in the section. Does "considering" mean that the court must take all of these factors into account, or that the court can apply a zero weight to some factors? If the latter, under what circumstances may the court do so? 3. Relevance of agreement The language concerning the relevance of the price or formula in an agreement is confusing. To the extent that it refers to the buyout price in an operating agreement, this would be inconsistent with ULLCA §701(c), which provides that the operating agreement price controls, and with the fact that §§701 and 702 are not among the non-waivable provisions listed in 103(b). In fact, the provision probably refers only to agreements other than the operating agreement. But then the agreement may be wholly irrelevant to the buyout price. That would be a problem particularly if, as discussed immediately above, the court must take the agreement into account. 4. Difference from Partnership Standard ULLCA §702 applies a different standard from RUPA as discussed above, which itself differs from the UPA. 94 Thus, cases under one act cannot be used under the others. There is no apparent reason why ULLCA departs in this respect from RUPA while questionably borrowing RUPA language in many other respects. This indicates that ULLCA's drafters lacked a coherent theory that would help determine when to link the LLC with other forms. 801 DISSOLUTION This section specifies the events which result in a dissolution of the LLC. These include agreed events, judicial decree, and member dissociation, depending on whether the firm is "term" or "at will," as discussed below in subsection 1. 1. Dissolution At Will Pursuant to ULLCA §801, a "term" LLC, defined as one whose articles so provide, 95dissolves on a member's dissociation only if the dissociation is caused by bankruptcy or death (or the equivalent of a non- individual member). Át-will LLCs, which ULLCA defines as those which are not "term," 96 dissolve on dissociation of a member in a member-managed LLC or of a manager in a manager-managed LLC. Dissolution at will should not be the default rule for any type of LLC. Dissolution at will is highly questionable even in general partnerships because of the disruption it causes and the leverage it gives each member to extract concessions from co-partners who want to continue the firm. 97 But at least in a general partnership the liquidation power is supported to some extent by the potential harm to minority members resulting from their continuing personal liability for partnership debts. An LLC member's buyout right under §701 adequately addresses minority members' need for exit. Indeed, ULLCA unnecessarily provides minority members with additional protection in the form of a default veto power. 98 Adding a default dissolution power to the minority's other rights radically tips the balance of power in their favor. It is no answer that firms can vary dissolution at will in their operating agreement or include the appropriate articles provision to make their firms term partnerships. The act should provide rules for informal firms that may not have such agreements or provide for such formalities. For the reasons discussed immediately above, few informal firms will be likely to want the rules ULLCA provides. Yet they will be forced to incur the costs of drafting around the Act. Worse, they probably will not have a formal agreement or special articles provisions, 99 or even if they do they may run into the unexpected consequences of specifying a term. 100 Firms are least likely to agree on dissolution, which is a remote event from the perspective of drafting operating agreements or initial articles. As a result, members' expectations will be frustrated, or courts will try to sort out what the parties really wanted, as they now do in close corporation dissolution cases. In the final analysis, ULLCA's position on dissolution at will reflects an unsatisfactory compromise of tax and transaction cost considerations. The statute undoubtedly provides for dissolution at will because this is an important partnership tax characteristic. However, perhaps because they recognized the hardships of dissolution at will, the drafters have provided for exceptions for "term" and manager-managed LLCs. These compromises have only created additional difficulties. The problems of "term" LLCs are discussed below. 101 The exception for manager-managed LLCs was a last-minute addition in the January 20, 1995 draft in response to the IRS's December Revenue Procedure which provides that non-dissolution after member dissociation from a manager- managed firm does not amount to corporate-type continuity of life for purposes of obtaining a private ruling. 102 This distinction makes no sense as a default rule apart from tax considerations. It is based on an inappropriate analogy to limited partnerships in which the significant difference between general and limited partners based on limited liability should matter regarding the existence of a power to liquidate the firm at will. In an LLC, by contrast, both managing and non-managing members have limited liability. The governance and liquidity benefits to members from dissolution at will increase when members are excluded from management, while the costs to the firm depend on the duration of the firm and not on the form of governance. Although the centralized- management exception from dissolution at will increases continuity, it is an inappropriate default rule because it may confuse members of informal LLCs. Without costly legal advice, such firms are likely to think that continuity depends solely on whether the firm is at will. 2. When does the firm continue following member dissociation? ULLCA §801(b)(3)(i) provides that ULLCA provides that an at-will LLC dissolves on member dissociation unless the business . . . is continued by the agreement of: (A) the remaining members that would be entitled to receive a majority of any distributions that would be made to them assuming the business of the company were dissolved and wound up on the date of the dissociation; and (B) the remaining members that would be entitled to receive a majority of any future distributions that would be made to them assuming the business of the company were continued after the date of the dissociation. 103 ULLCA defines "future distributions" as used in this section to mean the total distributions that, as of the date of dissociation, are reasonably estimated to be made to the remaining members if the company were continued until the projected date of its termination, reduced by the amount of distributions that would have been made to the remaining members if the business of the company were dissolved and wound up on the date of dissociation. 104 Finally, ULLCA defines "distribution" as a "transfer of money, property, or other benefit from a limited liability company to a member in the member's capacity as a member. . . " 105 It therefore "includes all sources of a member's distributions including the member's capital contributions, undistributed profits, and residual interest in the assets of the company. . . " 106 The Drafters explain the "majority-of-distribution" rule as follows: Decision-making under this Act is normally by a majority in number of the members or managers for ordinary matters and unanimity for specified extraordinary matters. See Section 404(a) to (c). The majority of members holding requisite distributions rights varies this rule and is used only in subsection (a)(3)(i). Under this Act, distributions are shared on a per capita basis. See Comments to Section 405. Therefore, under the default rule, a majority in number would also be a majority of members holding requisite distributions rights unless the company has in excess of one hundred members. 107 Although the Comments say that majority-of-distributions in effect means per capita voting in the absence of contrary agreement because distributions are shared per capita, 108 this is wrong. The drafters refer to the rule that applies only to interim distributions. 109But on winding up, members are entitled to return of contributions 110 which may vary from member to member even in a default LLC. Determination of member contributions may be difficult in an informal firm that does not keep clear, current records -- the sort of firm for which the statutory default rule should be designed. It will be even harder to guess at shares of "future distributions," which may include both interim and final distributions of capital, and harder still to apply complex distribution formulas in agreements that do not vary the default voting rule. Thus, the Drafters initially provided for a "majority-in-interest" voting rule which, like a similar late addition to the Revised Uniform Partnership Act, 111 was explicitly intended to conform with tax rules. 112The Drafters changed this rule after it was criticized in an earlier draft of these Comments. But the old rule, as unsatisfactory as it was, at least had the virtue of aligning with tax law, RUPA, and some LLC statutes. 113 As discussed above, the new rule does not solve the main problem of the majority-in-interest rule of relying on computation of member interests. Moreover, it is even more unsatisfactory because it is not only confusing in itself, but also completely idiosyncratic and so less likely to attract a body of interpretive materials. 3. Who may apply for judicial dissolution? ULLCA §801 provides for separate grounds for judicial dissolution upon application by a "member or a dissociated member" under subsection (5) or "transferee" under subsection (6). The member's very broad rights are discussed in the next subsection. A transferee of an interest in a term LLC can sue for dissolution only after expiration of the term. 114 The Comment says that the successor has the same rights as a member. But a successor is not a member. ULLCA unfortunately does not include a provision which would clarify the status of a member's successor. Some statutes explicitly provide that the successor is an assignee. 115This should be the result under all statutes. 116 Otherwise, members would be forced to share management rights with new parties, contrary to the default rule in all LLC statutes providing new members can be admitted only upon member consent. 117Moreover, the estate or other successor cannot be viewed as merely a continuation of the member's interest, since ULLCA provides that a member's death causes dissociation, 118 and that an event of dissociation terminates a member's power to participate in management. 119 The problem of successor's rights seems to have arisen as a result of the last-minute change in ULLCA in response to the IRS' Revenue Procedure 95- 10 which provides that non-dissolution on dissociation of a member from a manager-managed LLC does not amount to corporate-type continuity of life for purposes of seeking a private ruling. 120 In catching up to the tax law, the drafters suddenly created a potential glitch for successors. Prior to the change, in the absence of contrary agreement death caused dissolution and winding up. After the change, death does not always cause dissolution, which means that the estate of a member who dies during an unexpired term is not entitled to be paid until after expiration of the term. 121 Thus, the estate is trapped in the firm, at the mercy of the other members and seemingly without even a dissociated member's right to sue for judicial dissolution during this period. These consequences result from the spiraling complexity of trying to compromise the general transaction-cost need for continuity and the tax need for dissolution by providing limited exceptions for term and manager-managed LLCs. The drafters at least could have explicitly empowered the successor to sue for judicial dissolution. But this would have entailed an inconvenient change in the black letter of the law that was supposed to have been the last word on LLCs. So the last resort was to attempt to change the law through commentary. 4. When may a member apply for judicial dissolution? ULLCA §801(a)(5) provides for circumstances which justify a judicial decree of dissolution. Some of these circumstances are discussed below. Subsection 5(i) provides for dissolution when "the economic purpose of the company is likely to be unreasonably frustrated." The Comment to §801 explains that a "court has the discretion to dissolve a company under subsection (a)(5)(i)[sic] when the company has a very poor financial record that is not likely to improve. In this instance, dissolution is an alternative to placing the company in bankruptcy." But an internal remedy for the members is not an "alternative" to administering the firm's debts in bankruptcy, and bankruptcy has nothing to do with a solvent firm that is able to pay its debts but whose "purpose" is "frustrated." Although the Drafters think the section applies only to a company with "a very poor financial record," the black letter does not say this. Disappointed members may claim that the "economic purpose" of an otherwise viable firm has been or probably will be "frustrated." The other members may oppose dissolution by arguing that the firm may be "frustrated," but not "unreasonably" so. The analogous provision in the UPA for judicial dissolution if the "the business of the partnership can only be carried on at a loss," 122 which more clearly focuses on poor finances and which is at least minimally justified in a context in which partners are personally liable for these losses. The most troublesome ground for judicial dissolution is that which provides for dissolution when "the managers or members in control of the company have acted, are acting, or will act in a manner that is illegal, oppressive, fraudulent or unfairly prejudicial to the petitioning member." 123 This ground brings into the LLC the whole unsatisfactory body of "oppression" law from close corporations. These openended remedies give courts wide latitude to rewrite operating agreements to give members exit and other rights they were never intended to have. 124 Indeed, one of the most important characteristics of the LLC form is that, unlike the more awkward close corporation form, LLC statutes make such remedies unnecessary by giving members a default right to dissolve or have their interests purchased at fair value 125 which ameliorates the problems the close corporation oppression remedies were intended to address. 126 This remedy is particularly unnecessary when combined with the additional ground of dissolution where "it is not otherwise reasonably practicable to carry on the company business in conformity with the articles of organization and operating agreement" 127 (which is the sole ground provided for limited partnerships 128), the members' power to veto major decisions, 1298and the members' and managers basic fiduciary duties. 130 Finally, it is important to keep in mind that these causes apply irrespective of contrary provisions in the operating agreement -- that is, even if the parties explicitly have agreed that the firm should continue for a certain time or until a certain event. 131 5. When Does a “Term” LLC Dissolve? ULLCA provides that a term LLC may be continued as an at-will company after expiration of a specified term, including by members' or managers' continuation of the business without any winding up. 132 Unfortunately, ULLCA nowhere provides that a term LLC dissolves on expiration of its term if it is not continued. In fact, a provision to that effect 133 was deleted from the final draft. Although the Comments say that a term LLC "will generally dissolve upon expiration of its term," this is contradicted by the black letter of the dissolution section which not only fails to include expiration of the term as a dissolution cause, but also provides that a transferee of a member's interest may apply for a judicial dissolution after the expiration of the term. 134 On the other hand, ULLCA provides for dissolution on "an event specified in the operating agreement," 135 which may or may not include the expiration of an agreed term or undertaking. Assuming that a term LLC does generally dissolve on expiration of its term, the members could provide in the operating agreement for a continuation after expiration, in which case the term specified in the articles would be, in effect, a minimum rather than a maximum. This raises several additional questions. First, it is not clear when the operating agreement will override the articles as to third parties. 136 Second, it may not be clear when the operating agreement has been amended to permit continuation. ULLCA §411 provides that if a term LLC is continued after expiration of the term, including by continuation of the LLC's business by members or managers (depending on whether the LLC is manager- managed), the LLC becomes one at will. This provision leaves some doubt about what vote is necessary for continuation. The ULLCA Comments assert that continuation is an ordinary business matter which can be decided by a simple majority vote. 137 The same comment also says that a continuation after expiration of the term in effect amends the operating agreement to provide for continuation as an at-will LLC. Yet if this is an amendment, it would seem to require a unanimous vote. 138 Unanimity is also required under ULLCA §802 for continuation after dissolution which, as discussed above, 139 may or may not occur on expiration of the term. The confusion confronting a term LLC may be particularly hard on informal LLCs which provide for a term in order to have continuity, only to find that the term actually provides discontinuity unless the members can persuade a court that it really wanted something different from what the articles seem to say. All of these problems would disappear if the ULLCA simply did not provide for term LLCs. The drafters obviously inserted the term as a compromise which ameliorates the effect of dissolution at will. From a policy standpoint, if dissolution at will is deemed to be necessary to preserve partnership-like non-continuity for tax purposes, then the Act should eliminate the intolerable confusion discussed in this subsection and provide for a simple default rule of dissolution at will. 802 CONTINUATION OF LLC AFTER DISSOLUTION This section permits the members unanimously to agree to continue the LLC before completing winding up. The section provides that even the dissociating member must consent to the continuation, and that the waiver of dissolution does not affect the rights of creditors who relied on the dissolution or a member’s post-dissolution authority. In effect, then, dissolution alters the firm’s internal and external contracts, and this alteration can be reversed only through adequate consent by members and notice to third parties. Since the section provides adequate safeguards for dissociating members and creditors affected by the dissolution, it does not raise serious policy issues. 140 However, the usefulness of the section is seriously impaired by the notice and consent requirements: the validity of the continuation is threatened by any member who claims oral dissent from the continuation or any creditor who relied on the dissolution. Accordingly, the members who wish to continue might be better off forming a new business association rather than by using the odd procedure provided for in this section. 804: MEMBER'S OR MANAGER'S POWER AND LIABILITY AS AGENT AFTER DISSOLUTION This section provides that an LLC is bound by acts after dissolution that are appropriate for winding up "or would have bound the company under Section 301 before dissolution, if the other party to the transaction did not have notice of the dissolution." It is unclear when a third party will be deemed to have "notice of dissolution." ULLCA provides that one has "notice" when she "(1) knows of it; (2) has received a notification of it; or (3) has reason to know it exists from all of the facts known to the person at the time in question." 141 Among other possible questions that may arise, it is not clear whether a third party has "notice" of dissolution after the expiration of a term specified in the articles. 142 Although this section is based on RUPA, 143 RUPA at least permits the filing of a notice of dissolution which clarifies the termination of pre- dissolution partner authority. 144 It is odd that ULLCA did not follow RUPA in this as in so many other respects. 805 ARTICLES OF TERMINATION This section permits an LLC to file “articles of termination” and provides that upon filing “[t]he existence of a limited liability company is terminated.” However, the section does not provide for the effect of the filing or for consequences of failing to file. As to the consequences of filing, the Comment to this section goes beyond the black letter in saying that “[t]he termination of legal existence also terminates the company’s liability shield” as well as the obligation to file annual reports. Even if the Comment controls, it is not clear what it means to terminate the “liability shield.” Presumably the members retain limited liability for pre-termination debts. 902 CONVERSION Article 9 provides for conversions and mergers of LLCs. To the extent that this article permits mergers with and conversions into entities other than LLCs, it creates potential conflicts with the statutes which provide for those entities. For example, ULLCA §902(a) provides that conversion must be approved by all of the partners, which term includes limited partners under §901(5), or by the vote required in the partnership agreement. Suppose in a limited partnership/LLC conversion that the limited partnership statute and agreement are silent on conversion, and that neither the statute nor the agreement require a vote by the limited partners. 145 Is a conversion approved only by general partners valid? If the limited partnership agreement controls limited partner voting rights, why should not the default agreement provided by the statute, which gives no voting rights, also control? 903 EFFECT OF CONVERSION This section provides that a converted LLC is the "same entity" as prior to the conversion. It then specifies effects of the conversion in subsection (b), including vesting of property, debts and rights in the LLC. It is not clear what "same entity" means other than the effects specified in subsection (b). 904 MERGER This section provides for mergers of LLCs with LLCs and other business entities. 1. Purpose And Effect Of "Plan" Requirement ULLCA §904(a) provides that the merger must be pursuant to a "plan," while §904(b) sets forth the requirements for the plan. This is a needless and confusing requirement. It is not clear what the effect is of a plan-less merger in an informal firm -- precisely the sort of firm for which the act in general and these provisions in particular are most necessary. Moreover, since the plan may be oral, it may be unclear whether there is a plan or what it says. Consequently, the requirement of a plan does little to reduce litigation over merger terms. Rather, it only adds something to litigate about -- that is, the existence of a statutory “plan.” Finally, the members may agree under ULLCA §103 to dispense with the plan. Does actually dispensing with a plan constitute an oral operating agreement not to require a plan? 2. Application Of Other Statutes As with the conversion provisions the merger provisions create possible conflicts with other statutes. For example, §904(c)(3) requires the same vote by a limited partnership as is required for a conversion, and therefore creates a potential conflict with the limited partnership voting requirements. 905 ARTICLES OF MERGER This section provides for articles of merger, upon the filing of which the merger is effective under §904(e). The section does not specify the effect of failing to file the articles. There is no apparent reason why the merger should not be effective at least among the members according to the terms of a final merger plan. Moreover, the non-exclusivity provision 146 suggests that the agreement may be effective even as to third parties without filing. 906 EFFECT OF MERGER This section provides that a merger terminates the "separate existence" of LLCs and other non-surviving parties to the merger. It then lists specific effects of the merger, including on property, rights and liabilities. It is not clear what the overall termination of "separate existence" means apart from the specific listed effects or whether termination of "separate existence" in this section means something different from saying that a firm which converts "is for all purposes the same entity" as before the conversion. 907 NONEXCLUSIVE This section provides that "[t]his [article] does not preclude an entity from being converted or merged under other law." Under this provision, the act provides a "safe harbor" for mergers and conversions. 147 Unfortunately, it is not clear whether "other law" means (1) the law of other states; (2) the law relating to other business entities; (3) the law of the parties' contracts; (4) common as opposed to statutory law; (5) all of the above; or (6) none of the above. Assuming this section has the broadest meaning it raises a question about the effect of the merger and conversion provisions. Why comply with the act if the merger is effective even without compliance? Conversely, a court may conclude that Article 9 does have some function, and therefore invalidate noncomplying mergers or conversions despite §907, even if the transactions might have been effective without Article 9. 1001-1009 FOREIGN LIMITED LIABILITY COMPANIES Article 10 provides for certificates of authority and application of formation-state law of foreign limited liability companies. 148 There are similar provisions in most other LLC statutes. Thus, while this Article does not present any policy problems, it also does provide any benefits in facilitating uniformity or providing a model law. 1101-1104 DERIVATIVE ACTIONS Article 11 provides for derivative actions by LLC members in the right of the firm. These provisions, although similar to those in RULPA, 149 raise several questions in LLC statutes. 1. Relation with Member's Individual Action Members' individual rights to sue are broadly defined under ULLCA §410. 150 The separate derivative remedy may give rise to litigation over whether members are suing individually or derivatively. 2. Critique of Derivative Remedy Apart from the potential confusion with the member's individual remedy, there is the important basic issue of whether LLC members should have a derivative remedy. The derivative remedy involves very substantial litigation costs which often exceed the benefit of the action to anyone other than lawyers. 151 In light of these costs, litigation within the firm should be considered an extraordinary action which should be evaluated by managers and members generally rather than left to the discretion of a lone disgruntled member. A derivative remedy might make some sense in a public corporation since even seemingly disinterested managers may sympathize with defendants 152 and requiring a shareholder to obtain authority from the other shareholders would be burdensome. Also, in a limited partnership it may make sense not to require members to seek authority from limited partners who are completely isolated from management power and information. But, unlike these other types of firms, in the sort of small, informal LLC for which the act should be designed, a default derivative remedy is clearly a mistake. 153 In an LLC, there is no concern about leaving members to the mercy of hostile board members since they can seek authority directly from the members. So as long as the suit cannot be blocked by interested members or managers, fiduciary duty suits on behalf of the firm should be authorized by the members, who are in the best position to make the critical cost-benefit analysis. In short, individual members should not be able to litigate on behalf of the firm if authorized members or managers have refused to sue or if, under ULLCA §1101, "an effort to cause [authorized] members or managers to commence the action is not likely to succeed." Even if requiring authority for suits on behalf of the firm might alone leave some fiduciary breaches unremedied or undeterred, it is important to evaluate the need for the derivative remedy in the light of members' other means of self-protection. As discussed in subsection 1, LLC members are likely to be able to characterize their claims as direct rather than derivative. Moreover, unless otherwise agreed, disgruntled members have the power to dissociate at will and be paid a judicially-determined value of their interest in the firm, 154rather than merely the minority-discounted share price that an exiting corporate shareholder can obtain. LLC also members have veto and removal powers that corporate shareholders generally do not have. 155 Finally, even if individual members should be able to sue for injuries to the firm without seeking authority from other members or managers, it is not clear that they should have a derivative remedy. A derivative remedy puts the recovery back in the firm, and therefore back in control of managers who, by hypothesis, cannot be trusted with it. Members in closely held firms cannot "cash in" the award simply by selling their stock as can corporate shareholders. 156 Additionally, courts can easily award direct recovery to the very LLC shareholders who were injured by the breach because, unlike public corporations, LLC membership does not rapidly change in highly liquid markets. Consistent with these principles, the ALI Principles of Corporate Governance provides that in closely held corporations courts may treat derivative claims as direct actions in certain circumstances. 157 It is ironic that the LLC act should move toward a corporate-type derivative remedy just as close corporation law moves in the opposite direction. For all of these reasons, the limited-partnership-type derivative remedy is unsuited for LLCs. A much better alternative is the Prototype Act provision for suit on behalf of the firm by one or more members of any LLC, or by managers of a manager-managed LLC, if authorized by a majority of disinterested members or managers. 158 3. Waiver ULLCA does not list the provisions relating to the derivative remedy as non-waivable. 159 This strongly implies that the members ought to be able to contract around the derivative remedy. 160 This is the right result, since even if the statute should provide by default for a derivative remedy, members surely should be able to contract out of the remedy, particularly given the serious questions concerning its suitability for LLCs. However, making the derivative remedy a default rule is no answer for the closely held firms for which ULLCA should be designed. The derivative remedy, which assumes that members are isolated and powerless, is particularly poorly suited for such closely held firms. At the same time, such firms are unlikely to contract in detail regarding remedies. FOOTNOTES 1. Prototype Limited Liability Company Act, §102(k). 2 See Ribstein & Keatinge §1.03. 3 See Prefatory Note at 2 and Comment to §103. See also Comment to §411 (stating that continuation of the LLC after expiration of an agreed term constitutes an agreement to continue as an at will firm). 4 ULLCA §103(b), discussed below. It is not clear whether an agreement permitting only written amendments would itself have to be in writing. 5 See Comments on §§408 and 409. 6 ULLCA §103(b)(7). 7 Prior to the February 28, 1995 draft, ULLCA §103(b)(7) provided that an operating agreement may not "restrict rights of third parties under this [Act], other than managers, members or their transferees." (emphasis added). See ULLCA §103(b)(7) (January 20, 1995 draft, emphasis added). It is not clear how or whether the drafters intended to change the meaning of the provision by deleting the highlighted words from the February 28, 1995 draft. The uncertainty is compounded by the fact that ULLCA §203(c)(1) continues to provide that the operating agreement controls "as to managers, members, and members' transferees" in the event of inconsistency with the articles 8 ULLCA §101(14). 9 See Alan R. Bromberg & Larry E. Ribstein, Bromberg & Ribstein on Partnerships ("Bromberg & Ribstein"), §1.03. 10 See Comment on §303. 11 See UPA §6; RUPA §§101(4), 202. 12 See Ribstein & Keatinge §4.03. 13 See Rev. Proc. 95-10, §4.01, 1995-3 I.R.B.(December 28, 1994) (providing that one-member LLCs cannot seek a ruling that it is a partnership for tax purposes). 14 See Ribstein & Keatinge, §14.04. 15 See Comment on §801. 16 See Larry E. Ribstein, Limited Liability and Theories of the Corporation, 50 MD. L. REV.80 (1991). 17 See Bromberg & Ribstein §12.04. 18 See Ribstein & Keatinge, §4.15. 19 Because an "operating agreement" may not restrict third party rights under ULLCA §103(b)(7), an agreement with "third parties" might not restrict their rights under §202 to disregard the liability shield prior to formation or to hold members liable as partners. On the other hand, the "operating agreement" agreement may not apply because this is not a "limited liability company." 20 ULLCA §203(a)(5). 21 Id. §801, discussed below. 22 See ULLCA §411, discussed below. 23 ULLCA §101(19). 24 Id. §101(2). 25 UPA §31(1)(a); RUPA §602(b)(2). 26 It might make sense to require the term to be stated as a particular period of years if the only effect of the specification were on third parties, since third parties may not easily be able to determine when an undertaking has been completed. Yet ULLCA neither explicitly provides that the "term" affects third parties (see ULLCA §804 discussed below) nor limits the effect to third parties. 27 See ULLCA, Prefatory Note at 2. 28 ULLCA §203(c)(1). 29 Id. §203(c)(2). 30 Curiously, §203(c)(2), like id. §103(b)(7), refers to "persons other than managers, members, and their transferees" but, unlike §103(b)(7), does not actually refer to "third parties." 31 ULLCA §203(c). 32 ULLCA §103(b)(7). 33 See Comment on §103. 34 ULLCA §301, discussed below. 35 See Ribstein & Keatinge, §8.05. 36 See ULLCA §101(10). 37 See Comment on §203, above. 38 See ULLCA §§103(b)(7) and 203(c)(2), discussed above. 39 As to the usefulness of this provision in avoiding corporate-type limited liability, see Ribstein & Keatinge at 16-32 (1995 Supp.). 40 New York Partnership Law, Ch. 34, §609(b) (1994). One other LLC statute makes the members’ liability limitation subject to a provision in the articles. See Iowa Code §490A.601 (1992). Another statute provides that members can agree to be liable by a provision in the “regulations” (which are equivalent to an operating agreement). Tex. Rev. Civ. Stat. Ann. tit. 32, art. 1528n art. 4.03. 41 It is not clear whether a contract with creditors would be binding without the disclosure. Since the agreement with the creditor is arguably not an “operating agreement” (see Comment on §103) and in any event does not “restrict” creditor rights under ULLCA §103(b)(7), ULLCA §303(c) does not clearly invalidate noncomplying agreements even if it applies to guarantees. 42 Eleven states enforce oral contribution obligations, of which eight do require some record of contributions. See Ribstein & Keatinge, Appendix to Chapter 6 (table of state provisions). 43 See Ribstein & Keatinge, Appendix to Chapter 6 (table of state provisions). 44 ULLCA §203. 45 Id. §408. 46 Id. §401. 47 Id. §103(b)(7). 48 See RULPA §502(b) (1985). 49 ULLCA §403(a). 50 Comment to ULLCA §403. 51 See Ribstein & Keatinge at 8-5 -- 8-8. 52 See ULLCA §103 (permitting oral operating agreement to vary terms, and not including §404 among provisions that may not be varied by operating agreement). 53 Prototype Limited Liability Company Act, §601 (1992). 54 RULPA §504. 55 Prototype Limited Liability Company Act, §603 and Comments. 56 The only exception is the Minnesota statute. See Mn. St. §323.14(5) (providing that partner who receives a distribution from an LLP that would have violated corporate distribution provision is liable for the excessive distribution). 57 UPA §19; Bromberg & Ribstein §6.05. 58 RUPA §403. 59 See ULLCA §103(b)(1). 60 See Ribstein & Keatinge at 9-12. 61 UPA §20; RUPA §403(c). 62 See Larry E. Ribstein, The Revised Uniform Partnership Act, Not Ready for Prime Time, 49 BUSINESS LAWYER 45 (1993). 63 The Comments attempt to explain §409(e) by stating that "a member does not violate the obligation of good faith under subsection (d) merely because the member's conduct furthers that member's own interest," giving examples of voting in the member's own interest. See Comment to ULLCA §409. This would be clear even without subsection (e) from the fact that the good faith obligation does not impose a duty of selflessness. Yet subsection (e) is obviously not limited to the good faith obligation. 64 UPA §21 (1914). 65 ULLCA §409(h)(1). 66 See ULLCA §801(b)(5)(v), discussed below. 67 ULLCA §101(9). 68 The relationship between managers' powers and their fiduciary duties is an important and difficult issue in corporate law. See Larry E. Ribstein, Takeover Defenses and the Corporate Contract, 78 GEO. L. J. 71 (1989). The recent case of Paramount Communications Inc. v. QVC Network Inc., 1994 Del. LEXIS 57 (Del. 1994) suggests that directors are sharply limited in how they may sell control of the corporation -- an act which exceeds their usual power under the corporate statute. 69 See Comment on Article 11. 70 Curiously, subsection (b) refers only to “continuation” without specifying the kind of continuation to which it is referring. The title of the section indicates that both subsections refer to continuation of a term LLC. The drafters should have made this explicit. 71 See the Comments on these sections below. 72 ULLCA §§501-504 distinguish between LLC members and transferees of "distributional" interests, which ULLCA §101(5) defines as members' interests in "distributions." ULLCA §101(4) defines a "distribution" as "a transfer of money, property, or other benefit from a limited liability company to a member in the member's capacity as a member or to a transferee of the member's distributional interest." This is broad enough to include all of a member's financial rights, which ULLCA §501 provides can be "transferred in whole or in part." 73 See generally, Ribstein & Keatinge, Ch. 7. 74 See ULLCA §§603, 701 and 801, discussed below. 75 ULLCA §601(3). 76 ULLCA §601(5)(ii). 77 See Comment on §603. 78 A term LLC is one which is so designated in the articles. See ULLCA §101(19). Note that if the operating agreement provides for a term but the articles do not, the firm is apparently not a term LLC, despite the fact that ULLCA §203(c)(1) provides that the articles generally control among the members. Although the dissociation prior to expiration of the specified term is wrongful whether or not it explicitly violates the operating agreement, there would appear to be no reason under ULLCA §103 why the operating agreement could not make dissociation prior to expiration of the term non- wrongful. 79 ULLCA §602(c). 80 See UPA §38(2); RUPA §602. 81 ULLCA §801(b)(3), discussed below, provides that a member's premature dissociation other than for involuntary events such as bankruptcy or death does not cause the dissolution of a term LLC. 82 If the departure breaches an employment agreement, there would be a cause of action for that, and therefore no need to protect against this in the LLC statute. 83 ULLCA §§603(a)(2)(ii), 701 (a)(2). 84 See id. §602(a) (providing that power to dissociate is subject to contrary provision in the operating agreement). 85 Id. §602(b)(2)(iii). 86 See Frank Easterbrook and Daniel Fischel, Close Corporations and Agency Costs, 38 STAN. L. REV.271 (1986). 87 See Ribstein, supra note 62 (discussing problems of applying analogous RUPA provision). 88 See ULLCA §409 discussed above. 89 See Comment on §603. 90 ULLCA §702(a)(1). 91 RUPA §701(a)(1). 92 Id. . 93 See Comment on §801. 94 See Ribstein, supra note 62 (discussing the RUPA provision). 95 See ULLCA §101(19). 96 ULLCA §101(2). 97 See Ribstein, supra note 62; Larry E. Ribstein, A Statutory Approach to Partner Dissociation, 65 WASH. U. LAW QUARTERLY 357 (1987). 98 See ULLCA §404, discussed above. 99 It is particularly likely that they will not have an effective term election in their articles given the specificity of the required election. See Comment on §203. 100 See Comment on §801. 101 Id. 102 See Rev. Proc. 95-10, 1995-3 I.R.B. December 28, 1994, §5.01(1). The drafters explicitly acknowledged the tax derivation of the provision by stating that the January amendment to the dissolution provisions "harmonize[s] the Act with new and important Internal Revenue Service announcements." ULLCA Prefatory Note at 2. 103 Id. §801(b)(3)(i). 104 Id. §801(a). 105 Id. §101(5). 106 Drafters' Comment to ULLCA §101. 107 Drafters' Comment to ULLCA §801. 108 Drafters' Comment to ULLCA §801. If the default rule would be per capita in general, it is not clear why it would not be per capita if the company has more than a hundred members, as the Comment states. 109 Id., referring to ULLCA §405. 110 Id. §806. 111 See RUPA §801 (1994). 112 See Treas. Reg. § 301.7701-2(b)(1) (providing that corporate-type continuity of life does not exist notwithstanding the fact that a dissolution of the limited partnership may be avoided, upon an event of withdrawal of a general partner, by at least a majority in interest of the remaining partners agreeing to continue the partnership); Rev. Proc. 94-46, 1994-28 I.R.B. (June 29, 1994) (providing a safe harbor definition of “majority in interest” as majority of profit interests and of capital interests); Rev. Proc. 95-10, §5.01, 1995-3 I.R.B.(December 28, 1994) (specifying conditions under which LLC may obtain ruling that relates to its classification as a partnership for federal tax purposes). The drafters made clear their intention to align with tax rules in the Comment to ULLCA §801 (January 20, 1995 draft). 113 See McKinney's Cons. Laws of New York, ch. 34, §701(d); S.C. Laws §33-43-901(c). 114 See ULLCA §801(b)(6). 115 See Alaska Stat §10.50.385; Ark Code §4-32-707; Colo. Rev. St. §7- 80-704; Ga Code Ann §14-11-506; Idaho Code §53-639, Ky. Rev. Stat. Ann, Ch. 275, §54; La Rev Stat Ann §12:1333; Me. Rev. Stat. Ann., ch. 13, §688; Mo Rev Stat §359.772(1); NM Stat Ann §53-19-33(A).Wash. Rev. Code §702(3)(b); Wis. Stat. §183.0704(2). Other statutes include language similar to that in Revised Uniform Limited Partnership Act §705 (1985) which provides that the executor or other successor may exercise all of the member's rights for the purpose of settling the member's estate but does not explicitly provide for transfer of financial rights or that the estate is an assignee. See Ribstein & Keatinge, Appendix to Chapter 7 (table of statutes). 116 See Ribstein & Keatinge, §7.09. 117 See ULLCA §§404(c)(7) (requiring unanimous member consent to admission of new member); id. §503 (requiring member consent to transfer of management rights); Ribstein & Keatinge, §7.04. 118 See ULLCA §601(7)(i). 119 ULLCA §603(b)(1). 120 See Note 102 above and accompanying. 121 See ULLCA §701(a)(2). 122 UPA §32(e). See Bromberg & Ribstein §7.06(d). 123 ULLCA §801(b)(5)(v). 124 See Frank Easterbrook & Daniel Fischel, Close Corporations and Agency Costs, 38 Stan. L. Rev. 271 (1986); Dale A. Oesterle, LLC Statutes: Limiting the Discretion of State Courts to Restructure the Internal Affairs of Small Business, forthcoming 1995 Colo. L. Rev.. 125 ULLCA §§602, 603 and 701. 126 See Larry E. Ribstein, The Closely Held Firm: A View from the U.S., forthcoming 1995 MELB. L. REV.. 127 ULLCA §801(b)(5)(iii). 128 RULPA §802 (1985). It is not clear the extent to which this cause supplements the UPA causes. See Larry E. Ribstein, Linking Statutory Forms, forthcoming 1995 LAW AND CONTEMPORARY PROBLEMS. 129 ULLCA §404(c). 130 Id. §409. 131 Id. §103(b)(6). 132 Id. §411. 133 Id. §801(7) (January 20, 1995 draft). 134 Id. §801(b)(6) 135 Id. §801(b)(1). 136 The operating agreement seemingly would not bind a third party under ULLCA §§103(b)(7) (operating agreement does not restrict rights of third parties); 203(c)(2) (articles rather than inconsistent operating agreement controls as to third parties who rely on articles to their deteriment). But this is not entirely clear because of the "notice of dissolution" rule regarding continuing member authority to bind after dissolution. See ULLCA §804, discussed below. 137 Comment to ULLCA §411. 138 See ULLCA §404(c)(1). 139 See Comment on §802. 140 For criticism of a version of RUPA §802, on which ULLCA §802 is based, which originally did not adequately protect dissociating members or third parties who might be injured by the waiver, see Ribstein, supra note 62. 141 ULLCA §102(b). 142 See id. §203, discussed supra text accompanying notes__. 143 See RUPA §804 (1994). 144 RUPA §805 (1994). 145 RULPA §302 (1985) provides that the partnership agreement may grant voting rights to limited partners. 146 ULLCA §907, discussed below. 147 The Drafters' Comment to §904 so characterizes the merger provision. 148 "Foreign limited liability company" is defined as "an unincorporated entity organized under laws, other than the laws of this State, which afford limited liability to its owners similar to the liability under section 303 and is not required to obtain a certificate of authority to transact business under any law of this State other than this [Act]." This is similar to definitions in more than a third of the states. See Ribstein & Keatinge, Appendix to Chapter 13 (table of state provisions). 149 See RULPA §1001-1004. 150 See Comment on §410. 151 See generally Daniel Fischel and Michael Bradley, The Role of Liability Rules and the Derivative Suit in Corporate Law: A Theoretical and Empirical Analysis, 71 CORNELL L. REV. 261, 271-74 (1986). 152 See Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981) (noting possible "there but for the grace of God go I" attitude of members of directors). 153 See Ribstein & Keatinge §10.03. 154 See ULLCA §§603, 701, discussed above. 155 See ULLCA §404, discussed above. 156 See Crosby v. Beam, 548 N.E.2d 217 (Ohio 1989) (citing the latter problem in allowing a claim for unreasonable salaries in a close corporation to be brought directly). Members have a default power to exit the firm. But if this power is not enough to make a litigation remedy unnecessary, then it follows that it should not be enough to protect the members from managers’ misuse of a derivative judgment. 157 American Law Institute, Principles of Corporate Governance: Analysis and Recommendations (1994), §7.01(d) provides: In the case of a closely held corporation, the court in its discretion may treat an action raising derivative claims as a direct action, . . . if it finds that to do so will not (i) unfairly expose the corporation or the defendants to a multiplicity of actions, (ii) materially prejudice the interests of creditors of the corporation, or (iii) interfere with a fair distribution of the recover among all interested persons.See Richards v. Bryan, 879 P.2d 638 (Kan. App. 1994) (applying this rule to permit a direct suit on an otherwise derivative-type claim). 158 Prototype Limited Liability Company Act, §1102 (1992). 159 ULLCA §103(b). ULLCA raises a question whether waiver will be enforced by providing that the operating agreement may not "eliminate" the duty of loyalty or "unreasonably reduce" the duty of care. Id.§103(b)(2), (3). It is not clear whether agreements eliminating remedies for fiduciary breach would come within these prohibitions.