The Business Divorce Law Report
Operating Agreements for Limited Liability Companies to Change Under Revised Limited Liability Company Act
Part of an ongoing series on the adoption of New Jersey’s revised limited liability company act.
The amendments to the New Jersey’s Limited Liability Company Act, N.J.S.A. 42:2C-1-94 that begin to take effect in March 2013 will bring a new era in the way the members of a limited liabilit
y company structure their affairs. The days in which the members must put their agreements in writing will soon be over, and the owners of New Jersey LLCs should take a hard look at their own operating agreements and course of doing business.
In adopting the Revised Uniform Limited Liability Company Act, the state legislature has approved a fundamental change to the way LLCs operate in New Jersey. We are examining these changes in a series of articles and today focus on the effect of the changed definition of operating agreements.
Written Operating Agreements Not Required
The old law may have been rigid, but at least it was clear. It was not required in New Jersey (as in some other states) to have an operating agreement, but if you did, it had to be in writing. If there was no written operating agreement, then the “default” rules provided by the statute governed. That has changed significantly. The new law defines an operating agreement as
“the agreement, whether or not referred to as an operating agree
ment and whether oral, in a record, implied, or in any combination thereof, of all the members of a limited l
iability company …”
To understand just how much of a change is this definition, we can look at a 2004 decision of the Appellate Division in Kuhn v. Tuminelli, 366 N.J. Super. 431, 841 A.2d 496 (App. Div. 2004). In that case, the plaintiff and defendant owned a limosine service and the defendant embezzled funds by endorsing checks to the company and keeping the funds. Kuhn argued that the defendant did not have authority to convert the checks and named as a defendant the check cashing service that had negotiated the checks.
The answer to the case was simple. There was no written operating agreement, although Kuhn argued that an oral agreement was in place that limited the other member’s ability to bind the company. The Court looked at the writing requirement and, finding no written agreement, found that Tumminelli could and did bind the company with his acts. In short, as a member of the LLC, Tumminelli had authority to bind the business unless that authority was restrained in a writing.
Now consider the new statute. Kuhn’s arguments that the parties had an oral agreement that limited the members’ authority, or even that they had a course of dealing in which the members did not use company funds for personal purposes, would in all probability have been sufficient to create a factual issue for trial. Not only was an oral agreement, if it existed, binding, but the new limited liability company statutes do not automatically confer authority on members to bind the company.
This fundamental change in the definition of operating agreement presents significant issues for limited liability companies organized under New Jersey law. The revised law applies to LLCs formed after March 2013 and for all LLCs in March 2014.
- LLC owners should not assume that the “default” rules created by the statute will apply in the future. If the conduct of the business is different than the default rules, it is probably an operating agreement.
- Oral agreements will now bind the parties. Owners of LLCs need to look at their operating agreements and determine if they are inconsistent with oral agreements, whether their current agreement requires amendment in writing, and ultimately whether the oral agreements reflect the owners’ wishes.
- Owners need to be careful about accepting non-compliance with the terms of operating agreements. What may have been a waiver issue earlier now becomes an amendment issue. Consider, for example, the LLC that permits one of the partners to repeatedly ignore capital calls. Have they amended the operating agreement? Maybe. And will they now need the approval of all of the members to enforce the operating agreement as it was written? Perhaps. If the agreement was amended by the conduct of the parties, then all of the members must agree to amend the agreement to put it back as it was.
Owners of New Jersey LLCs will be well-advised in the coming months to take a hard look at their businesses and the upcoming revisions to the state’s limited liability company laws. The changes are profound.
We will look at the actual requirements of an operating agreement under the new statutory scheme in an upcoming post.
As always, we welcome questions and comments.