Changes to N.C. Limited Liability Company Act - Is it Time to Update Your LLC's Operating Agreement?

April 2, 2014

Effective as of January 1, 2014, the North Carolina General Assembly completely repealed the North Carolina Limited Liability Company Act ("Old Act") and replaced it with an entirely new act ("New Act"). The purpose of the New Act is to provide greater flexibility in the structure and management of each limited liability company ("LLC") created in North Carolina, along with more freedom in the drafting of operating agreements. This article addresses the key changes made by the New Act. The New Act applies to all North Carolina LLCs whether they were formed under the Old Act or the New Act and to foreign LLCs.

Clarification of Ownership Interests

The New Act strives to more clearly distinguish between the different types of ownership interests in an LLC. Such ownership interests include members and economic interest owners. A member is an individual or entity that has been admitted to the LLC as a member, which entitles such member to certain membership rights. On the other hand, an economic interest owner is an individual or entity that owns an economic interest in the LLC but is not a member and does not have the other membership rights. For example, if Member A transfers A's ownership interest to John Doe, then John Doe generally will only be an economic interest owner, unless the other members vote to admit John Doe as a member. The significance of this distinction is that economic interest owners generally do not have the same voting, management, and information rights as members. They just have the right to receive allocations of income, credits, and losses, together with the right to receive distributions from the LLC.

To further clarify the types of ownership in an LLC, the New Act provides that any owner of the LLC, whether a member or an economic interest owner, is denoted as an interest owner. The entire interest of such interest owner is also now referred to as an ownership interest instead of a "membership interest."

Management Structure

The New Act allows greater flexibility in the management structure of a North Carolina LLC. Instead of using a manager-managed or member-managed structure, the New Act expressly allows the use of a management structure similar to that used by corporations, which includes establishing a board of directors and electing officers such as Presidents, Chief Executive Officers, Vice-Presidents, or Chief Financial Officers. Therefore, the New Act provides that company officials, rather than just members or designated managers, may manage an LLC. The New Act defines a company official as any person exercising any management authority over the LLC, regardless of that person's title.

The LLC Operating Agreement

The foundation and strength of any LLC is its operating agreement. The New Act has made several significant changes to the definition, creation, and application of an LLC's operating agreement, which include the following:

• An operating agreement under the New Act is defined as any agreement that concerns the LLC or any ownership interest in the LLC to which each interest owner is a party or is otherwise bound as an interest owner. Consequently, the New Act authorizes economic interest owners, and not just members, to be parties to the operating agreement.
• The operating agreement may be in any form, including written, oral, implied, or any combination thereof. However, the operating agreement may specify the form that it or any amendments to it must take. For example, an oral amendment to the operating agreement will be valid and enforceable against another party to the operating agreement unless the operating agreement contains a provision that requires an amendment to be in writing. However, oral agreements and implied provisions of the operating agreement may not change or override any contrary or inconsistent written provisions in the operating agreement to the detriment of the rights of persons who are not parties to the operating agreement and who reasonably rely on those written provisions.
• The Articles of Organization and all other documents that the LLC files with the North Carolina Secretary of State are deemed to be, or be part of, the operating agreement. The intent of this change is to provide greater protection to third parties who are not parties to the operating agreement and who reasonably rely on documents filed with the Secretary of State.
• If the LLC has only one interest owner and no operating agreement to which another person is a party, then any document or record intended to serve as the operating agreement will be deemed to be the operating agreement.

Formation under the New Act

Under the New Act, the requirements for filing Articles of Organization ("Articles") are the same as provided under the Old Act, except:

• The New Act does not require the Articles to include a limit on the term of the life of the LLC; rather, every LLC is now deemed to have a perpetual duration;
• The New Act does not require the Articles to specify whether the LLC will be member-managed or manager-managed; but,
• The New Act does require that the Articles specify the professional services that the LLC will render if it is a professional limited liability company, such as a medical practice or an engineering practice.

Limitations on Modifying Provisions of the New Act in the Operating Agreement

The New Act provides that the terms of the operating agreement may not change or override certain provisions of the New Act. The list of statutory provisions that cannot be superseded by agreement is extensive and dependent upon the terms of each individual operating agreement. Since this is a significant change that may affect the enforceability of certain provisions in your LLC's current operating agreement, it is recommended that you have an attorney review your LLC's current operating agreement to determine what provisions, if any, are no longer enforceable.

Information Rights of Members under the New Act

The New Act provides inspection rights that are generally consistent with those provided under the Old Act, including the broad provision that requires the LLC to disclose information from which the status of the business and financial condition of the LLC may be ascertained. In addition, the New Act provides that:

• The LLC can elect whether to provide members with a copy of its tax returns or its financial statements for the prior four fiscal years, whereas the Old Act required the LLC to provide its tax returns; and,
• The LLC must provide information about both its economic interest owners and its members, whereas the Old Act only required the LLC to provide information about its members.

Grounds for Judicial Dissolution

The New Act changes the grounds upon which a member may request judicial dissolution of the LLC and limits such dissolution to the following circumstances:

• When it is not practicable to conduct the LLC's business in conformance with the operating agreement or the New Act; or,
• When liquidation of the LLC is necessary to protect the rights and interests of the member.

Consequently, the New Act removes the grounds for dissolution for management deadlock and misapplication or waste of assets available under the Old Act. Of course, to the extent any such matter would implicate the grounds for dissolution set out in the New Act, dissolution will still be an available remedy.

Charging Order

The New Act makes an important change that affects the rights of a judgment creditor against an interest owner of an LLC. The New Act expressly provides that a charging order is a judgment creditor's exclusive remedy against a non-member interest owner. This means that a judgment creditor cannot pursue any remedy against a non-member interest owner's ownership interest in the LLC other than placing a lien on the interest owner's economic interest.

Conclusion

There are many important changes made by the New Act which apply to every North Carolina LLC, regardless of when it was formed. Although the New Act does provide a transition provision for those LLCs formed before January 1, 2014 in order to limit any potential impairment to those existing LLCs, now is a good time to have an attorney review your LLC's current operating agreement to see what, if any, changes need to be made.

The North Carolina Limited Liability Company Act has been revamped with some important changes that may impact the current operating agreement of your LLC. It's important that you understand these new changes and determine whether any of them affect your LLC.

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