Bar News - December 14, 2007
Is It Time for New Hampshire to Amend Its LLC Act?
By: John M. Cunningham
The New Hampshire Limited Liability Company Act (the “New Hampshire Act”), RSA 304-C:1-85, was originally enacted in 1993. It is, in my view, a basically sound act, and the LLC business organization form has become tremendously popular in New Hampshire.1 New Hampshire citizens are now forming almost seven LLCs for every business corporation that they form.
However, the most recent year in which the New Hampshire Act was significantly amended was 1997. Since 1997, New Hampshire lawyers and business people have had extensive experience in forming LLCs and in guiding their operations. In addition, hundreds of significant LLC cases have been reported in dozens of states; many states have made major amendments to their LLC acts; and in 2006, the National Conference of Commissioners for Uniform State Laws approved the Revised Uniform Limited Liability Company Act (“Re-ULLCA”), a model LLC act. In my view, Re-ULLCA reflects to a very substantial degree the best current thinking about LLC business organization law.
For all of these reasons, I think that it is time for New Hampshire lawyers interested in LLCs to form a committee:
- To systematically review the New Hampshire Act;
- To identify all amendments to that act that, in their view, will be likely to significantly improve it; and
- To propose these amendments to the New Hampshire Legislature.
In undertaking these tasks, this committee (which I’ll refer to here as the “Drafting Committee”) should seek ideas for amendments of the New Hampshire Act in Re-ULLCA and in the LLC acts of other states that they believe may provide them with useful drafting concepts. These states should obviously include Delaware but perhaps also Texas, Florida and other states that, in recent years, have made substantial amendments to their LLC acts.
The basis for any project to develop amendments of the New Hampshire Act must be an understanding of LLCs as they actually exist in this state. In Part II of this article, I will present a brief portrait of the world of New Hampshire LLCs as I understand it and a very brief view of New Hampshire LLC practice. In Part III, I will outline what I believe should be the fundamental drafting policies that the Drafting Committee should follow in considering how best to amend the New Hampshire Act. In Part IV, I will specifically identify the various New Hampshire Act amendments that, on the basis of my New Hampshire LLC practice experience, seem to me to be appropriate.
I will be grateful for any comments that New Hampshire lawyers may have in response to this article and for expressions of willingness to serve in the above committee.
II. Survey of NH LLCs
On the basis of my own LLC practice experience, reviews by my law clerks of LLC certificates of formation on file in the Corporate Division of the New Hampshire Secretary of State, Internal Revenue Service filing statistics and other evidence, I suggest the following brief description of New Hampshire LLCs as they presently exist in this state.
1) There are presently about 30,960 LLCs formed and existing under the New Hampshire Act. (By way of comparison, about 18,998 New Hampshire business corporations are currently in good standing in New Hampshire.)
2) About half of these LLCs are single-member LLCs whose members are individuals. Most of the rest have only two members. Only a very small portion has three or more members.
3) The vast majority of New Hampshire LLCs have been formed by their members without the assistance of lawyers and have no written LLC agreement. Under Section 1,VI of the New Hampshire Act, all of these LLCs are governed exclusively by the mandatory and default provisions of that act.2
4) Under federal tax classification rules known as the Entity Classification Regulations, the vast majority of New Hampshire single-member LLCs are taxable as sole proprietorships and the vast majority of New Hampshire multi-member LLCs are taxable as partnerships.
5) By definition, all New Hampshire single-member LLCs operate in a highly informal manner, but the same is also true of New Hampshire multi-member LLCs.
6) Because there is relatively little demand in New Hampshire for specialists in LLC business organization law, most New Hampshire lawyers who assist clients in forming New Hampshire LLCs are not specialists in LLC business organization law and have only a general familiarity with the provisions of the New Hampshire Act.
II. What Goals Should the Drafting Committee Have in Amending the New Hampshire Act?
1) The New Hampshire Act as an off-the-shelf LLC agreement for small New Hampshire LLCs. In my view, the primary (though by no means the only) goal of the Drafting Committee should be to propose amendments to the New Hampshire Act to the maximum extent appropriate to ensure that the act provides to small, highly informal New Hampshire single-member and multi-member LLCs an appropriate statutory “off-the-shelf” LLC agreement. The economic rules, dissociation rules, membership transfer rules, management rules, fiduciary rules and other rules in this off-the-shelf agreement should reflect what the members of these LLCs would have chosen if they had spent the time and legal fees necessary to negotiate a well-reasoned and comprehensive written LLC agreement.
2) Fiduciary issues. In my view, the members of most New Hampshire LLCs are likely to want the other members of their LLCs to be subject to relatively strict fiduciary duties and fiduciary liabilities, and these members know that they cannot impose these strict fiduciary duties and liabilities on other members without also accepting them for themselves.
3) Lawyers. The meaning of all of the provisions of the New Hampshire Act should be reasonably clear to New Hampshire lawyers who are not specialists in LLC business organization law.
IV. Proposals for Amendments to the New Hampshire Act
On the basis of the above fundamental drafting policies and other considerations that seem to me to be relevant, I propose the following amendments to the New Hampshire Act for consideration by the Drafting Committee:
1) Validity of oral LLC agreements. Section 1,VI of the New Hampshire Act presently provides, in effect, that only written LLC agreements will be valid. I propose that the act be amended to provide that oral LLC agreements will also be valid.
2) Duty of loyalty. The New Hampshire Act imposes no explicit duty of loyalty on LLC members or managers. I propose that the act be amended as follows to address this duty as follows:
Unless the LLC agreement provides otherwise, in all matters relating to the business and internal affairs of the LLC, each member of an LLC that is managed by its members and each manager of an LLC that is managed by managers shall act in a manner that the member or manager reasonably believes to be in the best interest of the LLC.
3) Duty and standard of care. The New Hampshire Act contains no express provisions subjecting LLC members and managers to a duty of care, nor does it specify any standard of care. The most obvious such standard is the corporate “ordinary prudence” standard. I would have no problem with an “ordinary prudence” amendment to the New Hampshire Act. However, in my view, that standard is appropriate principally in governing the essentially deliberative functions of corporate directors. I would prefer an amendment imposing a more multi-dimensional duty-of-care standard applicable not only to the planning and review functions of LLC members and managers but also to their hands-on management responsibilities. The following is an illustration of what I have in mind:
Unless the LLC agreement provides otherwise, the members of LLCs managed by the members and the managers of LLCs managed by managers shall perform their management duties with the knowledge, judgment, skill, diligence and timeliness that an ordinarily competent person in a like position would use under similar circumstances.
4) Business judgment rule. I also propose that consideration be given to amending the New Hampshire Act to provide for a default provision providing for a statutory defense against manager liability generally similar to the defense afforded by the corporate business judgment rule.
5) Duty of candor. I propose that the New Hampshire Act be amended to include a default provision providing that in connection with the formation, operation and dissolution of LLCs, an LLC’s members and managers will have an affirmative fiduciary duty of candor such as that outlined in Justice Cardozo’s classic partnership law decision in Meinhard v. Salmon, 164 NE 545 at 546 (N.Y. Court of Appeals 1928).
6) Duties of good faith and fair dealing. Although I am confident that any New Hampshire court would rule that duties of good faith and fair dealing are implicit in the New Hampshire Act, I propose that the act be amended to provide a mandatory provision expressly imposing these duties.
7) Member voting power. Section 24,V of the New Hampshire Act provides, in effect, that unless the LLC agreement provides otherwise, each member shall have one vote on each matter on which the members may vote. I believe that this provision is inconsistent with the expectation of the members of most New Hampshire LLCs and that it should be amended to provide that unless the LLC agreement provides otherwise, the voting power of members shall be proportionate to their respective shares of aggregate contributions to the LLC.
8) Defined term for totality of a member’s rights. The New Hampshire Act contains a defined term—namely, the term “limited liability company interest”—for the right of members to share in LLC profits and losses and to receive LLC distributions. However, unlike a number of other LLC acts, it contains no defined term for the totality of a member’s rights under the New Hampshire Act and their LLC agreement, including not only their limited liability company interests but also their other economic rights (e.g., buy-sell rights) and their management (e.g., voting, informational, dispute resolution and fiduciary rights) and other non-economic rights. I think this term should be “membership rights,” and I propose to amend Section 1 of the New Hampshire Act to include the term.
9) Systematic use of the phrase “unless the LLC agreement provides otherwise.” I propose that all provisions of the New Hampshire Act that are intended to be default provisions but that do not begin with the phrase “unless the LLC agreement provides otherwise” (I call these “covert” default rules) be systematically amended to begin with that phrase. See, e.g., Section 76 (derivative suit provisions).
10) Interim distributions. I propose that the New Hampshire Act be amended to include a default provision providing that upon a majority vote of the members of member-managed multi-member LLCs, the LLC must make an interim distribution to the members in the amount and at the time required by the vote.
11) Delegations by members and managers. Section 7,II(j) of the New Hampshire Act provides that the “LLC” may appoint “officers.” However, no provision of the act expressly provides that unless the LLC agreement provides otherwise, the members of member-managed LLCs and the managers of manager-managed LLCs may delegate their management rights to third parties. I propose that the Act be amended to include a permissive provision providing that members and managers may make these delegations upon the majority vote of the members.
12) Fuller articulation of charging order protections. Section 47 of the New Hampshire Act provides statutory charging order protections for LLCs and their members, and, read together with BayBank v. Catamount Construction, 1997 NH 36 (1997), the section is best construed as implying that these protections are the sole remedy for creditors of LLC member-debtors-in-default with respect to an LLC’s assets. However, because of the critical importance of Section 47 to many New Hampshire LLC members, I propose that Section 47 be amended to provide for the express and comprehensive protections provided, for example, in Section 18-703 of the Delaware Act.
13) Better articulation of member information rights. I propose that Section 28,I of the New Hampshire Act be amended to provide for clearer and more comprehensive rules such as those contained, for example, in Section 18-305(a) of the Delaware Act concerning the right of members as such to LLC information.
14) Electronic filing. I propose that the New Hampshire Act be amended to provide, like the Massachusetts LLC Act, for electronic filing of certificates of formation and other official filings.
15) Clarification of Section 17-a concerning statutory conversions of entities that own real property. Although, in my view, the only reasonable interpretation of Section 17-a of the New Hampshire Act is that statutory conversions to LLCs of non-LLC entities that own real property do not constitute transfers of that property for purposes of the New Hampshire Real Estate Transfer Tax, I propose that that section of the act be amended to make this clear intent of Section 17-a express.
16) Authorized third-party signers. I propose that the New Hampshire Act be amended to provide that lawyers and other authorized third parties be permitted to sign certificates of formation and other documents filed with the New Hampshire Secretary of State. See Section 2,VI(a) and (b) of the act (which, as presently drafted, permit only members and managers to sign these documents).
17) Remedy for oppression. In keeping with current trends in close corporation law, I propose that the New Hampshire Act be amended to provide a remedy for the oppression of minority members. A good model for such a remedy might be Re-ULLCA, Section 701(a)(5)(B).
18) Dissociation rules applicable to single-member LLCs whose members are individuals. I propose that the New Hampshire Act be amended to provide that single-member LLCs whose members are individuals not be subject to dissolution upon the death, incompetence or bankruptcy of their members or upon their members’ assigning their entire LLC interest.
19) Dissociation rules applicable to multi-member LLCs. I propose that default provisions be added to the New Hampshire Act to provide that if a member becomes incompetent or bankrupt or if there is a bankruptcy filing by or against the member, the other members will have an option to dissociate the member but that the dissociation will not be automatic.
20) Validity of verbal LLC agreements. I propose that the New Hampshire Act be amended to provide for the validity of verbal LLC agreements.
21) Certificate of formation. Article V of the Secretary of State’s form for certificates of formation requires persons forming LLCs to specify whether their LLCs will be member-managed or manager-managed. Since most non-lawyers don’t understand the difference between these two types of LLC statutory management structures, I propose that the New Hampshire Act be amended to require that this form briefly explain the distinction in plain English.
It is time to consider amending the New Hampshire Limited Liability Company Act to reflect New Hampshire’s experience with LLCs during the past 10 years and the best current thinking about LLC business organization law as expressed in Re-ULLCA and in the LLC acts of various other states. Since the vast majority of New Hampshire single-member and multi-member LLCs are formed without the assistance of lawyers and have no written LLC agreement, any drafting committee of New Hampshire lawyers formed to develop proposals for amendments to the New Hampshire Act should have as its primary objective amending the act to the extent necessary to provide appropriate LLC business organization law rules for these LLCs.
3 To illustrate: Statistics of the Corporate Division of the office of the New Hampshire Secretary of State show that in the first six months of 2007, 4,824 LLCs were formed under the New Hampshire Act, while only 777 business corporations were formed under the New Hampshire Business Corporation Act. According to the Corporate Division, there were, as of August 17, 2007, domestic corporations and 30,960 domestic LLCs in good standing under New Hampshire law.
4 As most readers will know, default LLC statutory provisions are those that, under the terms of the governing LLC act, may be validly altered by the members in their LLC agreement; mandatory provisions are those that the members may not alter; and permissive provisions are those that validate particular LLC arrangements—e.g., the use of boards and officers—but do not require these arrangements. Section 1,VI provides, in effect, that under the New Hampshire Act, only written LLC agreements are legally valid.
John Cunningham is the principal of the Law Offices of John M. Cunningham, PLLC, and is of counsel to the New Hampshire law firm of McLane, Graf, Raulerson & Middleton, Professional Association. He was one of the drafters of the New Hampshire Limited Liability Company Act in 1993 and of its 1997 amendments.