Bar News - December 17, 2010
Business Law: Which Has The Better LLC Act: Massachusetts or New Hampshire?
By: John Cunningham
Mrs. Able, a New Hampshire resident, and Mr. Baker, a resident of Massachusetts, are starting a business ("AB") which they’ll own jointly. AB’s office will be in New Hampshire, but half of its operations will occur in New Hampshire and half in Massachusetts. Your client, Able, asks you whether AB should be formed under the NH Limited Liability Company Act (the "New Hampshire Act") and registered as a "foreign" LLC under the Massachusetts LLC Act (the "Massachusetts Act")—or vice versa.
|Marilyn Billings McNamara
Regrettably, the only way for you to answer this question in a truly comprehensive manner is:
- To develop a complete knowledge of the relevant facts concerning AB’s business and Able’s and Baker’s respective interests as to its legal and tax structure—a potentially difficult and time-consuming task all by itself;
- To make a detailed comparison of, on the one hand, the impact on Able and Baker of the scores of potentially relevant definitional provisions, mandatory provisions, default provisions, self-enabling permissive provisions and non-self-enabling permissive provisions of the Massachusetts Act; and on the other, the impact on Able and Baker of the corresponding provisions of the New Hampshire Act;
- To compare the impact on Able and Baker of all relevant Massachusetts and New Hampshire case law; and
- To determine through these comparisons which of the two acts will be more favorable to Able on a net basis.
Needless to say, carrying out the above procedures will require you to spend long hours of meticulous legal analysis and will result in a legal fee that Able will very probably not want to pay.
Thus, in the real world of choosing between the Massachusetts and New Hampshire Acts for an LLC that, like AB, will have members from two different states and that will operate in both of these states, "everybody’s second choice is Delaware." The quoted formula is often the basis for such a choice even though, quite possibly, a careful review of the provisions of the Delaware Limited Liability Company Act would show that they substantially favor one party over the other. And the matter will be complicated by the fact that Delaware LLC fiduciary law, which may be critical in the choice, is largely determined by Delaware corporate and limited partnership case law – a body of case law on which many LLC lawyers lack expertise.
In short, choosing the Delaware Act for your client Able instead of the Massachusetts or New Hampshire Act will only evade the deeper substantive issues and may even subject Able to significant disadvantages.
But there are two potentially major factors in choosing between the Massachusetts and New Hampshire Acts that, quite by themselves, may resolve the choice to Able’s (and your) satisfaction:
Flexibility. First, if Able wants maximum flexibility in tailoring AB’s operating agreement to meet her needs and interests—including the flexibility to include provisions in that agreement that are one-sided in her favor and even, arguably, oppressive—AB should unquestionably be formed as a New Hampshire LLC. This is because New Hampshire Act § 78,II follows § 18-1101(b) of the Delaware Act in providing that the policy of the New Hampshire Act is to give "maximum effect to the principle of contractual freedom and to the enforceability of limited liability company agreements." The Massachusetts Act contains no such provision.
Moreover, the fact that the Massachusetts Act does mirror so many other provisions of the DLLC Act but does not contain a provision similar to § 18-1101(b) strongly suggests an intent on the part of the Massachusetts legislature to impose distinct restrictions on contractual freedom under that act. These may well include surprising fiduciary restrictions like those imposed on majority members of closely held Massachusetts corporations under the famous case of Donahue v. Rodd Electrotype, 328 N.E. 2d 505 (Mass. 1975).
Fiduciary duties. Second, if a primary concern of Able is to subject Baker to strict fiduciary duties and if you think Baker is unlikely to focus on these duties in negotiating the AB deal, the LLC should unquestionably be a Massachusetts LLC. This is because, although the Massachusetts LLC Act is entirely silent about member and manager fiduciary duties, the decision of the Massachusetts Supreme Judicial Court in Pointer v. Castellani, 918 N.E.2d 805 (Mass. 2009) imposes on LLC members and managers rigorous Meinhard-v.-Salmon default fiduciary rules. By contrast, the New Hampshire Act, while apparently providing for a more-or-less traditional duty of loyalty, imposes a mere "avoidance of gross negligence" standard of care. (See, e.g., § 31,V(a) of the New Hampshire Act.) This is not a minor point, since fiduciary matters are often neglected even in LLC operating agreements negotiated with the help of experienced LLC counsel; yet they can be critical in protecting LLC members from management misconduct.
So which LLC act should you pick for Able as the act under which AB will be formed—the New Hampshire Act, the Massachusetts Act, or the Delaware Act? If this question isn’t answered by the above freedom-of-contract or fiduciary criteria, there may be no easy answer.
John Cunningham is of counsel to McLane, Graf, Raulerson & Middleton. His practice is focused on LLC formations and business entity restructuring. He has authored many books and articles on LLC law and tax. Read his LLC blog.