Ohio’s Revised LLC Act – What You Need to Know
February 2, 2022
- On Friday, February 11, Ohio’s Revised LLC Act (in new Chapter 1706 of the Ohio Revised Code) takes effect, replacing the existing Ohio LLC Act in Chapter 1705 of the Ohio Revised Code, and will govern all existing and new Ohio LLCs.
- For most practical purposes, the changes in the Revised LLC Act are not going to significantly affect the operation or governance of most LLCs or impair their operating agreements.
- The Revised LLC Act is designed to enhance the enforceability of LLC Operating Agreements and allow them to override virtually all statutory default provisions, especially if in writing.
- While an operating agreement can be oral, we highly recommend that all operating agreements be in writing and signed by the members to avoid uncertainty and to provide clear evidence of the agreement among the members.
- While most well-written operating agreements will probably not need to be amended to fit within Chapter 1706, all operating agreements should be reviewed to make sure they are conforming to their current governance practices and are not in need of revisions to address the new aspects and flexibility of the Revised LLC Act.
On Friday, February 11, the Ohio Revised Limited Liability Company Act (the “Revised LLC Act”), set forth in new Chapter 1706 of the Ohio Revised Code (“Chapter 1706”), will become effective for all Ohio limited liability companies, including those formed prior to that effective date. The Revised LLC Act, which was adopted by the Ohio legislature and signed into law over a year ago, was originally supposed to go into effect at the beginning of this year, but the effective date was briefly delayed.
Why is Ohio revising its Limited Liability Company Act?
In 1994, Ohio adopted the Limited Liability Company Act (the “LLC Act”), set forth in Chapter 1705 of the Ohio Revised Code (“Chapter 1705”), which was the first Ohio statute to permit and authorize the formation of limited liability companies (“LLCs”). However, it was adopted in the early years of LLCs in the U.S. before there were any uniform or prototype acts and before state laws had evolved with respect to limited liability companies. Since then, LLCs have, by far, become the predominant form of entity in Ohio and nationwide. Until now, unlike many other states, Ohio had not significantly updated its LLC, other than a few assorted, and not necessarily consistent, amendments addressing specific topics.
As a result, the LLC Act is less flexible and a bit out of step with modern LLC statutes. In addition, it contains a number of potentially confusing or uncertain provisions, such as those resulting from a series of amendments relating to fiduciary duties, as well as ambiguities about the enforceability of certain provisions in operating agreements that seek to override sections in the LLC Act. Meanwhile, LLC statutes across the nation have undergone a process of modernization and uniformity in recent years, as LLCs have become the entity vehicle of choice for most businesses. The path chosen by Ohio was to enhance and modernize the law governing all Ohio LLCs through an entirely new chapter of the Ohio Revised Code, Chapter 1706, rather than to overhaul existing Chapter 1705. As a result, Ohio will join the growing number of states that have modernized, or are in the process of modernizing, their LLC statutes.
Is there a transition or phase-in period?
No, there is no transition or phase-in period for, and there is no option to either “opt-in” or “opt-out” of, the Revised LLC Act. This means that when Chapter 1706 becomes effective on February 11, 2022, it will become the law that governs all Ohio LLCs, whether formed before or after that date, and Chapter 1705 will be repealed and replaced.
How important are the changes in the Revised LLC Act?
While every change could be important depending on your circumstances, we expect that in most cases and for most practical purposes, the changes in the Revised LLC Act are not going to significantly affect the operation or governance of most LLCs or impair their operating agreements.
Three of the more significant changes, discussed briefly below, relate to (1) the clarification of the “default” nature of the Revised LLC Act and the enforceability of written operating agreements, (2) the simplification and flexibility of the management of and the fiduciary duties in LLCs, and (3) the creation of “series” LLCs in Ohio. Another change is that Chapter 1706 does not statutorily provide relief to dissenting members in certain mergers, consolidations and conversions, as Chapter 1705 did, although such relief could still be provided voluntarily in operating agreements. In addition, the detailed indemnification provisions set forth Chapter 1705, which were based on the corporate indemnification structure, have been eliminated in place of a single permissive sentence in Chapter 1706.
Fortunately, for the most part, Chapter 1706 retains the Ohio-specific terminology of Chapter 1705, including:
- “membership interests” (referred to in Delaware and some other states as limited liability company interests);
- “operating agreements” (rather than limited liability company agreements);
- “Articles of Organization” (rather than Articles or Certificate of Formation); and
- “statutory agent” (rather than resident agent or registered agent).
One notable change in terminology is the addition of the term “dissociation” in Chapter 1706, which is derived from Ohio’s partnership law and effectively (although with some differences) replaces the term “withdrawal” in Chapter 1705.
What do you mean by the “default” nature of the Ohio Revised LLC Act?
While corporations are, to a large extent, creatures of statutes, limited liability companies – at least those with well-written operating agreements – are primarily creatures of contract. This is why the governance structure of LLCs is so flexible. Any well-formed LLC will be governed almost entirely by a written operating agreement covering its management structure. We note that while an operating agreement can also be oral, we highly recommend that all operating agreements be put into writing and signed by the members to avoid uncertainty and to provide clear evidence of the agreement among the members. Only those governance aspects that are not addressed in the written operating agreement, or those few governance provisions that the Revised LLC Act does not permit to be modified by a written operating agreement, will apply to an LLC with a written operating agreement. The more thorough the written operating agreement is, the less the LLC statute will apply to the limited liability company. There are some portions of Chapter 1706 that can only be varied in a written operating agreement and not an oral operating agreement, including certain aspects of fiduciary duties.
Specifically, the way Chapter 1706 will work – with greater clarity and certainty than the way Chapter 1705 has worked -- is that (with a few exceptions) only those sections of the Revised LLC Act that are not addressed and overridden in the written operating agreement will apply to an Ohio LLC. In other words, the Revised LLC Act serves as a “default” operating agreement – if you fail to have an operating agreement, the Revised LLC Act is there to act as your operating agreement. Even if you have an operating agreement, the provisions in the Revised LLC Act that are not overridden in your operating agreement will – by default – apply to your LLC. So the more thorough the written operating agreement, the less those default sections of the Revised LLC Act will apply. There are even more sections of the Revised LLC Act that cannot be modified in an oral operating agreement, which is yet another reason what we highly recommend all operating agreements be put in writing.
However, there are a few sections of the Revised LLC Act that cannot be modified and overridden even by a written operating agreement, but instead will apply to all Ohio LLCs irrespective of what their operating agreements provide. These mandatory provisions include the following:
- neither the covenant of good faith and fair dealing by members and managers, nor their liability for bad faith violations thereof, can be eliminated;
- the nature of the LLC as a separate legal entity cannot be varied;
- certain rights of a person other than a member, dissociated member, or assignee cannot be restricted;
- the power of a court regarding mandatory LLC filings cannot be varied; and
- the requirement that a promise of a member to make a capital contribution can only be enforced if it is in a writing signed by the member cannot be waived.
In this respect, Chapter 1706 does a much better job in distinguishing between its default provisions that an operating agreement can override, and its mandatory provisions that an operating agreement cannot override or waive. In addition, it clarifies that it is to “be construed to give maximum effect to the principles of freedom of contract and to the enforceability of operating agreements.”
Chapter 1705 had created some confusion and uncertainty in terms of which of its sections could be overridden and waived, and which sections could not. While one section of Chapter 1705 states that only certain enumerated items cannot be modified by an operating agreement (ORC Section 1705.081), it also – seemingly randomly and inconsistently -- includes words in some sections of Chapter 1705 (and not other sections) to the effect that those sections apply “unless otherwise provided in the operating agreement,” creating uncertainty regarding whether those sections that do not contain those magic “unless otherwise provided” words can still be overridden by an operating agreement. This uncertainty is most likely the result of the lack of initial uniformity of Chapter 1705 as adopted and the subsequent patchwork quilt of amendments over time, creating unnecessary and unintended confusion due to the inconsistency.
Chapter 1706 cleans this up and provides certainty and clarity by stating in Section 1706.06 that only certain enumerated provisions (those discussed above) cannot be modified in an operating agreement and then never addressing the topic again, so there is no inconsistent use of the unnecessary phrase “except as otherwise provided in an operating agreement”.
How are management rights and fiduciary duties changed in the Revised LLC Act?
One of the major areas of change in Chapter 1706 is the clarity it brings to the concepts of management rights and authority, and fiduciary duties of the members and managers of the LLC. Members of Ohio LLCs now have the flexibility to adopt virtually any management structure and to modify or eliminate the “default” fiduciary duties in a written operating agreement.
In Chapter 1705, the authority and the duties of members and managers depended on which of two – and only two – management frameworks governed the LLC: either member-managed or manager-managed.
Under Chapter 1706, those two strict management frameworks are gone and replaced by a default statutory framework that provides that the members have all the authority to manage the LLC and are subject to fiduciary duties of care and loyalty. In other words, if there is no operating agreement or the operating agreement does not state otherwise, the LLC is treated as member-managed. However, an operating agreement can modify that management structure virtually any way desired, with management by managers under a traditional LLC manager-managed model, or a corporate board of directors style, or a general partnership style or any other creative way desired, as long as it is clearly set forth in the operating agreement. This is accomplished, in part, by the expansive definition of “manager” to include not only persons designated as “managers,” but also any other persons with the authority to manage all or part of the activities or affairs of the LLC, whether designated as managers, officers, directors, managing-members, or otherwise. But the managers will only have that authority provided to them in the operating agreement, because Chapter 1706 (unlike Chapter 1705) does not provide any default management authority to managers. So in the operating agreement, it is not enough to just provide for the existence and designation of managers (as it was under Chapter 1705); rather, the power and authority of managers (regardless of title or designation) must be specified in the operating agreement.
If managers are designated, then the members no longer have any fiduciary duties but only have an implied covenant of good faith and fair dealing, unless the written operating agreement provides for fiduciary duties for members. Also, if managers are designated, then the managers have default fiduciary duties of loyalty and care, as well as the implied covenant of good faith and fair dealing. The fiduciary duties of managers can be waived or even eliminated, but only in a written operating agreement. However, whether or not there are managers, an operating agreement – even in writing – cannot limit or eliminate liability for any act or omission that constitutes a bad faith violation of the implied covenant of good faith and fair dealing.
Here is another area where oral operating agreements (even if provable) are far more limited than written operating agreements. Under Chapter 1706, fiduciary duties can only be modified or eliminated in a written operating agreement.
Thus, under the Revised LLC Act, a written operating agreement can provide for a much more flexible management structure that matches the business needs of the members, and can modify or even eliminate the duty of care and the duty of loyalty for members and/or any managers. The only restriction on written operating agreements is that the implied covenant of good faith and fair dealing by members and any managers cannot be eliminated. In addition, in order to modify or eliminate any of these fiduciary duties, the operating agreement must be in writing.
Is there a benefit to the new “Series LLC” provision?
With the Revised LLC Act, Ohio will join the growing – but still minority – number of states that authorize “series” LLCs. Series LLCs are complicated and rarely used vehicles except in certain businesses, such as investment companies and other financial industry organizations. A series LLC is an LLC with one or more separate and distinct series of assets and liabilities under the same parent (or umbrella) LLC, in a manner somewhat analogous to a parent/subsidiary structure in corporations, but within the same entity rather than as separate entities. The reason this is becoming more common is the desire to separate assets and liabilities within the same entity to provide asset protection, while at the same time reducing the administrative burden by doing so within a single LLC (rather than through a holding company with subsidiaries involving multiple LLCs). If properly structured, the debts, obligations and liabilities of each particular series are enforceable only against the assets of that series, and not against the assets of any other series or of the LLC.
There are several requirements in order to create a series LLC under the Revised LLC Act:
- The Articles of Organization must contain a statement that the LLC may have one or more series of assets.
- There must be at least one member (i.e., equity owner) associated with each series.
- Each series must maintain separate records for its assets.
Once properly formed, each series of the LLC can have its own members and managers, hold its own assets, have its own liabilities, enter into its own contracts and carry on its own business activities, separate from the assets, liabilities, contracts and business activities of any other series of the LLC or from the LLC itself. However, for most businesses, there is no clear benefit over--but greater uncertainty than--simply carrying on the same conduct in a parent/subsidiary structure, and the relative administrative burden of multiple LLCs is inconsequential for most businesses. Moreover, while the series LLC trend is clearly growing in the U.S., series LLCs are not authorized in most states and there is no certainty that the separateness of their assets and liabilities would be respected in those states that have not adopted, or like Ohio have only recently adopted, legislation enabling series LLCs.
What should I do now?
For most LLCs with written operating agreements, few if any changes may be required to those operating agreements when the Revised LLC Act becomes effective, especially if the governance structure and duties of members and, if applicable managers, are clear and well thought out and not dependent upon the default framework of Chapter 1705. However, we do recommend that all LLCs review their operating agreements to make sure they are conforming to current LLC practices and procedures and not in need of revisions to address the new aspects and flexibility of the Revised LLC Act. The flexibility of governance structures and the ease of modifying member and manager fiduciary duties is worth revisiting, especially for operating agreements that are either older or do not comprehensively address those topics.
If your operating agreement left many governance or fiduciary duty aspects to the default provisions of Chapter 1705, you will likely want to re-evaluate those same topics under Chapter 1706. In addition, some operating agreements contain not only general references to Chapter 1705, but specific references to sections within Chapter 1705 that will no longer apply. For example, an operating agreement might incorporate specific sections of Chapter 1705 with respect to matters such as dissenting members’ rights, indemnification, or events of withdrawal, but since those matters are not carried forward in Chapter 1706 (or not carried forward the same way), the operating agreement may need to be amended to effect the original intent of the members with respect to those issues.
Finally, if you have never adopted a written operating agreement, but are instead relying on the default provisions of Chapter 1705 or some oral operating agreement created by the practices, understandings and arrangements with your fellow members and/or managers, now would be a good time to put those oral understandings into a signed, written operating agreement that fits within the flexible framework of the Revised LLC Act.