California's New LLC Law

October 10, 2012

On September 21, 2012, Senate Bill 323 was signed into law by Governor Jerry Brown. Sponsored by Senator Juan Vargas, the bill will be designated as the California Revised Uniform Limited Liability Company Act (RULLCA). On January 1, 2014, it is slated to replace the Beverly-Killea Limited Liability Company Act, which was signed into law in 1994. California joins a growing minority of states that have rewritten their limited liability company laws in recent years, and now California business lawyers are left to decipher how the new laws will affect small business owners and entrepreneurs who wish to incorporate their small businesses as limited liability companies.

Some people that have studied the new law worry that it may open the door to a number of constitutional challenges. Portions of the law are written so as to be made retroactive to limited liability companies that were organized under the existing laws. The United States Constitution states at Article 1, Section 10, Clause 1:

"No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility."

This "Contract Clause" is at odds with RULLCA because RULLCA appears to be establishing an ex post facto law – one that changes the legal consequences of an action once the action has already been taken. In other words, the argument is that the owners of a limited liability company could not have predicted this change in the law, and may not have chosen to organize in quite the same manner if they knew that a new set of laws would govern the way their business was treated. There is also a compelling argument that the new RULLCA could constitute a "law impairing the obligation of contracts." California businesses routinely enter into contracts with customers and other business entities with the understanding that their contract will be honored under a certain set of laws. If the law were to suddenly change, it may have a dramatic effect on how existing contracts might be enforced.

Another troubling feature of the new RULLCA is some uncertainty regarding the law of LLC operating agreements. If the RULLCA is slated to become the law of the land on January 1, 2014, and if a particular LLC was incorporated prior to that date, which set of laws govern any amendments that are made to the operating agreement? Even worse, might the original parts of the operating agreement be governed by Beverely-Killea while the amendments are governed by RULLCA? Might a business owner refrain from making a beneficial amendment to their operating agreement based on the fear and uncertainty of the new law?

These questions, and others, will be hashed out in the next couple of years. Rest assured that you can rely on your California small business attorney to keep abreast of any developments and new interpretations in the new RULLCA so that you can run your business entity in the way you intended.