Ward on Iowa Limited Liability Company Law

Does 489 or 490A Apply to Foreign LLCs?

If you read the transition provisions of Iowa Code 489.1304 regarding the move from 490A (it still applies to LLCs formed before January 1, 2009 until January 1, 2011) to 489 you will not see the word "foreign." 

So let's say you have a client that is a foreign LLC.  It was formed in its home state several years ago and wants to come into the state for the first time.  It asks if it is required to register to do business in this state. 

Do you consult 490A or 489?  It matters because the rules for registering foreign LLCs are different under the two statutes.  For example, owning real property "without more" does not require registration under 490A but owning "income-producing" real property does under 489.

Iowa Code 489.1304 is of no help on its face, but I think it is reasonable to conclude that foreign LLCs coming into this state for the first time in 2009 and 2010 should be treated like newly formed domestic LLCs and 489 should apply.  Foreign LLCs that were in the state before 2009 should be able to continue to rely on 490A until January 1, 2011. 

Of course on January 1, 2011, 490A disappears and a lot of foreign LLCs will be required to register with the state.  An obligation that will probably be honored in the breach.

-Marc Ward

Errant Section of Chapter 489 to be Deleted

Section 489.407(2)(f) of the new Iowa LLC Act will be stricken from the law by the Legislature this session.  This section was added by the Iowa LLC Committee in an attempt to cover what was perceived to be a gap in the uniform law dealing with those events that required the unanimous consent of the members to undertake (unless, of course, the operating agreement provided otherwise).

We had added (f) as a new provision that read as follows "Approve a merger, conversion, or domestication under article 10."

Upon reflection it was concluded that Article 10 and 407(2)(d) adequately addressed this matter and we had forgotten to state the approval required in any event.  Our bad.

-Marc Ward

So, What Do You Think of the New Iowa LLC Law?

It's been four weeks since Iowa Code Chapter 489 went into effect.  Over 300 LLCs have been formed under the new law.  What are your thoughts about the new law now that you have had a chance to work with it?

This isn't just an idle question put forth by a blogger reaching for something to write about.  The Iowa Bar Association's LLC Committee is meeting next Tuesday to discuss issues that have come up since the beginning of the year.  A representative of the Iowa Secretary of State's office will also be at the meeting.

Currently on our agenda are two items:  (1) Section 202 regarding the certificates of organization and related issues with respect to the registered agent and (2) statements of authority under Section 489.304.

As chair of the committee, I would really like to hear your thoughts on the use of statements of authority.  It appears that the real estate bar is struggling with this concept and there is a lot of poor statutory interpretation contributing to the problem.  One solution to the issue is the adoption of an ultra vires provision like the one found in the Iowa Business Corporation Act.  What do you think?

-Marc Ward

Selling Real Estate Under the New Iowa LLC Act

A concern was posted today on the Iowa Bar's Real Estate Law list serve regarding whether the consent of all the members of an LLC is required under Chapter 489 in order to sell real estate owned by a manager-managed LLC.  First of all, the author of the post cites a section of Chapter 489 dealing with the sale of all or substantially all of the assets of an LLC outside the ordinary course of business.  Second, the answer is the operating agreement will control.

Remember from past posts that Chapter 489 is a default statute.  With certain exceptions (enumerated in Section 489.110(3)) the operating agreement controls (1) the relationship among the members and between the members and the LLC, (2) the rights and duties of the managers, and (3) the conduct of the activities of the LLC.  SeeIowa Code Section 489.110(1)(2009). Thus, the terms of the operating agreement will dictate the approval necessary.  Most likely in manager-managed LLCs the managers will have the authority to sell real estate in the ordinary course of business and some level of approval will be required for sales of all of the assets outside the ordinary course.

The author raises a second issue with respect to Statements of Authority and whether the reference to recording a "certified copy" of the statement in the county recorder's office means a copy certified by the Iowa Secretary of State.  The answer is YES.  Section 489.302(6) is derived from Section 303 of the Revised Uniform Partnership Act.  While the Official Comments to the Revised Uniform Limited Liability Company Act are silent on this issue the Official Comment on Section 303 of RUPA states that "the statement recorded with the land records must be a certified copy of the original statement filed with the Secretary of State."  To me, this means certified by the Iowa Secretary of State.

-Marc Ward

Ambiguity in the Iowa Certificate of Organization

An issue has come up on the first LLC to be organized under Iowa Code Section 489.  The first filing of a certificate of organization under Iowa's new LLC Act was rejected by the Secretary of State.  Like me, the Secretary of State interprets 489.201 to require, although not very artfully, only the name of the LLC and the name and address of its registered agent.  However, another permissible interpretation is that two addresses are required; the registered office of the LLC and the address of the registered agent. 

 

The first interpretation is based on (1) the use of the word "registered" to refer to the office and the agent and (2) the desire to simplify the certificate and make it merely a notice filing as distinguished from articles which imply a grant of authority from the state.

 

The second interpretation is based on a close reading of Section 489.113 and the definitions of "principal office" and "registered office" at 489.102(18) and (20), respectively. It is also supported, arguably, by the language of the Uniform Act which refers to designated offices instead of registered offices. I don't think that this is what the Iowa committee intended when it changed designated to registered.  My recollection is that we interpreted a designated office to be the same as a registered office and made the change to be consistent with other business statues in Iowa.  Also, the use of the plural for address in 489.201 adds more confusion.  I assume that means the street and mailing addresses may not be the same, but I suppose others could read it differently.

 

The bottom line is this:  I believe all the certificate need contain is the name of the LLC and the name and address (street and mailing, if different) of the registered agent.

Does anyone disagree?

Here are the relevant statutory provisions

489.102(18). "Principal office" means the principal executive office of a limited liability company or foreign limited liability company, whether or not the office is located in this state.

489.102(20). "Registered office" means any of the following:

a. The office that a limited liability company is required to designate and maintain under section 489.113.

b. The principal office of a foreign limited liability company.

489.113(1). A limited liability company shall designate and continuously maintain in this state all of the following:

a. A registered office, which need not be a place of its activity in this state.

b. A registered agent for service of process.

489.201(2). A certificate of organization must state all of the following:

a. The name of the limited liability company, which must comply with section 489.108.

b. The street and mailing addresses of the initial registered office and the name and street and mailing addresses of the initial registered agent for service of process of the company.

Yes, You Can Eliminate/Alter Fiduciary Duties of Officers

As you had better know in 8 days, Iowa Code Section 489.110(4) permits an operating agreement, so long as it is not manifestly unreasonable, to restrict or eliminate the duty of loyalty and "alter" the duty of care or any other fiduciary duty.  "Alter" means to make different, to change or modify, but implicitly not to eliminate.  Section 489.110(7) permits an operating agreement to eliminate a manager's liability to the LLC and the members for a breach of the duty of care (with certain exceptions).

The Delaware LLC law (18-1101(e)), similarly, also permits an operating agreement to eliminate any and all liability for a breach of any  fiduciary duty of a member, manager or other person.

This provision was put to the test recently in In re Heritage Organization, L.L.C., 2008 Bankr. LEXIS 3230 (N.D. Tex December 12, 2008).  The bankruptcy trustee attempted to hold two officers of the debtor liable for breach of their fiduciary duties to the company.  However, taking its cue from 18-1101(e), the Delaware LLC's operating agreement contained a shield from liability for its manager which said "The Manager shall not be required to exercise any particular standard of care, nor shall he owe any fiduciary duties to the Company or the other Members."  Several fiduciary duties were identified in a non-exhaustive list including the duty of care and the duty of loyalty.

The officers argued that because they acted as agents of the Manager (a corporation), the exculpatory language applied to them.  The trustee, naturally, argued that the exculpatory clause only applied to the manager, not the officers.  The court noted that it found the officers' agency theory "unpersuasive at this juncture" because from the record it was not clear if the individuals acted as agents of the manager "and thus protected pursuant to the terms of the exculpation clause itself" or as officers.

The court then went on to exam the operating agreement in terms of the duties owed by officers of the LLC.   The operating agreement permitted the Manager to appoint a president, one or more vice presidents, etc., and such "officers shall have such authority and perform such duties" as provided in the operating agreement.  Later, the operating agreement described the president to be "subject to the same duties and powers granted to the Manager."  The manager was also empowered to delegate any duties or powers upon such terms as may be designated in a written instrument."

As the court saw it, any duties imposed on the officers had to pass down from the manager.  Because there was no evidence that the manager had granted, prescribed or delegated any duties to the officers, the court was left with the provisions of the operating agreement.  The court concluded that the Heritage operating agreement "clearly contemplates that Heritage officers only owed those duties to Heritage that were either delegated or prescribed by Heritage's Manager or president."  Since no such delegation existed, there was no duty to breach.

It is also important to point out that the court dismissed the trustee's argument that there were common law fiduciary duties owed by the officers.  As "a creature of contract" the court noted, the operating agreement was controlling.

The lesson here is to consider officers when contemplating whether or not to impose fiduciary duties, including liability for breach, on the management of LLCs.

-Marc Ward

Information Rights Under the New Iowa LLC Law

Under Iowa Code 490A.709 the information obligation of Iowa LLCs and the rights to information of its members is straightforward and not unlike the corporate provisions (although probably honored in the breach).  That is about to change.

Pursuant to Iowa Code 489.410 there will no longer be any requirement to maintain any certain information at the principal offices of an LLC, but it is still a good idea to do so.

The bigger change, however, is the obligation, nay, the burden placed on LLCs.  The new law provides that "the company shall furnish to each member...without demand, any information concerning the company's activities, financial condition, and other circumstances which the company knows and is material to the proper exercise of the member's rights and duties under the operating agreement or this chapter."

In a manager-managed LLC the obligation is imposed on the managers. 

To put it differently, LLCs will have an affirmative duty to disclose all known information material to the member as a member. 

Of course, this duty is probably always present when an entity communicates with its owners.  The bigger question may be about the timing.  Is the duty applicable only when an LLC communicates with its member, only when it asks the members to vote or otherwise take some action, or must an LLC communicate with its members each time it becomes aware of a material piece of information? 

Section 489.110 permits LLCs to "reasonably restrict" information rights. It might make sense to restrict this duty of disclosure to those times when an LLC communicates with its members.

Members also have rights to seek information from the LLC subject to standards of reasonableness.

-Marc Ward

The Unwritten Written Operating Agreement

There will be many opportunities to screw up when the new Iowa LLC Act takes effect on January 1, 2009.  While existing LLCs can wait until 2011 to worry about it, your 2008 forms may need sprucing up before you start drafting agreements for new LLCs. (I know readers of this blog write all their documents from a blank slate, but some lawyers are known to use versions of previous agreements when writing new ones -- this post is for them.) Here is one example.

Under current law operating agreements must be in writing (unless the articles permit otherwise) which implies that all amendments must be in writing.  The new Iowa LLC Act will allow operating agreements to be oral in all cases.  It will also, and this is the rub, allow written operating agreements to be amended orally unless the operating agreement limits amendments to those in writing.  There is also the possibility of an implied amendment based on conduct.

Now, it is common for most written agreements to provide that all amendments must be in writing signed by all parties.  But you better make sure beginning in 2009.  And what about your clients who wrote their own operating agreements?

-Marc Ward

Economic Rights versus Governance Rights - A Refresher

Many people, including judges and the IRS, continue to confuse limited liability companies with corporations.  They are not interchangeable entities.  One of the most important differences is with respect to the ownership interests of the two companies.

In your typical corporation with one class of stock your economic interests and your voting interests are in direct proportion to the number of shares you own compared to the total number of shares owned by all shareholders.  That may be true in an LLC as well, but it does not have to be.  In fact the default rule under the new Iowa LLC Act is one member-one vote.

More importantly, assuming there is not a buy-sell restriction on your stock, when you sell the stock the voting rights go with it.  This is not the case in an LLC.  Your buyer will only obtain the economic interest; the governance rights can only transfer to the buyer with the unanimous consent of the other members (unless your operating agreement provides otherwise).

The point is this:  The economic rights and the governance rights in an LLC, unlike a corporation, are separate rights, unless otherwise provided in the operating agreement.

-Marc Ward

David Walker's Presentation Outline to the Iowa State Bar Association

Dean David Walker and I made a joint presentation at the Iowa State Bar Association's 135th Annual Meeting on Wednesday regarding the new Iowa LLC Act.  My presentation outline was posted here that afternoon.

David has graciously given me permission to also post his outline.  You can find it here.

-Marc Ward

Existing LLCs under the New Iowa LLC Law

At yesterday's session on the new Iowa LLC Act, Dean Walker and I were asked what lawyers should do about existing LLCs and operating agreements.  A great question.  You need do nothing until January 1, 2011 when the current law expires.  The current articles of organization will be deemed to be the certificate of organization under 489.  Any management provision in the articles of organization will be deemed to be contained in the operating agreement.  See generally, Iowa Code 489.1304 (2009).

If you want to get a jump on 2011 or consider opting-in to Chapter 489 before 2011, consider performing an operating agreement audit of the following subjects:

1.  If the LLC is manager-managed, does it expressly provide that it is "manager-managed," "managed by managers," management is "vested in managers" or words "of similar import" as required by Iowa Code 489.407(1)?

2.  Should the operating agreement restrict, eliminate or alter the duties of loyalty and care or any other fiduciary duties as permitted by Iowa Code 489.409(4)-(7)(2009)?

3.  Are the manager-managed rules described in Iowa Code 489.407(3) regarding management rights and decision-making adequately addressed?

4.  Because transferees of transferable interests have few rights under the default provisions of the new law, are they adequately protected in the operating agreement?  See Article 5 of Chapter 489.

5.  Dissociation is a new concept introduced in Chapter 489, although the Chapter 490A concepts of withdrawal, termination and cessation of membership (see in particular 490A.712) are similar.  How is dissociation dealt with in the operating agreement?  Are there any gaps that need to be addressed?

Of course, general rules may not cover the terms of a particular operating agreement, but these 5 points are a good start.

If you wish to adopt Iowa Code 489 before 2011, the new law permits it.  Iowa Code 489.1304(1)(b) allows an LLC formed before January 1, 2009 to elect to be subject to 489 by amending its operating agreement to that effect.

-Marc Ward 

Presentation Outline to the Annual Meeting of the Iowa State Bar Association

This afternoon David Walker and I had the honor and the pleasure of presenting the new Iowa LLC Act at the 135th Annual Meeting of the Iowa State Bar Association. 

As many of you know, David recently retired as Dean of the Drake Law School.  He also chaired the NCCUSL Drafting Committee that created the Revised Uniform Limited Liability Company Act which forms the basis of the new Iowa statute.

In my half of the presentation I discussed (a) Formation (b) Shelf LLCs (c) Series LLCs (d) Dissociation (e) Transferees and (f) Piercing the Veil.

You can obtain a copy of my outline here. 

-Marc Ward

The Case of the Naked Transferee

Without careful drafting in the operating agreement, a transferee of a transferable interest in an Iowa LLC can be an uncomfortable and unsatisfactory status.

Understanding the terminology is important before getting to the specifics.  Under the new Iowa LLC law (Iowa Code §489.102(24) and (25) (2009)):

A.        “Transferable interest” means the right, as originally associated with a person’s capacity as a member, to receive distributions from a limited liability company in accordance with the operating agreement, whether or not the person remains a member or continues to own any part of the right.

B.         “Transferee” means a person to which all or part of a transferable interest has been transferred, whether or not the transferor is a member.

Transfers of transferable interests are permissible and do not by themselves cause a member to dissociate or the LLC to dissolve. Iowa Code §489.502(1) (2009).  And herein lies the problem. When a member transfers a transferable interest, the transferor retains the rights of a member other than the interest in distributions transferred and retains all duties and obligations of a member. Iowa Code §489.502(7) (2009). 

The member can only lose this right if (a) she transfers her entire transferable interest and (b) the other members expel her by unanimous vote.

Transferees of a transferable interest who do not become members have few rights other than to receive distributions:

1.      They have no role in the management of the LLC;
2.      They have no right to information under 489.410; and
3.      They have no right to bring a derivative action.

One right granted to transferees in the Iowa Act not found in the RULLCA is the right of a transferee to seek judicial dissolution if the managers or those members in control of the LLC have acted illegally, fraudulently or oppressively.  See Iowa Code 489.701(1).  Throw the dog a bone.

Because there are a lot of ways a member or his successors in interest can become transferees and many are inadvertent (e.g. death), it is imperative that the issue be addressed in the operating agreement.  Some sort of buy-back clause or other buy-sell provision should be considered by the members and included in the operating agreement.

If a buy-back or buy-sell provision was overlooked, to avoid mere transferee status, it might behoove a transferee who does not expect to become a member to have the transferring member keep a fraction of the transferable interest and agree to exercise its governance rights in a manner that protects the transferee.

-Marc Ward

Member Approval of Mergers Under the New Iowa LLC Law

A merger of an LLC requires the unanimous consent of the members of an LLC under the new Iowa LLC Act, but the operating agreement may provide otherwise.  It will not be unusual for operating agreements to provide for less than unanimous approval of mergers, but what will the minority members expect in return for giving up their right to approve a merger?

If the history of corporations is any indication, appraisal rights will be the protection sought by minority members.  As many of you know, corporate law use to require unanimous shareholder approval of mergers.  The modern trend, adopted by Iowa and most other states, allows mergers to be approved by a majority of the shareholders but also allows shareholders who dissent to the proposal to assert appraisal rights as the "exclusive remedy" if they believe they are not receiving fair value for their shares.

That sounds reasonable enough, but be careful when drafting such a provision for your operating agreements.  It will be important to make it clear that appraisal is truly the exclusive remedy for dissenting members.  Several courts have interpreted the "exclusive remedy" or similar language in the corporate statutes not to be exclusive when the majority shareholders are using the merger process to eliminate minority shareholders.  See McMinn v. MBF Operating Acquisition Corporation, 164 P. 3d 41 (New Mexico 2007).  These courts have allowed claims for breach of fiduciary duty to survive in such circumstances.

-Marc Ward

Operating Agreement Do's and Don'ts

As explained in an earlier post, the operating agreement (if there is one, be it oral, written or implied) dictates the relationship among members and the rights and duties of the managers.  The new Iowa LLC Act only matters when the operating agreement is silent (or non-existent).  But  of course, there are exceptions.

An operating agreement may not:

1. Vary an LLC's capacity to sue;

2. Vary the applicability of Iowa law regarding (a) internal affairs of the LLC and (b) the liability of members and managers for the debts, obligations and other liabilities of the LLC;

3. Vary the power of a court to require a person to sign a record, deliver a record to the Secretary of State or order the Secretary of State to file a record;

4. Unreasonably restrict the duties and rights with regard to providing information about the LLC to the members, managers and dissociated members;

5. Vary the power of a court to dissolve an LLC unlawful, fraudulent or other extraordinary misconduct;

6. Vary the ability to wind up the affairs of a dissolved LLC;

7. Unreasonably restrict the right of a member to maintain a derivative action;

8. Restrict the right to approve a merger, etc. by a member who will have personal liability as a result of such fundamental change; and

9. Restrict the rights of a person other than a member or manager with one minor exception.

The duty of loyalty may be restricted or eliminated, the duty of care can be altered (except authorization of intentional misconduct and knowing violations of the law), as can all other fiduciary duties so long as such restrictions or eliminations are not manifestly unreasonable.

The operating agreement can also prescribe standards to measure the contractual obligation of good faith and fair dealing.

The operating agreement may also establish a process by which an act or transaction that would otherwise violate the duty of loyalty may be authorized or ratified by one or more disinterested and independent persons after full disclosure.

Finally, the operating agreement (not the certificate of organization) may eliminate or limit a member or manager's liability to the LLC for money damages except for (a) breach of the duty of loyalty, (b) a financial benefit to a member or manager to which the member or manager is not entitled, (c) receipt of an improper distribution, (d) intentional infliction of harm to the LLC or a member,and (e) an intentional violation of law.

See Iowa Code 489.110 (2009).

-Marc Ward

Dissociation of a Member from an LLC

Dissociation is the withdrawal of a member from an LLC.  It can be either voluntary or involuntary.  The operating agreement can vary or eliminate the manner in which a member can dissociate.  See generally, Iowa Code 489.110 (2009).  What the operating agreement cannot do is eliminate the power of a member to dissociate, rightfully or wrongfully.  Iowa Code 489.601(1)(2009).

The Act lists 14 events that trigger dissociation of a person as a member of the LLC.  See 489.602(2009).  Rather than repeat the law, in summary, a person is dissociated from the LLC (1) by express will to withdraw, (2) an event stated in the operating agreement occurs, (3) the person is expelled pursuant to the terms of the operating agreement, (4) the person is expelled by the unanimous consent of the other members because (a) the LLC cannot lawfully carry on its business with the person as a member or (b) the person transferred all of the person's transferable interest (other than for security purposes or due to a charging order), or (c) the person is a dissolved corporation, LLC or partnership, (5) the status of the person materially changes or its transferable interest is distributed.  Please see 489.602 for the complete, complex list.

A member's dissociation is wrongful if (1) it is in breach of an express provision of the operating agreement or (2) it occurs prior to termination of the LLC and is due to withdrawal by express will, expulsion by judicial order, the member in a member-manager LLC becomes a debtor in bankruptcy or willful dissolution or termination of the member other than a trust or estate.

When a person is dissociated as a member the person no longer has the right to participate in management of the LLC, if the LLC is member-manager the person's fiduciary duties as a member end going forward, and, with a couple of exceptions, the person becomes a transferee.

As will be seen in a future post, transferees who do not become members have few rights other than to receive distributions.  They have no role in the management of the LLC, no right to information under 489.410, and no right to bring a derivative action.  One right granted to transferees in the Iowa Act not found in the RULLCA is the right of a transferee to seek judicial dissolution if the managers or those members in control of the LLC have acted illegally, fraudulently or oppressively.  See Iowa Code 489.701(1).

To avoid being a mere transferee, it might behoove a transferee who does not expect to become a member to have the transferring member keep 1% of the transferable interest and then exercise its governance rights in a manner that protects the transferee.

The Iowa Act diverges from the RULLCA by adding 489.604.  This section permits dissociation by a member (if the operating agreement does not cover the topic or waive applicability of 489.604) if an amendment to the certificate of organization or operating agreement adversely affects the member's transferable interest any of six ways described in 489.604 (e.g. alters or abolishes right to distributions, right to vote, etc.)

-Marc Ward

Charging Orders and the New Iowa LLC Law

The charging order originates from the English Partnership Act of 1890 and the Uniform Partnership Act of 1914.  It exists in the current Iowa LLC Act (490A.904), but the new Iowa LLC Act provides more clarity and understanding to the concept.  The most important thing to know about charging orders is that they are "the exclusive remedy by which a person seeking to enforce a judgment against a member or transferee may, in the capacity of judgment creditor, satisfy the judgment from the judgment debtor’s transferable interest."  Iowa Code Section 489.503 (2009).  (There are cases to the contrary on this point.)

The point of the charging order is to allow creditors a means to satisfy judgments (through distributions from the LLC) while protecting the LLC and the other members from having an unwanted third-party participate in the management of the LLC.

Under the new Iowa LLC law, a charging order is entered by a judge and represents a lien on a judgment debtor’s transferable interest (better, if inaccurately, known as the LLC membership interest).  It requires the LLC to pay over to the judgment creditor any distribution that would otherwise be paid to the judgment debtor. 

If necessary a court can appoint a receiver to collect the distributions.  If the distributions will not satisfy the judgment within "a reasonable time" a court can foreclose the lien and order the sale of the transferable interest.  A purchaser only obtains the transferable interest and does not become a member (i.e. has not voting or other management rights).  The court also has the authority to issue orders to the extent necessary to collect the distributions.

Satisfaction of the judgment by the debtor prior to foreclosure extinguishes the charging order.  The other members and the LLC also have the right to satisfy the judgment and step into the shoes of the judgment creditor and receive the distributions; the charging order is not extinguished in this case.

-Marc Ward

          

Fiduciary Duties are Negotiable Under the New Iowa LLC Law

The new Iowa LLC Act implements new provisions regarding operating agreements, including modified rules for defining, limiting, and sometimes eliminating elements of fiduciary duties.  The Act parallels the Revised Uniform Limited Liability Company Act (“RULLCA”) to establish a “not manifestly unreasonable” standard for the modification of fiduciary duties.  Unlike other statutes using the term, however, the LLC Act purports to provide direction to courts applying the standard via section 489.110(8), which – in determining whether a modification is manifestly unreasonable – requires the court to make its determination as of the time the challenged term became part of the operating agreement and to consider only circumstances existing at that time.  It further provides that a term may be invalidated only if, in light of the purposes and activities of the LLC, it is readily apparent the objective of the term is unreasonable, or the term is an unreasonable means to achieve the provision’s objective.

Despite the attempted clarification of the standard, the new Act's approach leaves open for debate the extent to which courts will actually allow operating agreements to redefine the scope of fiduciary duties because the "not manifestly unreasonable" standard has yet to be clearly defined.

The "not manifestly unreasonable standard"  first appeared in business statutes when the Revised Uniform Partnership Act (RUPA) borrowed the concept from the UCC.  The phrase appears in various code provisions and is mentioned in various cases, but as one author has noted, although "numerous cases apply the concept, they rarely explain why a provision is found manifestly unreasonable." (Mark J. Loewenstein, Fiduciary Duties and Unincorporated Business Entities: In Defense of the "Manifestly Unreasonable" Standard, 41 Tulsa Law Review 411, 431 n. 112 (Spring 2006)).

Official Comments to the UCC suggest that a "manifestly unreasonable" provision might be equated  to an "obviously unfair" provision.  Other commentators say it is falls somewhere between "unreasonable and unconscionable" or "passing beyond the outer limits of permissiveness." (See Timothy R. Zinnecker, The Default Provisions of Revised Article 9 of the Uniform Commercial Code: Part I, 54 Business Law 1113, 1124 (May 1999)).

Ultimately, however, existing statutes with a not manifestly unreasonable standard, like the new Iowa LLC Act, fail to clearly define the term, and case law does little to clarify.  Definitions or suggested interpretations are limited, and those that exist very by court and context.  Forecasting a court's treatment of the not manifestly unreasonable standard is difficult.  One thing is certain: someone  is going to be the guinea pig for the Iowa Supreme Court as it tries to draw the line between unreasonable and unconscionable.

-Megan J. Erickson

Ms. Erickson is an associate with the Dickinson Law Firm and a contributor to this blog.

LLC Management Under the New Iowa LLC Act

As mentioned in an earlier post, under the New Iowa LLC Act (489.301(1)) members are not agents of an LLC merely by being members.  This is a break from the statutory apparent authority concept found in the current Iowa law and dating back to the 1914 Uniform Partnership Act.  This does not mean that a member's conduct cannot otherwise bind the LLC.  For instance, as the commentary to the RULLCA points out, the law of apparent authority, respondeat superior or negligent supervision might result in liability of an LLC for a member's conduct  (See 489.301(2))

By default under current law an LLC is managed by its members unless the articles of organization or operating agreement provide for management by managers.  This concept is carried over to the New Iowa LLC Act provided that it is only the operating agreement that can change management of an LLC from member-managed to manager-managed.  The operating agreement must expressly provide that (a) the LLC is "manager-managed" (b) the LLC is "managed by managers" (c) management of the LLC is "vested in managers" or (d) words of similar import.  Be safe, use one of the first three phrases recognized by the Act to avoid all doubt.

Now this is where things get a little complicated.  To fully understand the management options available under the new Iowa LLC Act (as well as other provisions of the Act) you have to go back to 489.110(1) and (2).  This is where the concept of the LLC as a contractual construct and not a creature of statute is expressed. 

Section 489.110(1) establishes the primacy of the operating agreement by declaring that it governs (a) relations among the members as members and between members and the LLC, (b) the rights and duties of the managers, (c) the activities of the company, and (d) amending the operating agreement.

Section 489.110(2) establishes the Act as the place to turn to fill in the gaps, if any, not covered by the operating agreement ("To the extent the operating agreement does not otherwise provide for a matter described in subsection (1), this chapter governs the matter.")

Section 489.110(3) takes back some of the broad authority granted to the operating agreement in subsection (1).  More about subsection (3) in a later post.

Back to 489.407 and the default rules for managing an LLC.  Unless the operating agreement provides otherwise the following rules apply to a member-managed LLC: (a) management is vested in the members, (b) each member has equal rights in the management of the LLC, (c) differences as to matters in the ordinary course of business are decided by majority of the members, (d) decisions  outside the ordinary course of business including a sale of all or substantially all of the LLCs assets require unanimous consent of the members, (e) amending the operating agreement requires unanimous consent of the members, and (f) mergers, conversions and domestications require unanimous consent under Article 10.

If the operating agreement provides for a manager-managed company, the following rules apply: (a) except as provided elsewhere in the Act matters related to the activities of the LLC are decided  by the managers, (b) each manager has equal rights in the management of the LLC, and (c) differences arising among the managers in the ordinary course of business are decided by a majority of the managers.

Decisions outside the ordinary course of business in a manager-managed LLC,including a sale of all or substantially all of the LLCs assets, mergers, and conversions, as well as amendments to the operating agreement, require unanimous consent of the members.

Managers are selected by a majority of the members and can be removed at any time by a majority of the members without notice or cause.

One final point appoint the default decision-making rules under the new Act.  Unlike the current default rule that provides for members voting power to be weighted based on the capital contributions of the members, the new Iowa LLC Act provides for votes based on one member, one vote.

-Marc Ward

Statements of Authority Clarify Responsibility and Real Estate Transactions

In this post I will look at two real improvements to Iowa's LLC law.  Currently, all members of an LLC are agents of the LLC unless the articles of organization provide otherwise (Iowa Code 490A.702).  Beginning in January 2009 Iowa Code Section 489.301(1) will provide that a member is not an agent of the LLC merely because he or she is a member.  The risk of a rogue member binding or otherwise obligating LLC will be gone.

To clarify the lines of responsibility further, Iowa Code Section 489.302 will permit an LLC to deliver to the Secretary of State for filing a statement of authority. The statement will be notice of who does or does not have authority to act for the LLC to execute an instrument transferring real property or to enter into transactions on  behalf of or otherwise act for or bind the LLC.  The statement can state the authority or limits on authority by position (e.g. manager or president) or a specific person or persons.

Filing the statement of authority in the recorder's office will be conclusive in favor of a person who gives value for real property in reliance on the statement.  Likewise, a recorded statement limiting the authority of a person or position to transfer real property will be notice to all.

A statement of authority will expire 5 years after it or the most recent amendment becomes effective, unless canceled earlier.

-Marc Ward

Shelf LLCs under the new Iowa Limited Liability Company Act

Currently, Iowa LLCs cannot exist without members.  Technically speaking, articles of organization should not be filed for an LLC until it has at least one member.  This probably comes as a surprise to many Iowa lawyers.

Shelf LLCs are limited liability companies permitted by state law to be formed without members and put on the shelf until needed.  They clear up many issues with regard to valid existence and due organization, but they run contrary to the idea that an LLC is an association of members, not an entity whose existence is created by a filing with the state government.  This subject was the single most contentious issue debated by the National Conference of Commissioners on Uniform State Laws Drafting Committee for the Revised Uniform Limited Liability Company Act.

The NACCUSL committee compromised and the official Revised Uniform LLC Act allows LLCs to have a shelf life of 90 days before needing at least one member.

In Iowa, we took a more practical approach.  Shelf LLCs can be formed under the new LLC Act, but LLCs will need at least one member in order to operate and do business.  Until an LLC has at least one member it can only (a) deliver filings to the secretary of state; (b) admit a member; and (c) dissolve.

An LLC with at least one member may ratify an act or activity that occurred when the company lacked  members.

-Marc Ward 

No More Articles

Beginning January 1, 2009, new LLCs will file certificates of organization, not articles of organization, to get things started.  And the certificates live up to their names.  The only information required in the certificates is the name of the LLC and the street and mailing addresses of the registered office and the registered agent.

It will be no longer necessary to state that the LLC has a perpetual existence; by law all LLCs will have a perpetual existence.  The other key difference from current law is eliminating the necessity of relieving members and managers from liability to the limited liability company for monetary damages except for (1) breach of the duty of loyalty; (2) improper receipt of a financial benefit; (3) making an improper distribution to members; (4) intentional infliction of harm on the company or a member; and (5) an intentional criminal violation.  This limitation of liability must be in the operating agreement,not the certificate, in order to be effective and bind the LLC.