A case for the adoption of the Revised Uniform Limited Liability Company Act in South Dakota.

• Author: Dylla, Joseph M.

In 2006 the National Conference of Commissioners on Uniform State Laws promulgated the Revised Uniform Limited Liability Company Act. Recently, the limited liability company has become the most popular business entity. As a result, the Revised Act recognizes and adopts the best features from various business entity acts and also includes a few innovations. However, in one notable area, the Revised Act falls short: series LLCs. This article argues in favor of adoption of the Revised Uniform Limited Liability Company Act by the South Dakota Legislature, with a few changes, including a series LLC provision. This legislation will help ensure South Dakota's reputation as one of the most business-friendly jurisdictions in the nation.

1. INTRODUCTION

   The limited liability company was first recognized as an alternative business entity in 1977 by the Wyoming legislature. (1) For years, the LLC was not a widely accepted business entity, (2) but that, all changed following Revenue Ruling 88-76. (3) This ruling announced that [a]n unincorporated [business] organization operating under the Wyoming Limited Liability Company Act [was] classified as a partnership for federal [income] tax purposes...." (4) The favorable tax treatment led many state legislatures to enact LLC legislation, (5) and it also provided an impetus for the National Conference of Commissioners on Uniform State Laws ("CCUSL") to consider drafting a uniform LLC act. (6) In 1996, NCCUSL promulgated the Uniform Limited Liability Company Act ("ULLCA"). (7) This act was the first generation of uniform state laws pertaining to limited liability companies drafted by NCCUSL. ULLCA was largely influenced by the Revised Uniform Partnership Act, the 1985 Revised Uniform Limited Partnership Act, and the Model Business Corporation Act. (8) Shortly after ULLCA was introduced, the Internal Revenue Service provided even more favorable tax treatment for LLCs with the "check the box" rules, making the LLC an even more attractive entity option. (9)

   However, the explosion in the popularity of LLCs did present a problem of uniformity. (10) Prior to 1996, nearly every state had its own LLC statute, resulting in significant variation in the applicability and enforcement of LLC law throughout the country. (11) Unfortunately, the promulgation of ULLCA did not solve the problem of variability in LLC law, in large part because it was introduced after most jurisdictions had already legislatively addressed LLCs. (12) Partially in response to the continued variation of LLC law throughout the United States, the National Conference of Commissioners on Uniform State Laws have "approved and recommended" that the Revised Uniform Limited Liability Company Act ("RULLCA") be adopted by all states. (13) Some states have already adopted RULLCA, and other jurisdictions are considering its adoption. (14) The introduction of a new uniform act is significant because it enters the legal scene at a time when LLCs are widely considered to be the "'go-to' entity." (15)

   This article will begin with a discussion of current LLC law in South Dakota. (16) Then, it will highlight the major innovations of RULLCA. (17) It will conclude with a brief analysis as to why the South Dakota Legislature should adopt RULLCA. (18)

2. THE CURRENT STATE OF SOUTH DAKOTA LLC LAW

   South Dakota first recognized the LLC as a business entity in 1993 through the enactment of Senate Bill 139. (19) The initial South Dakota LLC Act was modeled after the Wyoming LLC Act. (20) After the Internal Revenue Service made significant changes to LLC taxation through Revenue Ruling 88-76 and the adoption of the "check the box" rules, South Dakota chose to adopt ULLCA in 1998 rather than undertaking substantial amendments to the initial South Dakota LLC statute. (21) Even though South Dakota adopted the uniform act, it was not without alteration. Some changes were minor (22) while others were not. (23)

   The most significant changes made by the South Dakota Legislature involved asset protection and creditor rights. (24) In these areas, the South Dakota LLC Act places a priority on entity stability. (25) For example, in South Dakota, the dissociation of a member "does not dissolve" and trigger the winding up of an LLC's business, which is not necessarily true under the uniform statute. (26) Under Article 7 of ULLCA, a member's dissociation requires the entity to purchase that member's interest and also provides a court with a procedure to determine the fair market value of the interest if there is a dispute following dissociation. (27) However, the South Dakota LLC Act does not require the LLC to purchase a dissociated member's interest nor does it provide a mechanism for determining fair market value. (28) South Dakota's rejection of sections 701 and 702 of ULLCA prevents a dissociated member from holding the entity, and remaining members, hostage by requiring a buy-out or engaging in protracted litigation to secure the terms of a buy-out. (29) Similarly, the South Dakota LLC Act does not allow a member or dissociated member to seek judicial dissolution because of oppressive conduct. (30) In addition, a non-member transferee cannot file for judicial dissolution. (31) All of these omissions promote the South Dakota LLC Act's underlying policy favoring entity stability.

   With regard to creditors' rights, the South Dakota LLC Act provides a creditor who has obtained a judgment against a member with the right to "charge the distributional interest" of the member "to satisfy the judgment." (32) However, the South Dakota Act does not allow a court to appoint a receiver. (33) Further, the South Dakota LLC statute does not allow the court to order a foreclosure of the creditor's lien and sale of the distributive interest. (34) Most importantly, the South Dakota Legislature made it abundantly clear that the charging order was the only remedy available for a judgment creditor against a member's distributional interest when it added,

   [n]o other remedy, including foreclosure on the member's distributional interest or a court order for directions, accounts, and inquires that the debtor, member might have made, is available to the judgment creditor attempting to satisfy the judgment out of the judgment debtor's interest in the limited liability company. (35) The South Dakota LLC Act also prevents a "creditor of a member or a member's assignee" from "obtain[ing] possession of" or "exercis[ing] legal or equitable" rights against company property. (36) That language presumably forecloses many--if not all--potential avenues for payment to a creditor aside from the creditor's exclusive remedy of a charging order.

   In addition to these changes, the legislature also included several innovations to the South Dakota LLC Act that are not present in ULLCA. In South Dakota, the legislature expressly provided LLCs with the ability to create classes of members with differing "rights, powers, or duties, including voting rights...." (37) Additionally, the South Dakota act recognizes the concepts of conversion (38) and domestication, (39) which were not part of ULLCA. (40)

   Although LLCs have been a recognized entity option in South Dakota for nearly 20 years, there is surprisingly little case law interpreting S.D.C.L. Chapter 47-34A, (41) but as LLCs become more and more prevalent in South Dakota and across the nation, litigation creating a unique body of case law will continue to emerge. (42) In light of the increased use of LLCs and the inevitable evolution of LLC case law in South Dakota, it is important that the South Dakota Legislature continue to foster a favorable business environment (43) by adopting RULLCA, as this statute "identif[ies] the best elements of the myriad [of] 'first generation' LLC statutes" and also "infuse[s] those elements into a new, 'second generation' uniform act." (44)

3. DIFFERENCES FOUND IN RULLCA

   This section will present an overview of the major differences between the first generation and second generation uniform LLC acts, as well as a discussion of the different policy implications arising from the changes adopted by RULLCA. Delaware's treatment of each topic is also discussed briefly because of the importance of Delaware business entity law.

   1. THE OPERATING AGREEMENT

      RULLCA provides for a very broad definition of the operating agreement. (45) This broad definition encompasses all agreements whether express, implied, or some combination thereof, no matter how informal the agreement actually is between the parties. (46) In fact, the only requirement for an operating agreement under RULLCA's broad definition is assent of the parties. (47) Additionally, the definition includes an agreement of a "sole member." (48) The Delaware LLC Act is largely in conformity with RULLCA's broad definition of the operating agreement. (49)

      The broad definition of operating agreement does present questions concerning what actually constitutes the agreement among the members. (50) The comments to RULLCA section 111 even provide a warning to anyone contemplating becoming a member of an LLC to carefully determine the full extent of the operating agreement. (51) Although the broad definition of operating agreement may be advantageous in the formation of informal LLCs, expressly authorizing the ability to require a writing of some sort to constitute an operating agreement, or amendments thereto, would likely be the more appropriate approach for the majority of organizations. (52)

      Consistent with current LLC law, the RULLCA operating agreement--not the act itself--provides the "rules of the game" for LLC members and managers. (53) Because of the operating agreement's importance and RULLCA's policy decision to "uncabin" fiduciary duties, (54) the broad grants of authority, as well as the limited rights to restrict fiduciary duties, found in RULLCA section 110 are of great importance. (55) Initially, section 110 grants broad general authority to the...