California to Adopt Revamped LLC Act

California has adopted a substantially revised Limited Liability Company Act, which goes into effect January 1, 2014.  LLC Law Monitor has the details.

One item of particular note is this:

Non-economic Member. Beverly-Killea assumes that members have economic rights. For example, its definition of a membership interest includes the member’s economic interest, such as the right to share in profits, losses, and distributions. RULLCA, in contrast, allows an LLC to include members that have no economic interest and make no capital contributions. § 17704.01(d). The NCCUSL comment on this section indicates that the purpose of this provision is to “accommodate business practices and also because a limited liability company need not have a business purpose.” NCCUSL, Revised Uniform Limited Liability Company Act, § 401(e) cmt.

Delaware's LLC Act, like the Revised Uniform LLC Act ("RULLCA") allows for non-economic members. See, e.g., 6 Del. C. § 18-301.  This is frequently put into effect in structured finance transactions, in which Delaware single-member LLCs incorporate a non-economic "springing member" or "special member" who steps into the shoes of the member on the occurrence of any event that would cause the member to lose his status as such. We described the role of springing member in Part II of Third Party Delaware Opinions for Structured Finance and other Commercial Transactions:

The provisions of 6 Del. C. § 18-304 may cause a member to cease to be a member by operation of law under certain circumstances. This is particularly worrisome in situations where the LLC has only one member (as is frequently the case in commercial structured finance deals). Since an LLC with no members is dissolved automatically by operation of law, a mechanism must be put in place to continue the LLC's existence and prevent the liquidation of assets in the event of a sole member's resignation, "bankruptcy" (as broadly defined in the LLC Act), and/or assignment of interests. This is accomplished by having the Special Member “spring” into the shoes of the last remaining member of the LLC upon the occurrence of any event that would cause that person or entity to cease to be a member by operation of law or contract. Without a Special Member Delaware counsel may not opine that dissolution or bankruptcy of the
Member(s) will not lead to dissolution of the LLC. The LLC Act permits the use of a Special Member (sometimes referred to as a "Springing Member") who is named in the limited liability company agreement and who must execute it in order to be bound to its terms. The Special Member is given specific rights and responsibilities to prevent the dissolution of the LLC caused by such a resignation or assignment. The Special Member's function is to continue the LLC until a new member is admitted.
Among the typical rights and responsibilities are that the Special Member:

  • may not resign or transfer its rights unless a successor Special Member has been admitted;
  • may have no interest in the profits, losses and capital of the Company;
  • may have no right to receive any distributions of Company assets;
  • may not be required to make any capital contributions to the Company, 6 Del. C. § 18-301(d);
  • may not bind the Company and except as required by any mandatory provision of the Act; and
  • may have no right to vote on, approve or otherwise consent to any action by, or matter relating to, the Company, including, without limitation, the merger, consolidation or conversion of the Company.

The Special Member is a creature of contract, and there is no statutory restriction on who may serve (except that, in order to be effective, it should be someone other than the Member(s). Some lenders have their own such restrictions; for example, some lenders will refuse to permit a relative of the LLC's Member or the Member's principle to serve as Special Member. These restrictions are not based on any considerations relating to Delaware statute or common law.