The new law and ownership rights
The act’s provisions are so much stronger that not adopting them early might be a big mistake
Both the current New Hampshire LLC act and the new one contain specialized provisions called “pick-your-partner provisions” and “charging order provisions.”
In both of these acts, the provisions are intended to protect LLC members against the risk that the courts will transfer their ownership rights in their LLCs (called, in LLC jargon, their “membership rights”) to evil third parties. These evil third parties may include, for example, former spouses, irate creditors, or trustees in bankruptcy -- exactly the people you don’t want to replace you as members of your LLC.
However, as I’ll explain below, the main reason members of New Hampshire LLCs formed under the current act should make “Section 5 elections” to be covered by the new act in 2013, rather than waiting for mandatory coverage in 2014, is that the pick-your-partner provisions and charging order provisions are so much stronger in the new act than those in the current act. So much stronger, in fact, that not to make such an election might be downright stupid.
To explain: LLC pick-your-partner provisions provide, in effect, that members may not transfer their “management rights” to other persons, even involuntarily by court order, without the consent of all other members.
However, while the pick-your-partner provisions in the current act protect members’ management rights, they don’t define those rights. So a court might define them very narrowly and thus permit third parties to seize a wide range of an LLC member’s management rights.
By contrast, the new act’s pick-your-partner provisions effectively define “management rights” as including all of a member’s membership rights except the member’s LLC interest.
Charging order provisions
LLC charging order provisions provide, in effect, that the courts may grant creditors of LLC members “charging orders” that entitle them to acquire, to the extent of their claims, members’ “LLC interests.” However, they also provide that, by obtaining charging orders, creditors will not obtain any other membership rights. (“LLC interests” are members’ rights to receive allocations of their LLCs’ profits and losses; and to receive distributions of their cash and other assets. “Charging orders” are, in effect, liens on LLC interests.)
However, the charging order provisions in the current act can be interpreted as providing, in effect, that if creditors don’t want charging orders against LLC debtor-members, they can obtain the members’ LLC interests by any other procedure the law permits and they can force the sale of these interests in foreclosure sales. The purchasers in these sales can be the creditors themselves, and the purchase price may often be a fire-sale price.
By contrast, the new act’s charging order provisions expressly bar creditors from obtaining alternatives to charging orders, including foreclosure sales, except in very narrow circumstances.
In short, given the superiority of the pick-your-partner provisions and charging order provisions of the new act over those of the current act, what possible reason could justify your waiting until 2014 to get the benefit of these provisions when you can get them in 2013?
But let me end with two qualifications of what I’ve said above (and, since I’m a lawyer, with qualifications of these qualifications):
• LLC acts contain pick-your-partner provisions and charging order provisions. Corporate acts don’t. If your company is not an LLC, but rather a corporation, you can get the benefits of pick-your-partner provisions and charging order protections through well-drafted buyout provisions in a shareholder agreement. However, these provisions will create contingent liabilities that you may not like, and the very avoidance of these liabilities may sometimes be a compelling reason to convert your corporation to an LLC.
• Although pick-your-partner provisions, charging order provisions and many other provisions of the new act effectively mandate Section 5 elections by old act LLCs, high-stakes current act LLCs should carefully amend their operating agreements to protect themselves from possible downsides of these elections before they actually make them.
Attorney John Cunningham, of counsel to the Manchester-based law firm of McLane, Graf, Raulerson & Middleton, is author of “John Cunningham on New Hampshire’s New LLC Act,” available at cunninghamonnhllcs.com.