Important Changes to the Pennsylvania LLC & Partnership Laws

Philadelphia PA Business Planning Attorneys

The Commonwealth of Pennsylvania passed Act 170 (the “Act 170”) which has a profound effect on how Partnerships and LLCs are governed. Act 170 became effective this spring and redefined a number of the default governing rules and permissible arrangements that partnership and LLCs can undertake. The net effect of Act 170 is to clarify and liberalize the partnership and LLC governance system, interests and rules. In the interest of brevity, this newsletter will specifically discuss certain key changes to LLCs since LLCs are the most common form of independent business entities, however, many of these changes apply to other non-LLC entity forms.[1]

Transferable Interest

One of the changes is the legal concept and idea of a “transferable interest” with respect to creditors and member interests with transfer restrictions. In a nutshell, if a member becomes insolvent, Act 170 provides clarity on what rights a creditor will have in such insolvent member’s interest. A creditor may now obtain the right to the insolvent member’s “transferable interest” which means the member’s right to receive economic distributions, and the creditor may have a receiver appointed on his/her/its behalf to enforce the transferable interest judgment. However, the insolvent member is not automatically dissociated from the LLC as outside of the right to distributions the creditor receives no other rights in the LLC such as management, voting, control, and information rights. The insolvent member’s other rights remain intact unless there is some other arrangement. In summary, the default rule of Act 170 is that 1) management or governance rights may not be transferred to a person who is not a member of the LLC, 2) it keeps creditors out of the LLC’s management, control and affairs, and 3) it helps avoid a forced fire sale of an insolvent member’s interest.[2]

Fiduciary Duties

Act 170 somewhat clarified and liberalized the powers of members and managers as set forth by an operating agreement to disclaim the duty of loyalty and the duty of care. The duty of loyalty is the duty to act in the interests of the LLC and its members. This is that the managers and members will not act in bad faith towards one another or steal the business of the LLC. The duty of care is the obligation to use reasonable business judgment when making decision. Reasonable business judgment means the person will take the necessary steps to evaluate various actions. This usually runs afoul if there is no proper evaluation for example such as making a $100 million dollar decision in a quick five minute off the cuff meeting without any discussion, support, evidence of evaluating other options, or undertaking other usual steps a manager would take prior to undertaking such a decision.

Act 170 now permits operating agreements to disclaim such duties as long as it is not “manifestly unreasonable” given the circumstances. However, it remains to be seen how high the “manifestly unreasonable” bar will be construed by the courts. Certain situations should be expected to be disallowed such as if they are used to take advantage of a less educated or disenfranchised member, but outside of this or courts setting a high bar for manifestly unreasonable, this allows sophisticated business parties more freedom to disclaim these duties.

Authority to Bind the LLC

Act 170 helps clear up some issues as to whether a member can unilaterally and unintentionally bind the LLC. Originally, there was the legacy statutory “apparent authority” rule that a member can bind the LLC as an agent just by the fact of being a member. This blanket rule has been removed and being a member of a LLC no longer automatically implies authority.

Act 170 provides that a Certificates of Authority may now be filed which places the public on notice that a particular person has authority, does not have authority, or has a limited authority to sign legal documents on behalf of the LLC. This may be filed with the Department of State generally, and with the local county Recorder of Deeds if such authority relates to real estate. This adds definitive clarity of being able to check the legal authority online rather than merely relying on covenants. However, practical issues that may arise are 1) the extra red-tape as counterparties will require certified copies of the Certificate of Authority to be filed as part of business/real estate transactions, 2) errors in the database causing delays, 3) delays in obtaining the certificates causing closing issues, and 4) the extra fees and costs to obtain the certificates. It may clear up many misunderstandings when someone acts beyond his/her authority, but it needs to be seen how it plays out in the reality of the day to day business/real estate transactions.

LLC Not-For-Profits and Benefit LLC

The Act will permit not-for-profit LLCs and Benefit LLC (entities generally for the public benefit) as opposed to only trusts and corporations. It will be interesting how this plays itself out as the benefit of trusts was the informality at the risk of unlimited liability exposure, whereas a nonprofit corporation provided limited liability but required formalities including directors, officers, by-laws, periodic meetings and minutes of various actions, and such. The LLC provisions of Act 170 allow the middle ground by permitting more informality while still receiving the limited liability protection of a non-for-profit corporation in Pennsylvania.

Simplified Application

It is not much of a change, but upon filing an LLC the Certificate of Organization used to require whether it was member managed or manager managed, and whether the member’s interest was to be evidenced by certificates. It forced the LLC members to decide whether they want to vest the power in the members or in a certain manager or managers, and whether they required membership interest certificates. In reality, many entities do not decide these until after the fact when they draft the operating agreement and really think through the minutia of how the entity should be managed. Act 170 now allows the entity to figure these issues after the fact which helps the law follow the realities of how the average person is establishing LLCs.

Conclusion

This newsletter highlights some of the most major changes Act 170 has to the day to day management of LLCs. Act 170 was intended to clarify and provide simplicity for some of the day to day stumbling blocks and questions LLCs, their constituents, and third parties have faced with LLC governance. It also allows the statutory code to somewhat catch up with the realities of LLCs and businesses as LLCs have evolved since first introduced. If you are operating your business as an LLC it may be wise to revisit your operating agreement in light of these changes. As of April 1, 2017, Act 170 applies to all existing LLCs in this Commonwealth.


[1] Contact us if you have any questions about how any of the changes affect your non-LLC entity.

[2] One exception is that a sole member LLC’s entire interest may be subject to execution and forced sale.