Delaware LLC Agreements: Planning and Drafting Strategies Leveraging the Contractual Flexibility Afforded by the DLLC Act

Transcription

1 Presenting a live 90 minute webinar with interactive Q&A Delaware LLC Agreements: Planning and Drafting Strategies Leveraging the Contractual Flexibility Afforded by the DLLC Act THURSDAY, JANUARY 20, pm Eastern 12pm Central 11am Mountain 10am Pacific Td Today s faculty features: John M. Cunningham, Of Counsel, McLane Graf Raulerson & Middleton, Concord, N.H. Vernon R. Proctor, Partner, Proctor Heyman LLP, Wilmington, Del. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

2 DELAWARE LLC AGREEMENTS CRAFTING THE AGREEMENT TO LEVERAGE THE DELAWARE LLC ACT AND TO AVOID DRAFTING PITFALLS A LIVE 90-MINUTE WEBINAR PROGRAM WITH INTERACTIVE Q&A THURSDAY, JANUARY 20, 2011, 1 PM (E.S.T.) OUTLINE OF PRESENTATION BY JOHN CUNNINGHAM 1 I. INTRODUCTION...1 II. HOW TO CHOOSE BETWEEN THE DLLC ACT AND OTHER LLC ACTS IN LLC FORMATIONS...4 III. TAKING ADVANTAGE OF THE FLEXIBILITY OF THE DLLC ACT IN FORMING DELAWARE LLCS...6 IV. AVOIDING PITFALLS IN FORMING DELAWARE LLCS...9 EXHIBIT A The 20 Principal Provisions of the DLLC Act Providing for Statutory Flexibility in LLC Formations I. INTRODUCTION 1) Welcome; self-introduction. a) Good morning, ladies and gentlemen. b) I m John Cunningham. I m of counsel to the law firm of McLane, Graf, Raulerson & Middleton, Professional Association. My contact information is in the first footnote of this outline. My practice is focused on LLC formations. c) d) In addition, with Vern Proctor, the other speaker in this seminar, I m the co-author of Drafting Delaware LLC Agreements, a formbook and practice manual published by Wolters Kluwer Law & Business. e) This outline is intended to reflect my experience in forming these LLCs and in coauthoring this book. 2) My blog. I publish a twice-monthly blog on how to draft LLC operating agreements. The link is Among other contents, this blog, starting in February 2011, will contain summaries of recent Delaware court decisions under the DLLC Act. 1 John Cunningham may be reached by phone at the law firm of McLane, Graf, Raulerson & Middleton, Professional Association, at (603) and by at john.cunningham@mclane.com.

3 3) What is an LLC agreement? The topic of this seminar is the planning, negotiation and drafting of LLC agreements under the DLLC Act. 2 DLLC Act (7) defines these agreements as agreement[s], written, oral or implied, of the member or members as to the affairs of a limited liability company and the conduct of its business. 4) The scope of this seminar. a) This seminar deals only with Delaware LLC business organization law relevant to the drafting of Delaware LLC agreements. The seminar does not deal with LLC agreement tax issues. b) Furthermore, this is not a general seminar about how to draft LLC operating agreements. Rather, it is focused specifically on Delaware LLC agreements as such and on Delaware case law as applicable to these agreements. c) More particularly, it is focused on LLC agreements for Delaware multi-member LLCs. For obvious reasons, these agreements are normally far more complex and difficult to draft than LLC agreements for Delaware single-member LLCs. 5) The purpose of Delaware LLC agreements. However, it will be useful to state at the outset my view about the business organization law goals that lawyers should have in drafting not only Delaware LLC agreements but also LLC agreements and operating agreements under other LLC acts: a) Primary goals. The primary goals of these lawyers should be: i) To identify all of the business organization law issues potentially significant for their Delaware LLC formation clients; ii) To determine with their clients how to resolve each of these issues in their clients best interests; iii) To seek their clients best interests in negotiating the LLC deal; and iv) To formalize the outcome of these negotiations in a manner that is legally binding on the parties. b) Significant business organization law issues in Delaware LLC agreements. In most Delaware LLC agreements, the most important LLC business organization law issues are those concerning: i) Contributions, ii) Allocations, iii) Distributions, iv) Events of dissociation, v) Transfers of LLC membership rights, vi) Buy-sells (i.e., redemptions and cross-purchases), vii) Fiduciary matters, viii) Dissolutions, and ix) Dispute resolution. 2 As discussed further below, before you draft an LLC agreement for a multi-member LLC, you must first plan with your client what issues it should address and what resolutions of these issues will be in your client s best interest, and you must negotiate these issues on behalf of your client. However, for brevity, in the rest of this outline I will generally refer to this three-step process simply as the drafting of LLC agreements. 2

4 You can access a comprehensive overview of these issues by clicking on the navigation bar button marked LLC forms in the above blog. c) Delaware LLC agreements as users manuals. Delaware LLC agreements should also be drafted to serve as users manuals for Delaware LLC members and managers. Thus, to the extent possible, they should be drafted in plain, non-technical English. 6) Flexibility and pitfalls. As its title indicates, this seminar is about how to leverage the uniquely broad flexibility provided by the Delaware LLC Act in Delaware LLC formations and how to avoid pitfalls in handling these formations. a) Flexibility. The flexibility of the Delaware Act provides lawyers with great creativity to tailor LLC agreements to meet their clients business organization law needs and interests greater, to my knowledge, than under any other LLC act. b) Pitfalls. However, if lawyers are thoroughly familiar with the pitfalls in the Act, they may seriously disserve their Delaware LLC formation clients and, in extreme cases, they may face ethical or malpractice claims. 7) What do flexibility and pitfalls mean? See footnote below. 3 3 Flexibility. When we say in this seminar that the Delaware LLC is a highly flexible LLC act, we mean the following: a) Statutory flexibility. Very few of the rules in the DLLC Act that could significantly affect Delaware LLC deals are mandatory. Instead, these rules consist almost entirely of rules that, by their terms, parties can validly change in Delaware LLC agreements namely, default rules, nonself-enabling permissive rules and self-enabling permissive rules. The non-self-enabling permissive provisions of the DLLC Act provide, in effect, that LLCs may take advantages of the arrangements provided for in them if they authorize them in their LLC agreements; the selfenabling provisions make these arrangements available even without LLC agreement authorization. b) Freedom of contract. On business organization law issues not covered by DLLC Act rules ( statutory gap issues ), DLLC Act (b) provides parties to these deals with great contractual flexibility. c) Cases. Under DLLC Act (b) and by implication under Elf Atochem, the holdings in most or all cases that address provisions of the DLLC Act and statutory gap issues in the DLLC Act may also be construed as default rather than mandatory. d) Enforceability. DLLC Act (b) provides the parties to Delaware LLC deals with a high level of assurance that, in general, the Delaware courts will enforce the provisions of their LLC agreements addressing business organization law issues even if these courts view these provisions as one-sided and, with certain exceptions, even if they view them as unfair or oppressive. Pitfalls. When, in this seminar, we speak about drafting pitfalls for lawyers drafting Delaware LLC agreements, we mean dangers to their LLC formation clients under the DLLC Act: a) That are likely to be non-apparent to these lawyers unless they have a detailed familiarity with the Act; or b) That may even be counterintuitive to them. For example, DLLC Act (a) (third sentence) provides in general that except by resignation, a manager shall cease to be a manager as provided in a limited liability agreement. This sentence may well mean that if a Delaware LLC agreement is silent about the removal of a manager, the manager cannot be removed even for grave misconduct except, perhaps, by unanimous vote of the parties to the agreement. 3

5 II. HOW TO CHOOSE BETWEEN THE DLLC ACT AND OTHER LLC ACTS IN LLC FORMATIONS 1) Making a choice between the DLLC Act and another LLC act on the basis of a comprehensive analysis. In order to make a truly comprehensive analysis in choosing between the DLLC Act and another LLC Act for an LLC formation client, you must, among other things: a) Identify all of the provisions in each act potentially relevant to your LLC formation clients; b) Properly characterize each of these provisions as definitional provisions, mandatory provisions, default provisions, non-self-enabling permissive provisions and selfenabling permissive provisions; c) Determine on a net basis which act is most favorable to your clients; and d) Make the same determination with respect to all relevant cases under both acts. 2) Definitional provisions, etc. definitions. a) Definitional provisions. The definitional provisions of the DLLC Act are those that define terms used in the Act. An example of a definitional provision in the Act is (7). As noted above, this section defines LLC agreements as agreements as to the affairs of LLCs and the conduct of their business. b) Mandatory provisions. The mandatory provisions of the DLLC Act are those that, by their terms, may not be validly overridden in LLC agreements. An example of a mandatory provision in the Act is (a). In general, this section bars LLCs from making distributions of their assets to their members to the extent that these distributions will cause these LLCs to be insolvent. c) Default provisions. The default provisions of the Act are those that, by their terms, may be validly overridden in LLC agreements. An example of a default provision in the Act is In essence, this section provides that unless the LLC agreement provides otherwise, an LLC s profits and losses shall be allocated among the members in proportion to their respective contributions to the LLC. d) Non-self-enabling permissive provisions. The non-self-enabling permissive provisions of the Act are those that permit specified arrangements among the members and managers of LLCs to the extent that these arrangements are permitted for in LLC agreements. An example of a non-self-enabling permissive provision in the Act is (a). This section provides, among other things, that an LLC agreement may provide for non-voting members. e) Self-enabling permissive provisions. The self-enabling permissive provisions of the Act are those that permit specified arrangements among the members and managers of LLCs that the members may implement even without authorization in their LLC agreement. An example of a self-enabling permissive provision in the Act is (a). This section provides, among other things, that LLCs may pursue any lawful business, purpose or activity. 4

6 3) Table of DLLC Act provisions. The above provisions of the DLLC Act are identified and discussed in detail in Drafting Delaware LLC Agreements. To my knowledge, no similar discussion may be found in any other source. The following is a table of these provisions: TYPE OF PROVISION NUMBER OF PROVISIONS OF THIS TYPE IN DLLC ACT 1. Definitional Mandatory Default Non-self-enabling Permissive Self-enabling Permissive 9 Total 223 4) Shortcuts in choosing between the DLLC Act and other LLC acts. The process of choice outlined in Paragraph II(1) of this outline is obviously complex and time-consuming and is likely to result in substantial legal fees for clients. However, in many cases, you can make the choice on the basis of the following relatively simple shortcut guidelines: a) The statutory flexibility of the DLLC Act. In my experience, the DLLC Act provides greater flexibility than any other act in meeting the needs and interests of LLC formation clients. If your client wants highly tailored LLC agreement provisions, including fiduciary and other provisions that strongly favor your client over other parties to the agreement, you should probably form the LLC under the DLLC Act. b) Charging order protections. DLLC Act provides for special statutory business asset protections called charging order protections. In essence, LLC statutory charging order provide that if a member of an LLC incurs an unsatisfied judgment unrelated to the business of the LLC: i) The remedy of the creditor who holds the judgment will be to obtain a lien (a charging order ) on the right of the member to receive LLC distributions; and ii) The creditor may not levy on the voting rights or other membership rights of the member. By its terms, is an exclusive remedy. The charging order provisions of 28 other states are exclusive; the remaining 21 U.S. jurisdictions are silent on the issue of exclusivity. In many LLC formations, the exclusivity of may constitute a significant reason for choosing the DLLC Act over other LLC acts. 4 c) Preeminence of the DLLC Act. The DLLC Act is generally recognized as the preeminent U.S. LLC Act. If your client s LLC will be dealing with sophisticated 4 It is true that of the Wyoming LLC provides that charging order protections apply not only to multi-member LLCs but also to single-member LLCs. It is unclear whether may be applied to Delaware single-member LLCs. However, in my view, it is doubtful that would be enforced in non-wyoming courts. 5

7 U.S. or foreign parties, including venture capital investors, managers, lenders, and their lawyers and accountants, you should probably form the LLC under the DLLC Act, and these parties may well expect you to do so. d) Delaware LLC case law. There are roughly 115 decisions of Delaware and non- Delaware courts interpreting provisions of the DLLC Act far more than under any other LLC Act. This plethora of Delaware LLC cases may in many cases be a significant factor in choosing between the DLLC Act and other LLC acts. e) Everybody s second choice. Where two or more parties to an LLC formation reside in two or more non-delaware states, the DLLC Act will often be, as LLC lawyers often say, everybody s second choice. 5) The Court of Chancery factor. Lawyers often choose the DLLC Act in LLC formations for their clients because of the acknowledged excellence of the Delaware Court of Chancery in resolving internal LLC disputes. However, a number of Delaware cases suggest that if the dispute resolution provisions of the operating agreement of a non-delaware LLC so provide, the Court of Chancery will generally view itself as obligated to construe and enforce those provisions. III. TAKING ADVANTAGE OF THE FLEXIBILITY OF THE DLLC ACT IN FORMING DELAWARE LLCs A. INTRODUCTION 1) Exhibit A. As noted, a principal reason for forming an LLC under the DLLC Act is the remarkable contractual flexibility provided by that act. By my count, 20 principal provisions of the Act provide for this flexibility. These provisions are identified and briefly described in Exhibit A to this outline. 2) Leveraging the flexibility of the DLLC Act in Delaware LLC formations. As indicated by its title, a key goal of this seminar is to provide guidelines for taking advantage of the flexibility of the DLLC Act in planning, negotiating and drafting Delaware LLC agreements. In order to fully leverage this flexibility, in every Delaware LLC formation in which you represent clients: a) Review all of these provisions; b) Determine the impact of each of them on your clients; and c) Negotiate the LLC deal accordingly. 3) Part II(B) of this outline. In Part II(B) of this outline, I will focus on the provisions in Exhibit A that I believe are likely to be of greatest importance to most LLC formation clients namely, DLLC Act (b) and (c). B. CONTRACTUAL FLEXIBILITY UNDER DLLC ACT (b) 1) DLLC Act (b). DLLC Act (b) provides that [i]t is the policy of this [Act] to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements. Section (b) contains two rules 6

8 a) A permissive rule that gives maximum contractual freedom to parties to LLC agreements in drafting these agreements; and b) A mandatory rule that requires the courts to accord maximum enforceability to these agreements. 5 c) Maximum does not mean absolute. The following are, in my view, among the principal limitations on the scope of (b): i) Section (b) does not override DLLC Act provisions clearly intended to be mandatory even if these provisions are not intended to protect third parties. See, e.g., DLLC Act (d) (second sentence). 6 ii) Section (b) does not override traditional common law grounds for invalidating contract provisions, such as such as misrepresentation, fraud, duress, undue influence, unconscionability, adhesion, lack of consideration, or public policy. iii) Section (b) does not negate the equitable powers of the courts. 2) DLLC Act (c) overview. A provision of the DLLC Act that is almost as important as (b) for many LLC formation clients is DLLC Act (c). Section (c) provides that an LLC agreement may expand, restrict or eliminate fiduciary and other duties of LLC members and managers except for the implied contractual covenant of good faith and fair dealing (the Implied Covenant ). 7 3) The Implied Covenant a) Reasonable expectations. Under the Implied Covenant under Delaware law, the courts will construe to require contract parties to meet the reasonable expectations of other parties on issues not addressed in the contract. b) Reluctance of Delaware courts to apply Implied Covenant. The Delaware courts are reluctant to decide claims on the basis of the Implied Covenant, since, among other considerations, they do not like to second-guess contract parties. 5 It is true that the LLC acts of 18 other states contain provisions identical or similar to (b). These are Colorado, Connecticut, Idaho, Kansas, Kentucky, Louisiana, Maine, Mississippi, Missouri, North Carolina, New Hampshire, New Jersey, New Mexico, Oklahoma, Utah, Virginia, Washington, and Wisconsin. How, my research has uncovered no state whose courts have issued decisions with holdings similar to those of Elf Atochem, supra; and I am aware of no state whose permissive provisions are as numerous and varied as those of the DLLC Act. 6 This sentence provides as follows: Except by agreeing to arbitrate any arbitrable matter in a specified jurisdiction or in the State of Delaware, a member who is not a manager may not waive its right to maintain a legal action or proceeding in the courts of the State of Delaware with respect to matters relating to the organization or internal affairs of a limited liability company. 7 Section (c) provides in its entirety as follows: To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member s or manager s or other person s duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement; provided, that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing. 7

9 c) Impact of Implied Covenant on drafting of Delaware LLC agreements. Thus, the Implied Covenant does not impose a substantial restriction on the parties freedom of contract in drafting Delaware LLC agreements. d) The importance of being express. Indeed, I would argue that, in general, under the Implied Covenant the Delaware courts will uphold any express provision in an LLC agreement even if, as indicated above, it seems to the courts to be unfair or even oppressive unless it is invalid on the grounds of fraud or other applicable traditional contract law doctrines. The key is to be express. 4) Section (c) as a mere implementation of (b). However, (c) is essentially a mere implementation, with respect to fiduciary and other duties, of the sweeping freedom of contract available under (b). 5) Contractarianism. The legal philosophy underlying (b) and the other provisions identified in Exhibit A is known as contractarianism. This philosophy holds that persons forming business entities should have maximum contractual freedom to engage in the private ordering of their business affairs and should be subject to only the most minimal government restraint in doing so. 8 6) Advocates and opponents of contractarianism. a) Many corporate lawyers, scholars and judges, including Chief Justice Myron Steele of the Delaware Supreme Court, 9 are contractarians; but many other corporate lawyers, legal scholars and judges often called traditionalists oppose contractarianism. See generally, Callison and Vestal, Contractarianism and Its Discontents: Reflections on Unincorporated Business Organization Law Reform, 42 Suffolk University Law Review 493 (2009). The focus of that article is DLLC Act (b) and (c). The article at page 504 refers to (c) as [c]ontractarianism triumphant. b) However, at least one legal scholar argues that (b) is invalid because it limits the equity powers available to the Delaware courts under the Delaware constitution. Lyman Johnson, Delaware s Non-Waivable Duties, 91 Boston University Law Review (2011). 7) Elf Atochem. The most important Delaware decision interpreting and applying (b) is the landmark decision of the Delaware Supreme Court in Elf Atochem North America, Inc. v. Jaffari, 727 A.2d 286 (Del. 1999). For present purposes, the key holdings of Elf Atochem are these: a) Section (b) must be construed strictly in accordance with its terms. b) An implication of (b) is that unless they are intended to protect third parties (such as creditors), even provisions of the DLLC Act that, by their terms, appear to be mandatory should generally be interpreted as default or permissive. 8) The potential utility of (b) and (c). The potential value of (b) and (c) for LLC formation clients depends on the relevant facts. Their greatest value, however, is arguably for clients who, for whatever reason, want their LLC 8 See, e.g., Steele, Freedom of Contract and Default Contractual Duties in the Delaware Limited Partnerships and Limited Liability Companies, 46 A. B. L.J. 221 (2009). 9 Id. 8

10 agreements to provide them with the maximum possible control over their LLCs and the least possible risk of adverse claims, including fiduciary claims, by other parties to these agreements. Two examples from my own Delaware LLC formation practice: a) Venture capital fund. Jones, a wealthy and successful investor, is forming an entity to serve as a venture capital fund. He wants to exercise maximum control over this entity and to minimize the risk that its members will be able to oppose his management initiatives or to bring claims against him or persons whom he appoints as managers. b) High tech start-up. Smith, a brilliant inventor with a Ph.D. in quantum physics, is forming an entity to exploit a patent she has obtained. She will be both the owner and the manager of this entity. She wants several colleagues of hers to work for this entity and she wants to incentivize them by making them co-owners of it with a right to share in its profits. However, she wants to minimize any risk that these colleagues will be able to oppose her management initiatives or to bring claims against her as a co-owner or manager. IV. AVOIDING PITFALLS IN FORMING DELAWARE LLCs Set forth below are the principal pitfalls that, in my view, lawyers should avoid in handling Delaware LLC formations. As readers will observe, the first and second of these pitfalls largely overlap. 1) Failure to address relevant DLLC Act default and permissive provisions. As noted, the DLLC Act, by my count, contains 70 principal default provisions, 62 non-self-enabling permissive provisions and nine self-enabling permissive provisions potentially important to LLC formation clients. Some of the default provisions in the Act may conflict with the interests of particular Delaware LLC formation clients; some of the non-self-enabling provisions may be important for them to authorize expressly in their LLC agreement; and some of the self-enabling permissive provisions may be adverse to them. a) Lawyers unaware of specific default provisions of the Act that are adverse to the interests of their Delaware LLC formation clients may fail to negotiate provisions in the LLC agreement that override these provisions. b) Lawyers unaware of any specific non-self-enabling permissive provisions that will be useful to their Delaware LLC formation clients may fail to provide for them in LLC agreements. c) Lawyers unaware of specific self-enabling permissive provisions that may be adverse to their Delaware LLC formation clients may fail to draft provisions in LLC agreements that will prevent their use. 2) Failure to make the flexibility analysis described in Paragraph III(A)(2) of this outline. 3) Failure to address DLLC Act statutory gap issues. In addition to fiduciary issues, there are, by my count, at least 10 other significant types of business organization law issues that many other LLC acts address but on which the DLLC Act is silent. Some of these issues may be significant for Delaware LLC formation clients. The failure of lawyers to address these issues for their Delaware LLC formation clients may create serious problems for these clients after the LLC s formation. 9

11 4) Failure to address relevant case law. The DLLC Act is silent about the fiduciary duties to which members of member-managed multi-member LLCs and the managers of managermanaged multi-member LLCs are subject and about many other important LLC business organization law issues. However, some of these issues are covered in Delaware and non-delaware case law interpreting the DLLC Act, and many others are covered in Delaware corporate and limited partnership cases (which the Delaware courts often apply in deciding Delaware LLC issues). The rules in these cases are, effectively, default rules governing Delaware LLCs unless overridden in LLC agreements. The failure of lawyers handling Delaware LLC formations to be aware of default case law rules adverse to their clients interest may create serious problems for these clients after the LLC s formation. 10

12 EXHIBIT A THE 20 PRINCIPAL PROVISIONS OF THE DLLC ACT PROVIDING FOR STATUTORY FLEXIBILITY IN LLC FORMATIONS There are 20 principal provisions of the DLLC Act that, if properly implemented in LLC agreements, can provide valuable statutory advantages to LLC members, managers and others. Many of these advantages are unavailable to the same degree to LLCs formed under other LLC statutes or to corporations formed under the Delaware General Corporation Law or under other corporate statutes. The principal relevant provisions of the DLLC Act are as follows: 1) Section (7) definition of LLC agreement. Section (7) contains nine principal provisions. One of these provisions is definitional, six are probably best construed as mandatory, and three are permissive. The permissive provisions provide, among other things, that: a) An LLC agreement, whether written or oral, may provide enforceable contractual rights to any person, including a person that is not a party to the agreement ( (7)) (seventh sentence) (a non-self-enabling permissive provision). b) A written LLC agreement may provide that even though particular persons do not sign the agreement, they may be admitted as members of an LLC if they comply with conditions for admission set forth in the LLC agreement. Section (7)a.2 (eighth sentence) (a non-self-enabling permissive provision). These conditions may include the making of contributions to the LLC The text of (7), edited by John Cunningham to set forth each of its nine sentences in one or more separately captioned and separately numbered paragraphs, provides as follows: [1] [LLC AGREEMENT DEFINITION.] [DEFINITIONAL PROVISION.] Limited liability company agreement means any agreement (whether referred to as a limited liability company agreement, operating agreement or otherwise), written, oral or implied, of the member or members as to the affairs of a limited liability company and the conduct of its business. [2] [BINDING EFFECT OF LLC AGREEMENT.] [MANDATORY PROVISION.] A member or manager of a limited liability company or an assignee of a limited liability company interest is bound by the limited liability company agreement whether or not the member or manager or assignee executes the limited liability company agreement. [3] [NO REQUIREMENT THAT LLC EXECUTE AGREEMENT.] [MANDATORY PROVISION.] A limited liability company is not required to execute its limited liability company agreement. [4] [LLC IS BOUND BY LLC AGREEMENT WHETHER OR NOT IT SIGNS IT.] [MANDATORY PROVISION.] A limited liability company is bound by its limited liability company agreement whether or not the limited liability company executes the limited liability company agreement. [5] [SINGLE-MEMBER LLC MAY HAVE ENFORCEABLE LLC AGREEMENT.] [MANDATORY PROVISION.] A limited liability company agreement of a limited liability company having only 1 member shall not be unenforceable by reason of there being only 1 person who is a party to the limited liability company agreement. [6] [STATUTE OF FRAUDS INAPPLICABLE TO LLC AGREEMENTS.].] [MANDATORY PROVISION.] A limited liability company agreement is not subject to any statute of frauds (including 2714 of this title). 11

13 2) Section business transactions. Section , a default provision, provides that unless the LLC agreement provides otherwise, members and managers of LLCs may do business with the LLC and, in so doing, have the same rights and duties as third parties. 11 The section arguably negates the otherwise applicable fiduciary duty of managers of manager-managed multi-member LLCs and members of member-managed multi-member LLCs to avoid self-interested transactions. 12 3) Section indemnification. Section , arguably a self-enabling permissive provision, permits the members of Delaware LLCs to provide virtually unlimited [7] [LLC AGREEMENT MAY PROVIDE RIGHTS TO ANY PERSON, INCLUDING A NON-PARTY.] [PERMISSIVE PROVISION.] A limited liability company agreement may provide rights to any person, including a person who is not a party to the limited liability company agreement, to the extent set forth therein. [8] [ADMISSIONS OF MEMBERS UNDER LLC AGREEMENT IN CERTAIN CIRCUMSTANCES.] A written limited liability company agreement or another written agreement or writing: a. [ADMISSIONS OF MEMBERS AND ASSIGNEES IN CERTAIN SITUATIONS.] [PERMISSIVE PROVISIONS.] May provide that a person shall be admitted as a member of a limited liability company, or shall become an assignee of a limited liability company interest or other rights or powers of a member to the extent assigned: 1. [ADMISSION UPON EXECUTION OF AGREEMENT.]... [if] such person (or a representative authorized by such person orally, in writing or by other action such as payment for a limited liability company interest) executes the limited liability company agreement or any other writing evidencing the intent of such person to become a member or assignee; or 2. [ADMISSION WITHOUT EXECUTION.]...[w]ithout such execution, if such person (or a representative authorized by such person orally, in writing or by other action such as payment for a limited liability company interest) complies with the conditions for becoming a member or assignee as set forth in the limited liability company agreement or any other writing[.] [9] [ADMISSIONS OF MEMBERS UNDER LLC AGREEMENT IN CERTAIN CIRCUMSTANCES.] A written limited liability company agreement or another written agreement or writing: [MANDATORY PROVISION]: b. Shall not be unenforceable by reason of its not having been signed by a person being admitted as a member or becoming an assignee as provided in paragraph (7)a of this section, or by reason of its having been signed by a representative as provided in this chapter. 11 Section provides as follows: Business transactions of member or manager with the limited liability company. Except as provided in a limited liability company agreement, a member or manager may lend money to, borrow money from, act as a surety, guarantor or endorser for, guarantee or assume 1 or more obligations of, provide collateral for, and transact other business with, a limited liability company and, subject to other applicable law, has the same rights and obligations with respect to any such matter as a person who is not a member or manager. 12 However, because of the phrase subject to other applicable law, this matter is unclear; thus, drafters who want to negate this duty should generally do so expressly in the LLC agreement. 12

14 indemnification to any member or manager or other person from and against any and all claims and demands whatsoever. Given the breadth of its language, arguably provides for indemnification even for breaches of the implied contractual covenant of good faith and fair dealing. 4) Section mergers. Section , a self-enabling permissive provision, permits LLCs to merge into other LLCs or into non-llc entities. 5) Section appraisal rights. Section , a non-self-enabling permissive provision, provides in essence that LLC agreements may provide appraisal rights to specified members in connection with amendments of the LLC agreement, mergers, consolidations, statutory conversions, transfers, domestications and sales of all or substantially all LLC assets. 6) Section domestications. Section , a self-enabling permissive provision, provides that, if applicable non-united States law permits, non-united States entities may become domesticated as Delaware LLCs by filing appropriate certificates with the Delaware Secretary of State. Under (h) (first sentence), the non-united States entity may continue to be governed by non-united States law for the relevant non-united States purposes. 7) Section transfers. Section , a self-enabling permissive provision, provides that even while remaining a Delaware LLC for United States legal purposes if it so chooses, an LLC may constitute itself a non-united States entity in any non-united States jurisdiction whose laws permit. 8) Section (a) statutory conversions of LLCs to non-llc entities. Section (a), a self-enabling permissive provision, permits non-llc entities to make statutory conversions to LLCs. 13 9) Section series LLCs. Section of the DLLC Act, a non-self-enabling permissive provision, provides that LLCs may form one or more series and may associate specified members, managers, assets and activities with these series. Under , the parent LLC will have limited liability with respect to claims against each of its series, and each series will have limited liability with respect to claims against each other series and even against the parent LLC. Section 215 is discussed extensively in Chapter 7 of Drafting Delaware LLC Agreements. 10) Section (a) statutory conversions of non-llc entities to LLCs. Section (a), a self-enabling permissive provision, permits LLCs to make statutory conversions to non-llc entities. 11) Section (a) (second sentence) actions without member votes. Section (a) (second sentence), a non-self-enabling permissive provision, provides that an LLC agreement may provide for the taking of specified actions without the vote of any member; and these actions may include the creation of new classes of limited liability company interests and even of amendments of the LLC agreement itself. 12) Section (d) (first sentence) non-contributing members with limited liability company interests. Section (d) (first sentence) (a self-enabling permissive 13 Statutory conversions are procedures whereby an entity changes its business organization form while remaining the same entity. Statutory conversions are roughly similar to interspecies mergers, but, by definition, interspecies mergers involve at least two entities. Statutory conversions involve only one. 13

15 provision) permits persons to become members of an LLC and to receive limited liability company interests without making contributions to the LLC. 13) Section (a) (third sentence) non-voting members. Although voting rights are often viewed as essential rights of owners of entities, (a) (third sentence), a nonself-enabling permissive provision, permits LLC agreements to provide for non-voting members. (Presumably, these members, though they have no voting rights, will, unless the LLC agreement provides otherwise, have limited liability company interests and various non-economic rights, such as fiduciary rights, information rights and the right to attend meetings.) 14) Section (c) manager discretion with respect to LLC information. Section (c), a self-enabling permissive provision, provides managers LLC with broad discretion to keep LLC information confidential from the members if, among other things, these managers believe in good faith that the disclosure of this information is not in the best interest of the LLC or could damage the LLC s business. 15) Section imposition of penalties on members. Despite the general common law prohibition against contractual penalties, DLLC Act , a non-self-enabling permissive provision, provides that an LLC agreement may impose penalties, including the nine specific types of penalties described in 502(c) (second sentence), on members upon their breaching the agreement or upon the occurrence of events specified in the agreement. 16) Section (a) (second sentence) actions without manager votes. Section (a) (second sentence), a non-self-enabling permissive provision, provides that an LLC agreement may provide for the taking of specified actions without the vote of any manager; and these actions may include the creation of new classes of limited liability company interests and even amendments of the LLC agreement itself. 17) Section imposition of penalties on managers. Section , a non-selfenabling permissive provision, provides that an LLC agreement may impose penalties on managers upon their breaching the agreement or upon the occurrence of events specified in the agreement. 18) Section (b) freedom of contract and enforceability of LLC Agreement. Section (b), a provision that is a non-self-enabling permissive with respect to parties to LLC agreements but mandatory toward the courts, provides these parties with maximum freedom of contract in tailoring these agreements to meet the parties needs and interests and it requires the courts to accord maximum enforceability to these agreements. In addition, as construed in the decision of the Delaware Supreme Court in Elf Atochem North America, Inc. v. Jaffari, 727 A.2d 286 (Del. 1999), (b) generally provides that provisions of the DLLC Act that by their terms appear to be mandatory may be construed as default or permissive provisions unless they are intended to protect third parties. The precise parameters of this general rule of construction in Elf Atochem are unclear. However, the rule arguably implies, among other things, that the seemingly absolute right of the Delaware Court of Chancery under (f) to hear cases involving documentary demands and of through 1004 to require claims that belong to the LLC to be brought as derivative actions are mere default rules that may be overridden in LLC agreements. 14

16 19) Section (c) expansion, restriction and elimination of duties. Section (c), a non-self-enabling permissive provision, provides that an LLC agreement may expand, restrict or eliminate the duties of members, managers and other persons except for those arising under the implied contractual covenant of good faith and fair dealing. 20) Section (e) exculpation of liabilities. Section (e), a non-self-enabling permissive provision, provides that an LLC agreement may limit or eliminate the liability of members, managers and other persons for breaches of contract and for breaches of duties except those arising under the implied contractual covenant of good faith and fair dealing. C:\J2\Strafford seminar ff\jmc sentence outline CL.DOC 15