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Equitable protection for LLC shareholders

It didn’t get as much attention as new state laws regarding teen drivers and invasive aquatic species, but legislation regarding limited liability companies could have a significant effect both on those companies and on the attorneys who represent them.

The primary change in the law, which will take effect in stages over the next three years, is that it shifts Minnesota from a corporation-based model to the partnership-based model used by other states.

“To accommodate the existing LLCs, we created a template for a corporate governance structure using a board of governors like the current act has,” said Daniel S. Kleinberger, a professor emeritus at William Mitchell College of Law who helped draft the new legislation. “If people want to use a board of governors, they don’t have to reinvent the wheel, because most of the wheel is already there.”

Minnesota previously had the same remedies available to minority owners of both corporations and LLCs. Under the new act, courts still have the same broad equitable power, but it’s found in a provision for seeking the dissolution remedy for oppressed members, according to Lindquist & Vennum partner Wallace G. Hilke.

“This act is designed with sophisticated parties in mind,” Hilke said. “It contains many if not most of the same protections for minority members that we [had before]. And we departed from the revised Uniform LLC Act in that we have the concept of good faith and fair dealing in our statute that isn’t found in the uniform act.”

Two years of study

The new law, which was signed by Gov. Mark Dayton last April, started with the Uniform Law Commissioners, a national body that advocates for and drafts legislation in areas including business law so that there’s uniformity in statutory frameworks across the United States. Consistency from state to state is that group’s goal.

A few years ago the chair of that committee, Gray Plant principal Bill Klein, had it do a study of the proposed uniform limited liability company act. Kleinberger, the principal designer of the first LLC statute in 1991, was the reporter on the committee that developed the revised act.

“The committee studied the new act and thought it contained several improvements over our prior statute,” said Wade R. Wacholz, a partner with Gislason & Hunter in Minneapolis, who is part of Minnesota State Bar Association’s Business Law Section committee on partnerships and LLCs.

“We spent more than two years in study and negotiation regarding the final text of the bill,” said Wacholz. “The Minnesota law tracks the Uniform Act significantly, but it does have some wrinkles specific to Minnesota, such as a provision that allows an LLC to be governed by a board of governors.”

Minnesota’s corporate law traditionally has had one of the most aggressive protections for minority shareholders, protections that were inserted into the old act as “part of the cost of getting it passed,” according to Kleinberger.

The new act is contract-based, meaning that no longer is the relative voting power of members based on their contributions of capital to the entity. Under the new statute, the number of votes is consistent per person, regardless of how much capital is contributed — if there are three members, each one gets a vote.

“We had to do a lot of discussing and negotiating with people who were concerned about the rights of minority members,” Kleinberger said. “We drafted some clarifying language explaining what oppression means. It makes it clear, we hope, to the courts that you figure out people’s reasonable expectations in light of the contract they made, and that something doesn’t automatically become oppression just because it’s the breach of a contract.”

More consistency

What will the new act mean for business lawyers and their LLC clients? For one thing, it will mean that the LLC law is more like those in other states, including those nearby: Iowa’s had an almost identical law since about 2006, and Wisconsin is working on a version of it. Meanwhile, California, Florida and New Jersey have adopted it, and the law in other states is close to what Minnesota now has.

“Lawyers in other states look at the Minnesota statute as sort of a foreign concept,” Wacholz said. “It put us at something of a disadvantage. Folks tend to run to a state like Delaware to form their entity, which can be expensive and confusing.”

In fact, fostering that consistency and discouraging LLCs from incorporating in Delaware were among the objectives of the new act, according to Kleinberger.

“When you do deals across state lines, no lawyer wants to take the time and the risk of trying to become an expert on another state’s LLC laws,” he said. “That means everybody runs to Delaware, which is a very dangerous place to be. Their laws are extremely complicated, and they change annually to keep out competition.

“The idea is to help lawyers keep from taking what in my judgment is a risky step.”

The new law also means it’s more important than ever that both entrepreneurs forming LLCs and minority investors in LLCs get independent counsel to work with them, according to Hilke.

“It’s going to take a lot of time for folks to get up to speed,” he said. “Anyone who’s practiced in the area of shareholder and member litigation knows that there are a lot of bad operator agreements and shareholder agreements out there. The operating agreement under the new statute allows for many more alterations of rights than we have under the current act.”

Kleinberger, Wacholz and Hilke will be presenting at a CLE about the new LLC act on Friday, Jan. 23. More information is at: seminardetail.aspx?ID=104681501.

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