Changes to Indiana Business Flexibility Act Likely to Impact LLCs Significantly
May 20, 2013    Disclosures    POSTED IN  Personal FinanceInstitutional ServicesEducation

Authored by John Millspaugh, Attorney, and Alan Becker, Attorney, Bose McKinney and Evans, LLP.

The Indiana General Assembly recently approved changes to the Indiana Business Flexibility Act that appear likely to have a significant impact on LLCs, especially related to estate planning for LLC members and fiduciary relationships between LLC members.

House Enrolled Act (HEA) 1394 (the “Act”) was signed into law by Governor Pence on April 9, 2013.  The revisions become effective July 1, 2013.  All together, the Act impacts Indiana corporations, partnerships, LLCs, nonprofit corporations and limited partnerships, although the biggest changes affect Indiana LLCs.

These seem to be the most important developments for LLC owners and we lawyers who serve them:

  • Nonprofit LLCs – The Act now explicitly permits LLCs to have a specified business, personal or nonprofit purpose.  The addition of personal or nonprofit purposes likely clarifies what was previously allowed (but was not explicit), and also forecloses potential disagreements over whether an LLC must maximize profits or member returns (if a different purpose is specified).  I.C. 23-18-2-1.
  • LLC Officers – Management structure flexibility serves as a big selling point for the LLC over other entity types.  The Indiana law previously spoke in terms of member-managed or manager-managed companies exclusively, although many an LLC boasts a superimposed pseudo-corporate management structure with more traditional director and officer titles created solely by the operating agreement.  The Act embraces this pseudo-corporate structure and allows creation of “officers” in the operating agreement.  As defined in the Act, these officers will have the duties and powers specified in the operating agreement, will be agents of the LLC, may bind the LLC through acts within the officer’s apparent authority, and notice of business matters provided to an officer will be deemed notice to the LLC.  However, authority to manage the LLC was not granted to officers by the Act; this power is still reserved to members or managers unless passed down to an officer in the operating agreement.  In many cases, officers will already be designated as managers in the operating agreement or will already be members with management authority, so actual authority will not be a question (except as and if limited in the operating agreement).  But if officers are not designated as managers or are not managing members, it will be important to address the scope of officers’ management authority in the operating agreement.  I.C. 23-18-3-2.5 and I.C. 23-18-4-4.
  • Contractual Limitation or Elimination of Fiduciary Duties.  Indiana common law imposes fiduciary duties on members of LLCs similar to those imposed on shareholders in close corporations.  Unlike in some other states, in Indiana the extent to which members could modify or eliminate those fiduciary duties by contract was unclear.  The Act settles this issue by allowing members to “modify, increase, decrease, limit or eliminate the duties (including fiduciary duties) . . . of a member or manager” in the operating agreement.  I.C. 23-18-4-4.
  • Agreement of the Members is Paramount.  The Act includes a broad statement that Indiana policy “is to give the maximum effect to the principle of freedom of contract and to the enforceability of operating agreements of limited liability companies.”  This gives LLC members authority to create enforceable business arrangements in their operating agreements even if the law is silent about whether they are permitted.  I.C. 23-17-4-13.
  • Estate Planning – In order to facilitate estate planning by LLC owners, the Act amended Indiana law to permit LLC interests to be held by two or more persons as joint tenants with right of survivorship, and to permit LLC interests to be designated as “transfer on death property” with a designated beneficiary of the interest on the death of the member.  In both instances, the survivor/beneficiary following the death of a member automatically receives the interest of the deceased member (without probate), and the survivor is treated as an assignee of the interest (meaning, essentially, they have an economic interest but no voting or management authority in the LLC) unless and until the survivor is admitted as a full member of the LLC by the other members.  (That is, except in the case where the surviving joint tenant was admitted as a member before the death of the deceased joint tenant, in which case the survivor continues as a member.)  More than one joint tenant may be admitted as a full member with respect to the interest held in the joint tenancy.  The Act also clarifies that all transfer restrictions, redemption provisions and the like contained in an LLC’s operating agreement will likewise apply to the interest held by the survivor/beneficiary.  I.C. 23-18-6-2.5.
  • Unanimous Approval of LLC Dissolution – The Act fixes what this author viewed as a flaw in current Indiana law, which required dissolution of LLCs upon approval of 2/3rds in interest of the members (or 2/3rds in interest of each class of members if more than one class) but did not allow modification of the dissolution approval threshold by agreement.  This yielded a unique and immutable statutory pressure point reserved (somewhat arbitrarily) for the benefit of significant (2/3rds or greater) majority owners.  The Act now defaults to a rule that protects minority owners but also provides contractual flexibility:  unanimous member approval of dissolution is now mandatory for LLCs formed after June 30, 2013, unless a lower approval threshold is specified in the operating agreement.  This is a positive development, but it will also be a trap for the unwary operating agreement drafter whose client owns more than 2/3rds of a new LLC, yet fails to recognize that unanimous approval of dissolution is now the default rule.  I.C. 23-18-9-1.1.

John Millspaugh and Alan Becker are partners in the Business Services Group at Bose McKinney Evans, LLP.

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