The Tennessee Revised Limited Liability Company Act: Effective January 1, 2006

Alert

January 6, 2006

On June 1, 2005, Tennessee Governor Phil Bredesen signed into law the Tennessee Revised Limited Liability Company Act (the "New Act"), which became effective on January 1, 2006. The following is a brief summary of (i) the reasons for adoption of the New Act, (ii) the applicability of the New Act to existing and newly formed limited liability companies ("LLCs") and (iii) some of the New Act's key changes from the existing Tennessee Limited Liability Company Act (the "Old Act").

Why is there a new statute governing LLCs in Tennessee?

When the Old Act became law in 1994, it was primarily designed to ensure that a properly organized LLC would be treated as a partnership for federal tax purposes while maintaining a corporate-type liability shield. To achieve this goal, it contained numerous, complex technical requirements governing the organization and operation of LLCs. An LLC complying with those requirements would be guaranteed treatment as a partnership for federal tax purposes.

Since 1994, however, the tax laws have changed. Now, an LLC simply has to check a box on a tax form to be taxed as a partnership. Although the Old Act has been amended over the years to remove some of the tax-driven provisions, it continues to be a complex statute that is difficult to navigate and understand.

The Tennessee Bar Association, with encouragement from business attorneys throughout Tennessee, desired to have a simpler, shorter, more flexible and more user-friendly statute, without unnecessary tax-driven provisions. Thus, in 2003 the Tennessee Bar Association appointed a committee of experienced Tennessee business attorneys to make recommendations on the potential implementation of a new, simplified statute governing LLCs in Tennessee. The result of this committee's work is the New Act.

To which LLCs does the New Act apply?

The New Act applies only to (i) any LLC formed in Tennessee on or after January 1, 2006 and (ii) any LLC formed in Tennessee before January 1, 2006 that files an amendment to its articles of organization in which it elects to be governed by the New Act. The Old Act continues to govern all LLCs formed in Tennessee before January 1, 2006 that do not elect to be governed by the New Act.

The New Act also applies to each LLC that is formed in any jurisdiction other than Tennessee and that qualifies to transact business in Tennessee on or after January 1, 2006. A foreign LLC that qualified to transact business in Tennessee prior to January 1, 2006 continues to be governed by the Old Act until the date it files its 2006 annual report with the Tennessee Department of State, at which time it will automatically become governed by the New Act.

What are some key changes from the Old Act?

The following is a list of ten key changes from the Old Act:

1. New Management Structures. One of the most significant changes from the Old Act to the New Act is the change in available management structures for LLCs. The Old Act contained two possible management structures for LLCs: member-managed and governor-managed. Under the New Act there are three possible LLC management structures. The first is a member-managed structure, which is similar to the member-managed structure under the Old Act in that members have powers like those of general partners of a general partnership. The second structure is a manager-managed structure, in which the members elect managers that have powers similar to those of general partners of a limited partnership. The third is a director-managed structure, in which the LLC has a board of directors and officers like a corporation. Also, the requirement that each LLC have an individual acting as Chief Manager, as well as the concept of having a Chief Manager at all, have both disappeared in the New Act. If there is to be a chief executive, that person may now be called "president" or have any other title desired by the LLC.
2. Nonwaivable Provisions. Under the Old Act, one has to read each individual provision to determine if it is changeable or waivable in the LLC's articles of organization or operating agreement. Under the New Act, there is a single section listing 21 items that cannot be changed or waived. Every other provision in the New Act can be altered or waived in the LLC's articles of organization or operating agreement.
3. Classification of Payment for Services. The New Act modifies the definition of "distribution" so that payments made to a member as compensation for services rendered to the LLC are statutorily deemed not to be distributions.
4. Buyout Upon Death of a Member. The New Act provides default provisions for the buyout of a deceased member's membership interest. The estate of the deceased member can require that the LLC buy the membership interest, and the LLC has the option to buy the membership interest if the estate of the deceased member does not require the LLC to buy it.
5. Dissolution. Under the Old Act, there are several complex provisions in which the dissolution of an LLC could be triggered by the termination of a membership interest (especially for LLCs formed prior to July 1, 1999). These provisions were designed to make sure that the LLC would be treated as a partnership for federal tax purposes. Under the New Act, the termination of a membership interest never automatically triggers the dissolution of an LLC.
6. Family LLCs. The New Act contains default provisions that are designed to ensure that members of a "family LLC" (one in which 50% or more of the members are from the same family) do not have the power or right to terminate their membership interests. These provisions, if not overridden in the LLC's articles of organization or operating agreement, guarantee that LLCs formed for estate planning purposes qualify for certain federal gift and estate tax discounts.
7. Conversions. Under the New Act, any entity organized in any other jurisdiction may convert to a Tennessee LLC if the laws governing the other entity permit the conversion. Similarly, the New Act permits a Tennessee LLC to convert to another entity in another jurisdiction if permitted by the laws of the other jurisdiction. Under the Old Act, the only permitted conversion was from a Tennessee limited partnership to a Tennessee LLC.
8. No Statutory Appraisal Rights. The New Act contains no statutory appraisal rights for the holders of minority membership interests in an LLC in the event of the merger of the LLC, the conversion of the LLC or sale of all or substantially all of the LLC's assets. Minority owners who desire to seek fair value for their membership interests in any of these events must now withdraw from the LLC (if not prohibited by the LLC's articles of organization or operating agreement) in order to receive "fair value" for their membership interests.
9. Professional Limited Liability Companies. The provisions governing professional LLCs contain several technical and stylistic changes from the Old Act to eliminate inconsistencies with the provisions of the statute governing professional corporations.
10. Fiduciary Duties. The Old Act leaves open the possibility for a court to create fiduciary duties in addition to those set forth in the Old Act. The New Act makes it clear that the only fiduciary duties owed by a member of a member-managed LLC or by a manager of a manager-managed LLC are the statutory duties of loyalty and care. The directors of a director-managed LLC and the officers of any LLC are held to the same standards of conduct as directors and officers of corporations under the Tennessee Business Corporation Act.

Please note that the foregoing list is only meant to highlight some of the most important changes from the Old Act to the New Act. There are several other differences, substantive and stylistic, from the Old Act.

If you are interested in learning more about the New Act, or determining whether electing to be governed by the New Act may be a good decision for your LLC, please feel free to contact your usual Baker Donelson attorney if you are an existing client or any of the attorneys listed below. This alert was prepared by Jim Levine, a shareholder in our Chattanooga office who is a member of the Tennessee Bar Association's LLC Act revision committee.

Chattanooga, Tennessee

Knoxville, Tennessee

Tri-Cities Tennessee/Virginia Office

Nashville, Tennessee

Memphis, Tennessee