This year, Ohio made important updates to both its corporate and LLC codes. Overall, the changes to the corporate code were well warranted and should be seen as an improvement over the previous iteration of the code. However, the updates to the LLC code, especially in the area of fiduciary duty, may prove to be too broad and might have the effect of causing Ohio businesses to more frequently organize LLCs in alternate jurisdictions such as Delaware. Importantly, these changes apply not only to new entities, but entities that have already been formed in Ohio.
Revisions to the Corporate Code.
The revisions to both the general corporate code and the limited liability code went into effect in Ohio on May 4, 2012. The revisions to the corporate code add flexibility and certainty to the code, making Ohio a slightly more attractive jurisdiction in which to organize a corporation than before.
Board of Directors
First, bringing the Ohio code in line with Delaware, ORC 1705.56 now allows for a board of directors to have only one member no matter how many shareholders there are. Under the previous rule, a one-member board was not allowed if the company had more than one shareholder.
Voluntary Dissolution and Creditors Claims
Next, the corporate code saw changes to the laws pertaining to voluntary dissolution of a corporation. Now, a resolution to dissolve can set out the future dissolution date as well as provide for authorization for the directors or officers to abandon the proposed dissolution before filing the certificate of dissolution. This gives companies greater flexibility when planning for dissolution.
Next, the statute sets out a procedure for notifying creditors and any party holding a potential claim against the company about the impending dissolution and allows the company to set a deadline to make a claim before such claim is statutorily barred. This notice procedure, which is now similar to that used by Delaware, will add some procedural complication to the dissolution process; however, it will give dissolving corporations greater certainty in the dissolution process – which is ultimately good for both the corporation and for legitimate creditors of the corporation.
The corporate code also now provides that indemnification provisions for directors and officers cannot be eliminated after a claim has arisen. This provides certainty for directors and officers serving Ohio corporations.
Revisions to the Limited Liability Company Code.
Overall, the changes to the LLC code are troubling – working to make the LLC both less flexible and less certain than before. It is also important to note that these changes apply to already existing Ohio LLCs, not just to LLCs formed after the effective date of the changes.
Fiduciary Duties of Members and Managers
The LLC Code now clarifies many of the fiduciary duties of members and managers and limits how these duties can be adjusted in the operating agreement. These changes make Ohio LLC law divert pointedly from Delaware law.
First, the duty of loyalty is now defined in 1705.281(B):
(B) A member’s duty of loyalty to the limited liability company and the other members is limited to the following:
(1) To account to the limited liability company and hold as trustee for the limited liability company any property, profit, or benefit derived by the member in the conduct and winding up of the limited liability company’s business or derived from a use by the member of the limited liability company’s property, including the appropriation of a limited liability company opportunity;
(2) To refrain from dealing with the limited liability company in the conduct or winding up of the limited liability company’s business as or on behalf of a party having an interest adverse to the limited liability company;
(3) To refrain from competing with the limited liability company in the conduct of the limited liability company’s business before the dissolution of the limited liability company.
Importantly, unlike in Delaware, these duties of loyalty may no longer be eliminated from the operating agreement. However, these duties may be limited by “identifying specific types or categories of activities that do not violate the duty of loyalty if not manifestly unreasonable, and all of the members of a percentage specified in OA authorize or ratify, after full disclosure of all material facts, a specific act or transaction that otherwise would violate the duty of loyalty.”
This is important for any member of an LLC who also participates in or even plans to participate in a possibly competing company. In the tech and startup community, these “competitive” practices are very common and will now need to be expressly set out and agreed to by the other members. Furthermore, it may prove difficult to adequately set out just what the competitive practices may be since nothing can be eliminated that is “manifestly unreasonable,” a term that is by its nature, not entirely defined. It will be up to a court to decide what is or is not “manifestly unreasonable,” which will lead to uncertainty for owners and potential litigation costs in the event of a dispute.
Delaware, the likely alternative candidate for a company considering LLC formation in Ohio, allows the duty of loyalty to be entirely eliminated, and because of this, some companies may elect to choose Delaware over Ohio for organization.
Next, the statutory duty of care for members under 1705.281(C) is now limited to “refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law.” Under 1705.81 this duty cannot be “unreasonably” reduced. Similarly for the duty of good faith and fair dealing, 1705.081(B)(5) states that the duty cannot be eliminated, but the operating agreement may “prescribe in writing the standards by which performance is to be measured or specify types or categories of activities that do not violate the duties in each case if not manifestly unreasonable (emphasis added). Along those same lines, under 1705.081(B)(6) the duty of a manager to act in good faith may not be eliminated from the operating agreement, but it may “prescribe in writing the standards by which performance is to be measured or specify types or categories of activities that do not violate the duties in each case if not manifestly unreasonable.”
Again, Delaware allows for the full elimination of these duties in LLC operating agreements. Entrepreneurs should consider whether the elimination of flexibility and the potential for greater risk for managers or investors merits forming a Delaware rather than Ohio LLC, or possibly even whether it would be prudent to convert an existing Ohio LLC to a Delaware LLC.
While the changes to the corporate code are welcome and work to make Ohio a better jurisdiction in which to incorporate, the changes to the LLC code will likely make business owners less confident in choosing to organize an LLC in Ohio. The new statutes have reduced some of the flexibility associated with LLCs and reduced the certainty of a court’s treatment of the operating agreement.