Cozen O’Connor: Comprehensive Revisions to Pennsylvania Law Mean Big Changes for LLCs and Partnerships

Comprehensive Revisions to Pennsylvania Law Mean Big Changes for LLCs and Partnerships

Corporate Alert

April 25, 2017

If you have any dealings with a Pennsylvania limited liability company, Pennsylvania limited partnership, or Pennsylvania general partnership, then April 1, 2017, was an important date for you. That is the date on which Pennsylvania Act 170 (Act) became effective.1 The Act results in comprehensive changes to the existing law relating to the governance and operation of limited liability companies, limited partnerships, and general partnerships.

While the Act amends numerous provisions of Title 15, Corporations and Unincorporated Associations, it completely replaces those chapters of Title 15 governing general partnerships, limited partnerships, and limited liability companies (collectively the “alternative entities”). In an effort to modernize Pennsylvania law, each of these chapters has been replaced by new chapters generally based on the Uniform Partnership Act (UPA), the Uniform Limited Partnership Act (ULPA), and the Uniform Limited Liability Company Act (ULLA).

The new chapters set forth certain default rules that the owners of alternative entities can modify in the operating agreement or partnership agreement. This freedom of contract among the owners to modify the governance and operation of alternative entities is subject to certain provisions that the Act states cannot be varied or may be varied subject to a stated limitation.

Fiduciary Duties

Perhaps the most important change under the Act is its modification of the rules pertaining to fiduciary responsibilities of members, managers, and partners of alternative entities. Prior to the Act, Title 15 did not permit variation of the fiduciary duties of partners, members, and managers, similar to the fiduciary duties of a director of a business corporation. The Act provides default rules for alternative entities pertaining to such fiduciary responsibilities that are quite extensive, including what fiduciary duties partners, members, and managers owe. Notwithstanding the default rules, the Act allows such default rules to be modified by the operating or partnership agreement and the certificate of organization, subject to those provisions that the Act states cannot be varied.

The ability to modify the default rules with respect to fiduciary responsibilities is significant. Under the Act, certain fiduciary duties of a member, manager, or partner may be expanded, restricted, or eliminated by provisions in the operating agreement or partnership agreement, but the implied contractual duty of good faith and fair dealing may not be eliminated. For instance, certain aspects of the duty of loyalty, including the duty to refrain from appropriating company opportunities, may be eliminated if the agreement so states. This is an attempt to modernize Pennsylvania law and bring it more closely in line with Delaware law governing alternative entities. The Act, however, does not go as far as Delaware law and limits this contractual freedom by requiring any restriction or elimination of fiduciary duties to be subject to a not “manifestly unreasonable” standard. While the scope of this standard has not been delineated in the statute or by the courts, as noted in the Committee Comments to the Act, proving that a term of an operating agreement or partnership agreement is manifestly unreasonable is a very demanding standard. A court may only invalidate such a term if, in light of the purposes, activities, and affairs of the entity, it is readily apparent that the objective of the term is unreasonable or that the term is an unreasonable means to achieve the term’s objective. Because of the ability to limit or restrict fiduciary duties of partners, members, and managers of alternative entities, persons serving in those roles should consider amending the applicable operating agreement or partnership agreement (and including in future operating agreements or partnership agreements) provisions that take advantage of these new protections, if appropriate.

Nonprofit Limited Partnerships and Nonprofit LLCs

The Act permits the creation of nonprofit limited partnerships and nonprofit limited liability companies, in addition to nonprofit corporations that have been permitted for many years. The nonprofit purpose must be stated in a public filing and certain other provisions fundamental to a nonprofit entity must be included in the operating agreement or partnership agreement. These two new types of nonprofit entities permit greater freedom of contract in modifying the governance and operation of the entity, which are not permitted in nonprofit corporations.

Benefit Limited Liability Companies

The Act permits the creation of benefit LLCs (called benefit companies). Benefit corporations were authorized in Pennsylvania several years ago. Benefit companies (and benefit corporations) are entities that have an explicit purpose of creating a general public benefit. In order to qualify as a benefit company, the company’s status as a benefit company must be clearly stated in the certificate of organization and certain requirements must be met. Benefit company members or managers must consider the effect of any company action on the company’s members, employees, and customers (as beneficiaries of the public benefit purpose), as well as the community, the local and global environment, and any short-term and long-term interests of the company. The members and managers must also take the company’s continued ability to accomplish its public benefit purpose into account when making decisions. While the requirements are extensive, the ability to create benefit companies, in addition to benefit corporations, is an important revision.

Charging Orders

The Act also clarifies and codifies certain concepts, such as transferable interests and charging orders, which were previously murky under Pennsylvania case law. The statute now provides that, absent a contrary provision in the operating agreement or consent of all of the members, a transferable interest is the only interest in an LLC that can be transferred to a non-member. Unlike the transfer of an entire membership interest, the transfer of a transferable interest will not cause the dissociation of the transferring member. Instead, when a transferable interest is transferred, the transferee will obtain the right to distributions while the transferring member will retain governance rights. If a judgment is entered against the member or transferee, the judgment creditor may, on application to the court, obtain a charging order against the transferable interest for the unsatisfied amount of the judgment. The charging order acts as a lien on the transferable interest requiring any distributions to go to the judgment creditor instead of the judgment debtor. Neither the court nor the creditor has any influence over the timing or amount of distributions; however, if it becomes apparent that the distributions will not cover the judgment amount, the court may foreclose the lien and order the sale of the transferable interest. The purchaser at the foreclosure sale will receive only the transferable interest unless the foreclosure is against a single member LLC, in which case the foreclosure would actually force the dissociation of the sole member and the purchaser would obtain the entire membership interest. While case law in Pennsylvania previously attempted to define the scope and effect of transferable interests and charging orders, this codification in the Act provides important clarity.

Liability Partnerships and Limited Liability Limited Partnerships

Another important amendment under the Act is the creation of a full liability shield for general partners in a limited liability partnership (LLP) or a limited liability limited partnership (LLLP). Before this revision, a general partner in an LLP or an LLLP could only be protected from liability for negligent or wrongful acts or misconduct committed by another partner or representative of the partnership, but not from contractual liabilities (such as under bank loans or leases). The Act broadens the liability shield so that a general partner in those entities is not liable for any debts or obligations of an entity, whether sounding in contract or tort. As a result of the Act, general partners will now only be liable for their own negligent or wrongful acts, a standard more akin to that of a shareholder in a corporation.

Conclusion

The amendments adopted by the Act are extensive and govern everything from the contents of the certificate of organization (an LLC no longer is required to state in its certificate of organization if it is member managed or manager managed) to the ability to alter fiduciary duties. This Alert touches on a small number of changes to the Act. It is important to contact your attorney to fully understand the implications that these amendments will have on you.

1 The effective date of the Act was February 21, 2017, for entities formed after that date and for entities formed prior to that date if such entity specifically elected to be governed by the Act prior to April 1, 2017.

 


Authors

Joseph C. Bedwick

Member

jbedwick@cozen.com

(215) 665-4753

Larry P. Laubach

Chair, Corporate Practice Group

llaubach@cozen.com

(215) 665-4666

Related Practices


To discuss any questions you may have regarding this Alert or how the Act may apply to your particular circumstances, please contact Joseph C. Bedwick at jbedwick@cozen.com or 215-665-4753, Larry P. Laubach at llaubach@cozen.com or 215-665-4666, or your principal Cozen O’Connor lawyer.