Interpreting Wisconsin’s New LLC Laws
As we approach January 1, 2023, the effective date of the new Wisconsin LLC statute, it’s becoming a hot topic of conversation. If you’ve been watching this space over the last few months, you’ve seen discussion of the new law. You’ll get as many different opinions and reactions to the new statute as there are attorneys to talk to about this topic.
Below is my point of view, based on the variety of LLC businesses that I work with day in and day out and conversations we’ve been having with business owners.
Statement of Non-Applicability
One feature of the new statute is the option to file a Statement of Non-Applicability before the end of the year in order to continue to have your LLC governed by the old statute. I know that some people are thinking hard about this strategy. In my view this would be a good idea for LLCs that are going to be of a short duration. If you have a project where, for example, you’re buying a piece of real estate and planning to flip it sometime soon, you probably formed your LLC with a set of rules in mind and you’d like to retain that same set of rules during the time period your LLC will exist. But if the LLC will be around for a long time, it makes sense, at least to me, to have it governed by the new statute since the old statute will become an anachronism over time. People will lose track of what the old statute was all about. New operating agreements will be drafted with the new statute in mind instead of the old statute. For those reasons, I think it makes more sense to prepare for a future in which the new statute is the rule and draft new agreements and amend old agreements accordingly.
The most common reason for opting out that I’ve seen given is the new rule that, in a single-member LLC, a creditor of the LLC’s member can obtain ownership of the LLC in satisfaction of the debt. The rule under the old statute is that a creditor of a member could only obtain a court order (called a “charging order”) directing that any distributions from the LLC to the member be paid to the creditor instead. That’s still the rule for multi-member LLCs under the new statute. The idea is that the other members shouldn’t have to become partners with a creditor of one of the other members, and the new statute recognizes that this isn’t an issue in a single-member LLC.
So, if you’re the member of a single-member LLC, a benefit of opting out of the new statute is that if you get sued by your bank or other creditors those creditors can’t obtain your ownership in the LLC to get at the assets inside the LLC and can only get at the profits or losses or tax distributions you would normally get from the LLC. If you own a single-member LLC and you’re concerned about being foreclosed on by your creditors, and want to be sure your LLC will remain yours and will keep the assets inside of it, then opting out of the new statute is worth considering. You could also solve that problem by adding another member to the LLC so that it is no longer a single-member LLC. For most people, the most important aspect of putting their business into an LLC is that the LLC shield insulates them from liabilities created by the operation of the company, rather than the other way around.
If in doubt, it would make sense to file this statement before the end of the year, since your LLC can always opt back in to the new LLC laws if it chooses to in the future. And if you’re reading this after January 1, 2023, don’t panic. If there are portions of the new law you don’t want to apply to your LLC, you can amend your operating agreement to address them.
Shifting ownership percentages and rights
The first change that I think impacts most LLCs is that, under the old statute, the written terms of your operating agreement governed who owned how much of the LLC and how they split up profits and allocated voting rights. The operating agreement itself might provide, for example, that the two members are 50/50 owners and split profits equally and have equal voting rights.
Under the new statute, the default rule is that the relative capital accounts of the members establish who owns what percentage of the LLC unless the operating agreement is drafted to provide otherwise. So if one of those two 50/50 members doesn’t take as large a draw or gives the LLC some cash or other item of value, the capital accounts change, and ownership percentages change as well. I don’t think that is what most people intend.
We are drafting new model operating agreements and will draft amendments to existing operating agreements, making it clear that the members intend that the percentages of ownership and the attendant voting rights and rights to profits will remain as stated in the operating agreement, unless and until that operating agreement is amended to say otherwise. Any varying capital contributions or draws should be treated as loans to or from the company. LLCs should also talk to their CPAs to let them know their intent with regard to any variations in contributions or draws and whether they are shown as loans to or loans from the company or as additions to/subtractions from capital and changes in the capital accounts of the members.
Creation of or Changes to Operating Agreements
Another significant change under the new law is that an operating agreement can be created orally or amended orally or by an exchange of emails or text messages. I think that most LLC members would be surprised to learn that a conversation they had with another member could be viewed as having revised their operating agreement permanently despite not being written down and signed as an official amendment.
Under the new statute, the operating agreement is whatever you can prove it is. One member could try to prove terms of the operating agreement that no one else might think are part of their arrangement. To my mind this creates an unending litigation trap in which operating agreements are created and amended and re-revised constantly by conversations and day-to-day e-mail exchanges in ways that members might not understand or intend. Day-to-day communication rarely has the specificity and clarity of an official written amendment.
In this setting, there will be many more arguments about what the operating agreement actually is because it can be amended willy-nilly by conversations and e-mail or even text exchanges that can be used as evidence of an intent to revise the agreement, whether that is what was actually going on in the minds of the parties or not.
I, and the other attorneys at McCarty, are of the opinion that operating agreements should be clearly written to state that amendments cannot be made to the agreement except when they are in writing and signed by all of the members.
Duties of Members and Managers
Another feature of the new statute relates to the duties of loyalty and care that are owed to the LLC by members and managers. Under the old statute and existing case law, members and managers had obligations of loyalty and due care with regard to the LLC, but these duties are more explicit under the new statute.
Under the new law, there are non-waivable duties of loyalty and care for the managers or, in a member-managed LLC, any managing members. A duty of loyalty refers to the obligation not to compete with the company or to have dealings with the company where you have a conflict of interest except where the arrangement is beneficial to the company. In some settings this is exactly what members would intend but in other settings members might intend the opposite.
For example, if a group of investors gets together to purchase an office building in a limited liability company and another office building later becomes available on the market, are the managers or managing members of the first LLC prohibited from purchasing that building with a different group of investors and in a different LLC? Or should they be free to pull together a new, different, perhaps overlapping group of investors for this new project? This is something that each LLC will need to think about as they form the entity. It will also be important to keep in mind that members will not have these obligations, by statute, in a manager-managed LLC or in an LLC where other members are taking on management authority.
Statements of Authority
One final revision worth talking about here is the ability to file a Statement of Authority with the Department of Financial Institutions. An LLC can file this statement to indicate which members or managers have authority, or do not have authority, to make binding commitments on behalf of the company. A Statement of Authority is not a requirement, but it may be beneficial under many circumstances.
Other Fascinating Tidbits
There are numerous other revisions to the statute that could be discussed here but, if you’re reading this sentence, you’ve already been extraordinarily patient, so I’ll keep it short. Those revisions include a change to how charging orders work when creditors of a member try to collect their debts, the permissible content of articles of organization, statutory inclusion of the wrongful disassociation from an LLC, and the ability to have non-economic members of the LLC who have only voting and other management rights and no economic rights in the business of the LLC (which might be useful in the case of a nonprofit LLC).
When do I need to deal with this?
The real deadline here is the December 31, 2022, deadline for filing of a Statement of Non-Applicability, if that’s something you want to do. The other matters discussed above are worth consideration but can be dealt with in January or later.
Scott C. Barr
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