The Business Lawyer
American Bar Association
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LLC Default Rules Are Hazardous to Member Liquidity
DOI 10.928/ac.2021.03.25, Volume: 76, Issue: 1,
Abstract

Simply by forming LLCs, entrepreneurs now unwittingly lock themselves in to perpetual entities that offer them no liquidity and present them with costly procedural obstacles to enforcing both their agreement among themselves and their statutory rights. Even in at-will LLCs that are member-managed, recent LLC acts deny members both a right to dissolve and a right to be bought out. While thus locking members in, these acts deny them standing to bring many if not most of their claims among themselves or against the firm. In swinging so dramatically toward a corporate model, recent acts have failed to consider the presumptive intent of small groups of entrepreneurs who operate informally and expect to have a direct role in management. At least in the case of member-managed LLCs, legislatures should reinstate more appropriate default rules and courts should be receptive to claims that members never intended their relationships to have such harsh consequences.

Weidner: LLC Default Rules Are Hazardous to Member Liquidity

Introduction

In the mid- to late-1990s, there was unprecedented legislative activity to offer unincorporated business owners liability shields protecting them from personal liability for the obligations of the firm. In 1994, the Uniform Law Commission (“ULC”) approved the first major overhaul of partnership law in eighty years.1 Only three years later, the ULC added to it the option to become a limited liability partnership (“LLP”) with a protective shield. This combined package, which the ULC refers to as the Uniform Partnership Act (1997)2 but is popularly known as “RUPA,” is the law in most states. At about the same time the ULC finalized RUPA, it also finalized the Uniform Limited Liability Company Act (1996) (“1996 Act”),3 with its shield for members of limited liability companies (“LLCs”).

The LLP and LLC shields were virtually identical, and the two acts were also extremely similar on the two key issues that are the subject of this article: they provided members with significant liquidity rights and with easy access to judicial remedies. In just ten years, the ULC promulgated the 2006 Uniform LLC Act (“RULLCA”),4 which reversed course on both these key issues. It declared LLCs to be perpetual entities, and it denied dissociated members both the right to dissolve and the right to be bought out. It also took away their easy access to judicial remedies by importing the direct versus derivative distinction from corporate law. This rapid and dramatic change between these two uniform acts reflects the national shift that has taken place on these two key issues. The purpose of this article is to explain and critique this shift, which leaves LLPs and LLCs with very different default rules.

Part I of this article explains that RUPA’s default rules were primarily designed to reflect the presumed intent of small groups of entrepreneurs who form without representation and expect to operate their business informally. These rules included significant liquidity rights and gave partners easy access to judicial remedies, although the buyout rules included corporate-style procedural requirements the target groups probably do not intend. Part II discusses how and why the uniform LLC acts first embraced, then eliminated, the liquidity rights of partners. The default rules were redirected away from small LLCs formed without the benefit of counsel in order to protect family LLCs engaged in sophisticated estate planning. This elimination of liquidity rights made LLCs more like corporations. Part III critiques how and why the uniform LLC acts first embraced, then eliminated, easy access of members to judicial remedies, adopting instead the corporate approach that denies members standing to bring claims RULLCA now classifies as derivative. In addition to noting the usual arguments that the derivative limitation typically serves no policy in the context of closely held firms, Part III argues that the limitations on judicial remedies are costly obstacles that are contrary to the presumed intent of most small groups of entrepreneurs. In particular, the default rules on special litigation committees are both cumbersome and inconsistent with broader national law that disfavors pre-dispute binding arbitration in the absence of clear agreement. Part IV concludes that, by forming LLCs, entrepreneurs across the nation are now unwittingly locking themselves in to perpetual entities that offer them no liquidity and present them with costly procedural obstacles to enforcing both their agreement among themselves and their statutory rights. It further concludes that, at least in the case of member-managed LLCs, the statutory default rules ought to be brought closer to those that apply to LLPs, which more accurately reflect the presumed intent of small groups of entrepreneurs who form businesses without the benefit of counsel. If LLC acts are not liberalized to restore greater liquidity rights or other member remedies, courts should be attentive to claims made by members that they are protected by oral operating agreements, by the terms of an overarching partnership, or by historic principles of law and equity.

A RUPA Perspective on Choice of Default Rules

Choosing the Default Rule: Number and Character of Target Group, Their Presumed Intention, and a Conception of the Entity

The RUPA Drafting Committee considered the choice of default rules to be informed by the number and character of the target group, their presumed intention, and a particular conception of the entity.

The Target Group: Small, Informal, and Unrepresented

RUPA’s primary target for default rules is small groups of entrepreneurs who organize their business without the benefit of counsel. The drafters assumed that, whatever the mix of services and capital the members contribute, they all expect to have some role in the management of the business, which they expect to operate informally. The Committee thought that the members are often heavily invested in the firm, perhaps with little or no diversification, and so might be looking to the firm for income, through either distributions or salaries to themselves or their family members.5 They are also likely to engage in other third-party transactions, such as selling or leasing property to the partnership or lending it money.

These small, informal groups of entrepreneurs are in greatest need of appropriate statutory default rules because, unlike large firms or syndications of investment interests, they typically have little or no written partnership agreement.6 They tend to avoid or minimize a written agreement for any one of a number of reasons. They may rely on the glue of their pre-existing relationships, either as friends, family members, or business associates. They may underestimate the problems that are likely to arise over the life of the business, or want to avoid lawyers, either on aesthetic grounds, to save costs, or to avoid facing difficult issues lawyers might call to their attention. The task of the Drafting Committee, in a sense, was a very modest one. Throughout the Committee’s deliberations on RUPA, the recurring hypothetical involved two or three people who owned and worked in a business that used a truck.

Default Rules Based on the Presumptive Intention of Target Group

The RUPA default rules were based on the Committee’s determination of the presumptive intention of the target group. In drafting an “off the rack” partnership agreement for these small groups of entrepreneurs, the Committee asked two separate questions about their presumptive intent. One, what are the terms that the parties would probably have in mind but fail to express? Two, what are the terms that the parties probably would not have in mind, but would agree to if the matter were brought to their attention? These two questions of presumptive intent are essentially empirical questions. To the extent the Committee could not with any confidence determine presumptive intent as an empirical matter, it chose a default rule it thought was most likely to be fair.

It is especially important to avoid inappropriate default rules for a target group that has little or no written agreement. For this group, the cost of an inappropriate default rule is not the cost of drafting around it. For this group, there is no practical difference between a default rule and a mandatory rule. A person who finds herself on the wrong side of a default rule will be forced either to accept it or to incur what might be considerable cost to try to establish a contrary agreement, either through negotiation, mediation, arbitration, or litigation before a court.

The Committee had no empirical studies to answer the two questions of presumptive intent. The best evidence of presumptive intent was the experience of the members of the Committee and the statements of numerous other attorneys involved in the RUPA process. The ULC often appoints drafting committees of generalists, on the assumption that generalists in the legislatures enact the ULC products and on the further assumption that the statutes need to be accessible by generalists. Generalists on the Drafting Committee, and more broadly among the membership of the ULC, often defer to others, especially American Bar Association (“ABA”) Advisors, who often have considerable additional experience across a wide range of industries. ABA Advisors are also important because the ULC is aware that ABA support or opposition can make or break uniform adoption by the states, which is a primary goal of the ULC.

On occasion, the Committee added default rules that reflected language that appeared in agreements drafted and negotiated by some of the sophisticated business counsel involved in the drafting process, precisely the sort of expertise we assumed our target group would not have at its side. Particularly in the case of a partner’s right to be bought out, the result was longer and more technical default rules.7 Unfortunately, the details went beyond what we could have assumed was the intent of our target group of unrepresented entrepreneurs.8 Instead, the rules reflected what the Committee felt were fair provisions similar to those that had been included in agreements that had been fully negotiated with the assistance of counsel.

The Conception of the Entity

RUPA was drafted to replace the venerable Uniform Partnership Act of 1914. Without belaboring here the UPA’s well-documented history, the UPA began with an emphasis on an entity theory and ended with an emphasis on an aggregate theory. In the end, the UPA represented a blend of both approaches. In terms of partnership property, for example, an entity-type of result was reached but stated in aggregate terms. The UPA declared each partner a co-owner of partnership property,9 but then removed the normal incidents of co-ownership.10

RUPA declared for the first time that a “partnership is an entity distinct from its partners.”11 First, declaring partnerships as entities reflected the reality that third parties treat partnerships as entities. Second, the entity theory was consistent with the intent to give stability to partnerships that had contracted for it. Third, the entity theory was adopted for the sake of simplicity.12 For example, the rules reflecting partnership property are much more cleanly and simply stated in terms of an entity theory. Finally, RUPA partnerships become even more entity-like if they register as LLPs to qualify for the “shield” against personal liability for partnership obligations.13 The RUPA rules for limited liability partners are very different from the new rules for limited liability company members. Entrepreneurs seeking the shield of an unincorporated form should carefully consider their choice between an LLP and an LLC.

RUPA made no attempt to adopt a theoretically pure entity model. The Committee adopted an entity theory only to reach and clearly state the substantive results it wanted, not the reverse. As was the case in the UPA, it adopted a blended approach. RUPA includes aggregate features, particularly on issues affecting the relationships among the members themselves. It adopted an aggregate approach to look “inside” the partnership to identify and enforce the partners’ expectations of one another and of the firm. Most importantly, for example, a partner has fiduciary duties both to the partnership and to the other partners.14 As noted commentator Bob Keatinge so aptly summarized, the transition from the UPA to RUPA represents “going from a partnership’s being an aggregate which is sometimes an entity to an entity that is sometimes an aggregate.”15

RUPA’s blended approach to the entity is similar to the blended approach the federal income tax law takes to partnerships and LLCs. While overall, the partnership is a tax-computing and reporting entity, the partnership rules, now also the LLC rules, still possess many aggregate features. In some cases, the parties are free to choose whether to adopt an aggregate approach or an entity approach. For example, assume a taxpayer purchases an interest in a partnership or LLC that has highly appreciated depreciable assets. The taxpayer can be treated simply as purchasing an interest in the entity, which will compute and allocate to the purchaser its share of the entity’s depreciation deductions. Or, the entity and the purchaser can elect to look inside the entity,16 and recognize that the price the purchaser is paying for a membership interest reflects the purchaser’s share in the entity’s highly appreciated, depreciable assets.17 The result is that the purchaser can claim more depreciation deductions than if it had simply been allocated its share of the deductions computed and reported by the entity.

No Concern for the Length of the Statute

The RUPA Drafting Committee ultimately dismissed concerns that the statute could get too long. The prevailing view was that the Committee should include all the rules it thought appropriate, and not concern itself with the risk that the statute was getting too long. On occasion, the prevailing view was that the Committee should answer, in the statute, every significant question that was raised. The more questions addressed and answered in the statute, the longer it got.

A statute ought to be short enough and clear enough to state a readily accessible philosophy of the business organization. The statute ought to be easily readable, certainly by lawyers and judges, and ideally by the parties themselves. The longer statutes get, the more difficult they are to read, especially by generalists. In addition, the longer and more detailed the default rules, the greater the likelihood of error in determining presumptive intent.

The tax rules for allocations in partnerships and LLCs illustrate the pitfall.18 Those rules, traditionally addressed to small business, were revised in the 1980s to comprehensively address tax shelter allocations, and in the process became unreadable by small businesspeople, their accountants, and their attorneys. Unlike state statutes defining business associations, the federal income tax rules are divided between the statute and the regulations under it. That is, to some extent, the statute can serve as a shorter conceptual overview and leave it to regulations to get into the weeds. On the state law side, however, everything is in the business statute, weeds and all. That means that the business statute is much longer than it would be if some of the details could be diverted to regulations.

The Importation of Corporate Law into RUPA

In General

There is no reason the statutory reform of the law of any business organization should reinvent the wheel. It can be efficient to borrow from successful provisions of other statutes. For example, it makes sense for a partnership or LLC drafting committee to borrow from other statutes defining when a firm is imputed with the knowledge or notice of its owners. Borrowing successful provisions in existing law not only makes the drafting process less costly, it also lowers the information costs to the ultimate readers of the statutes. The reader has to spend less time parsing the partnership knowledge and notice rules if she recognizes them from the Uniform Commercial Code or from LLC law.

It was therefore expected and perhaps commendable that real estate and law firm experts wanted the best of partnership law continued, estate planners and investment groups wanted the best of limited partnership law reflected, and corporate lawyers wanted their favorite corporate law reflected. A major problem with this borrowing is that rules from other business forms do not always fit.

An Example of a Bad Fit Within the RUPA Buyout Rules

RUPA provides that a partner who dissociates from a term partnership has the right to be bought out for a statutorily defined buyout price. The partnership must tender either cash or a promise to pay it at the end of the term. However, RUPA went further and imported from corporate law certain procedural rules about how the buyout right is to be exercised. Those rules require a partnership to give its estimate of the buyout price and either pay the amount, or tender a promise to pay it,19 “within 120 days after a written demand20 for payment.”21 A dissociated partner who wants to sue the partnership to determine the buyout price must do so “within 120 days22 after the partnership has tendered payment or an offer to pay or within one year after written demand for payment if no payment or offer to pay is tendered.”23

These procedural provisions, and the statutes of limitations within them, were drawn from “the dissenter’s rights provisions” of the Revised Model Business Corporation Act.24 There are two basic reasons they do not quite fit in RUPA. First, they are inconsistent with the fundamental rule that a partnership can be formed and operated without the need for a writing. Indeed, no writing is required to dissociate from a partnership. These procedural rules, however, make writings particularly important. Second, the 120-day statute of limitations, for example, is inconsistent with the fundamental rule of RUPA section 405 that general law determines the limitation periods on actions between a partner and the partnership. RUPA intended the partnership agreement to be treated as a normal commercial contract, and as such be subject to normal limitation periods.

A more fundamental problem with inserting these corporate rules25 is that even attorneys with a deep expertise in all other areas of partnership law—indeed, with every other provision of RUPA—could be completely blindsided by these dissonant procedural rules and their statutes of limitations. These rules are also likely to serve as a trap for unwary members of our target group, both dissociating partners and the continuing partners.26 Dissociating partners may not be aware that they need to make a written demand for payment. The continuing partners may not be aware that they have only 120 days to respond. Indeed, even if the continuing partners know of the 120-day period, they may find the deadline difficult to meet. Partnerships without counsel or sophisticated accountants may find it difficult to mark assets up or down to market, estimate known and unknown liabilities against which they are required to indemnify the dissociating partner, and estimate any damages from wrongful dissociation, all within 120 days. Finally, the dissociating partner may then not realize she has only 120 days to respond to the partnership’s tender or be barred from suing the partnership to determine the buyout price. The only people who will not be surprised are the very sophisticated corporate lawyers whom we assume our target group does not have at its disposal.

LLC Acts First Adopt with Modification, then Eliminate, RUPA’s Liquidity Rights

RUPA Liquidity Rights

A partner’s liquidity rights under RUPA vary depending upon whether the partnership is at-will or for a term. If there is no agreement “to remain partners until the expiration of a definite term or the completion of a particular undertaking,”27 the partnership is classified as “at-will” and each partner has a right to dissociate and cause a winding up of the business and be paid a share of the surplus after creditors are satisfied.28 On the other hand, if a partnership is for a term or particular undertaking, each partner has the power to dissociate, but is denied the right to trigger a business windup. Instead, the other partners have the right to continue the business, provided they buy out the dissociating partner for a statutorily defined buyout price,29 which is determined at the date of the dissociation.30

The buyout price generally does not have to be paid until the end of the term.31 If a partner were allowed to exit prematurely and force the continuing partners to pay the buyout price in cash, the continuing partners could be hurt in any number of ways. In order to pay the buyout price, they might be forced to sell or mortgage firm assets. Therefore, the default rule allows the continuing partners merely to promise to pay the buyout price in the future—at the end of the term—provided they secure their promise to pay.32 However, a dissociating partner may demand earlier payment if she “establishes . . . that earlier payment will not cause undue hardship to the business of the partnership.”33

The 1996 LLC Act Eliminated the Liquidation Right but Provided Two Different Buyout Rights

Same Target Group as RUPA: Similar Liquidity Rules

The liquidity rights of members under the 1996 Uniform LLC Act are very similar to RUPA’s liquidity rights of partners because the drafters had the same target group in mind. They “maintained a single policy vision—to draft a flexible act with a comprehensive set of default rules designed to substitute as the essence of the bargain for small entrepreneurs.”34 They “recognized that small entrepreneurs without the benefit of counsel should also have access to the Act. To that end, the great bulk of the Act sets forth default rules designed to operate [an LLC] without sophisticated agreements and to recognize that members may also modify the default rules by oral agreements defined in part by their own conduct.”35

At-Will Versus Term: One of Two Key Designations

As under RUPA, the liquidity rules of the 1996 Act were based upon the fundamental distinction between at-will firms versus those for a term or particular undertaking. It also continued the default rule that LLCs are at-will.36 The at-will versus term designation was one of two “key designations” under the 1996 Act. The other was whether the LLC is member-managed or manager-managed. According to the Prefatory Note, “[a]ll default rules under the Act flow from one of these two designations.”37 The liquidity rules in particular flowed from the at-will versus term designation.

Member Dissociating from At-Will LLC Denied Windup Right but Given Immediate Buyout

Unlike RUPA, the 1996 Act does not give a dissociating member in an at-will LLC the right to force a business windup. The drafters eliminated the windup right in part because of criticism that said that the right to “blow up” an at-will partnership gives the dissociating partner too much leverage over the partners who wish to continue the business.38 The drafters also wanted to take advantage of new tax rules providing that LLCs could be taxed as partnerships even if they more nearly resembled corporations.39 Instead of a windup right, members of an at-will LLC “may demand a payment of the fair value of their interests at any time,”40 with fair value41 “determined as of the date of the member’s dissociation.42 Because valuation is set at dissociation, a dissociated member in an at-will company “receives the fair value of their interest sooner than in a term company and does not bear the risk of valuation changes for the remainder of the specified term.”43

Member Dissociating from Term LLC Has Diminished Deferred Buyout Right

If, on the other hand, the LLC is for a term, a dissociating member “must generally await the expiration of the agreed term.”44 However, unlike the buyout from a term partnership, the fair value of the interest is not determined at the time of dissociation. Instead, it is determined as of “the date of the expiration of the term.”45 Thus, a member who dissociates from a term LLC bears the risk of further declines in value between the time of her dissociation and the end of the term. If the LLC extends its term after the member dissociates, the term that matters is the term “at the time of the member’s dissociation.”46

RULLCA Eliminated Both Buyout Rights: The Question Is Why?

Elimination of Buyout Rights and the “Necessary” Oppression Action

Like the 1996 Act, RULLCA denies dissociating members the right to trigger a windup. However, RULLCA also denies dissociating members a right to be bought out, either in an at-will LLC or in a term LLC. Indeed, the labels “term” and “at-will” no longer appear in the statute. Instead, LLCs are declared to be entities that have “perpetual duration,”47 just like corporations and, more recently, limited partnerships. A member’s liquidity right is simply the right to share in distributions of any surplus whenever, if ever, the perpetual entity is wound up.48 While awaiting a liquidating distribution, a member still has the right to her share of any current distributions. If she dissociates, her interest is “degraded” to that of a mere transferee.49

It is remarkable that there is virtually no explanation in the Prefatory Note or Official Comments about the elimination of all buyout rights. The only mention of their elimination is in a statement in the Prefatory Note that, because members are being denied the right to be bought out from entities now deemed to be perpetual, it is “necessary to give them a right to seek judicial dissolution in the event of oppressive conduct.50 There are three responses to this language, which at a minimum supports the inference that the remedy for oppressive conduct is being added because members are now being locked in. First, the 1996 Act, which included two buyout rights, already gave members and dissociated members a right to judicial dissolution in the event of oppressive conduct.51 Second, RULLCA actually reduces access to the oppression remedy by taking it away from dissociated members.52 Third, not all states that adopted RULLCA included its oppression remedy. Florida, for example, eliminated the buyout rights but rejected its “necessary” protective remedy in the event of oppression.53

Commentators were of course quick to point out that minority members of LLCs were being “locked in” and made as vulnerable to abuse as minority shareholders in closely held corporations.54 Some defenders of the new regime have suggested that the LLC “lock in” is not as bad as the corporate lock in. The minority shareholder is typically locked in to a corporate regime that is governed by majority rule. Hence, the minority shareholder is vulnerable to changes made by the majority. By contrast, in the typical LLC, the minority member has some protection because the operating agreement cannot be changed without unanimous consent.55 Despite this difference, there is no question that the elimination of liquidity rights still leaves minority members vulnerable to the majority, for example on important issues such as employment, compensation, and fringe benefits.56

Why the Course Reversal?

The obvious question is why RULLCA reversed course on the issue of member liquidity. Either the target group changed, its presumptive intent had been reevaluated and determined to be different than what was originally thought, or the tail of the entity theory came to wag the dog of the substantive default rules. The answer appears to be primarily twofold: a new target group came to the fore and there was a desire to create a more corporate entity.

Target Group Shifted to Include Family Businesses Engaged in Sophisticated Estate Planning

The first thing that happened, well before RULLCA, is that the target group for setting LLC default rules, at least the default rules on liquidity rights, shifted to family businesses engaged in sophisticated estate planning.

Tax planners for family businesses had become used to contracting away liquidation rights in order to reduce the value of ownership interests in businesses for estate tax purposes.57 In 1990, Congress adopted a provision58 that disregarded contractual restrictions on liquidation rights “that are more restrictive than the limitations that would apply as a default rule under the state law generally applicable to the organization in the absence of the restriction.”59 In short, restrictions in statutory default rules could result in valuation discounts whereas restrictions in operating agreements could not. This change created “a tax incentive to create restrictive state law provisions regarding the ability to sell, redeem, or otherwise liquidate an ownership interest in a business entity.”60 Practitioners started “lobbying their state legislatures to eliminate all dissociation rights,” both in LLC acts61 and in limited partnership acts. Their lobbying was successful, and by the time RULLCA was promulgated, the target group for the liquidity rules had shifted from small groups of entrepreneurs unrepresented by counsel to affluent families engaging in sophisticated estate planning. To protect the represented few, RULLCA denied liquidity rights to the unrepresented many.62

The Desire for a More Corporate Entity

The second and related thing that happened was an increased demand for a more corporate entity. As the 1996 Act was being finalized, the Internal Revenue Service issued its now-famous “check the box” regulations, which allowed LLCs to elect to be taxed as partnerships even if they possessed a preponderance of corporate characteristics.63 There was, of course, no tax requirement to make LLCs more like corporations. Nevertheless, it is clear that the drafters of RULLCA intended to take advantage of the newfound freedom to make LLCs more like corporations.

Like RUPA and the 1996 Act, RULLCA states that an LLC “is an entity distinct from its . . . members.”64 However, RULLCA goes further and also provides that an LLC “has perpetual duration,”65 conforming LLC law to corporate law66 and to recent limited partnership acts.67 Despite this unqualified statement of perpetuity, the Official Comments are equivocal: “The word ‘perpetual’ is a misnomer, albeit one commonplace in LLC statutes. In this context, ‘perpetual’ means that the act: (i) does not require a definite term; and (ii) creates no nexus between the dissociation of a member and the dissolution of the entity.”68

The question is obvious: why say in the statute that the LLC is perpetual and then say in the Official Comments that you don’t really mean it? By embracing the corporate “perpetual entity” model, the drafters appear to be providing a theoretical foundation for eliminating both the present buyout right in an at-will LLC and the deferred buyout right in a term LLC. At the same time, the perpetual entity model provides a rationale for importing corporate restrictions on member access to judicial remedies.69 For whatever mix of reasons, it is clear that the RULLCA drafters sought to make a more perfect entity. For further example, section 105(c)(2) states the very modest mandatory rule that an operating agreement may not “vary a limited liability company’s capacity under Section 109 to sue and be sued in its own name.” By contrast, the Official Comment to that relatively narrow provision is much broader. It states that the now-perpetual LLC “is emphatically an entity, and the members lack the power to alter that characteristic.”70

Despite the intent to give LLCs more entity features than partnerships or early LLCs, it is an overstatement to say that members “lack the power to alter” the entity characteristic. Indeed, RULLCA itself continues to treat the association of members in an LLC as an aggregation to the extent it provides that a member of a member-managed LLC “owes to the company and, subject to Section 801, the other members the duties of loyalty and care.”71 The monkey-wrench in this statement is, of course, the reference to section 801, which imposes a distinction from corporate law that limits a member’s remedies for contractual and statutory breaches by classifying many member claims as derivative rather than direct. Like almost all the rules in RULLCA, this limitation on the right to bring a direct action can be contracted away in the operating agreement.72 Just as shareholders in a corporation, members can add aggregate features to their relationship. For example, they may agree to be personally liable for third-party claims against the entity or to one another if they breach the operating agreement. Whether such contractual stipulations make an LLC or a corporation less of an entity is in the eye of the beholder.

Establishing Liquidity Ex Ante and Ex Post

Members who do not wish to be locked-in to a perpetual entity can, of course, contract for windup or buyout rights. Perpetual entity status is not mandatory under RULLCA. Neither Section 108(a)’s rule that an LLC is an entity distinct from its members nor section 108(c)’s rule that the entity “has perpetual duration” is on the exclusive list of mandatory rules.73 Therefore, those rules can be varied or even eliminated by the operating agreement, except that there can be no limit on the entity’s ability to sue and be sued.74 Indeed, the Official Comments to section 108(c) expressly confirm that, under section 701(a)(1), the operating agreement may determine when dissolutions occur.75

The problem, of course, is that the original target group, by definition, is not represented by counsel and has little, if any, written agreement.76 If there is a bare-bones agreement, it may not address resolving disagreements or liquidity rights. After dissension arises, dissatisfied members are likely to resort to the rule that the operating agreement can be oral, written, or established by conduct.77 If they are resisting changes in policy, including decisions affecting them in particular, such as their employment or compensation, they may also rely on the rule that unanimous consent is necessary either to amend the operating agreement or to act outside the ordinary course.78

If dissatisfied members want to go further and establish liquidity rights, particularly the right to be bought out, courts should and can be expected to be attentive to their claims. To many members, the default rule of a perpetual lock-in will come as a harsh surprise. Under partnership law, courts have strained to avoid default rules they find too harsh. For example, they have found continuation agreements or other workarounds to avoid the at-will liquidation right they consider harsh.79 Courts can be expected to do the same under LLC law. They should be prepared to find liquidity rights, particularly in small, informal, member-managed LLCs formed without the benefit of counsel.80 Many of these involve heavily invested members who are not broadly diversified81 and who thus are dependent upon income either from the LLC or from a return on capital they can invest elsewhere.82

A major question is the level of specificity of proof courts will require to find a liquidity agreement. In some cases, members may be able to prove a specific oral agreement either to a buyout or to a business windup. In other cases, it may only be possible to establish a more general proposition. For example, it may only be possible to prove that the members agreed either that the association was at-will or that it was limited to a term or particular undertaking. In either of these situations, the members should be seen as having contracted out of the default rule of perpetual existence and its attendant lack of liquidity. Whether a buyout or a business windup would result could be determined either by analogy to partnership or other LLC law or by resort to the statutory mandate to supplement the statute with the principles of law and equity,83 particularly the laws of contract and agency.84 In either situation, courts should keep in mind that a business windup is an extreme remedy. In yet another class of cases, it may only be possible to prove an even more general proposition, for example, that the members agreed either to operate the LLC as a partnership85 or to use the LLC as simply an instrumentality of an overarching partnership.86

LLC Acts First Adopt, then Eliminate, RUPA’s Easy Access to Member Remedies

As we have seen, RULLCA continued to give members an action for oppression, which became “necessary” when it declared their LLCs to be perpetual.87 At the same time, however, and perhaps more significantly, it also took away their easy access to remedies in many more garden-variety situations.

RUPA Significantly Expanded Member Access to Remedies

One of RUPA’s major policy changes was to provide partners easier access to remedies, both in suits against one another and in suits against the partnership. The UPA had made a first step in this direction by giving partners a limited right to an accounting88 before dissolution.89 RUPA section 405 went “far beyond” the UPA rule and provided that a partner may sue the partnership or another partner at any time, for legal or equitable relief, to enforce the partner’s rights under the partnership agreement or under RUPA.90 Section 405 “reflects a new policy choice that partners should have access to the courts during the term of the partnership to resolve claims against the partnership and the other partners, leaving broad judicial discretion to fashion appropriate remedies.”91

In short, RUPA treated the partnership agreement like a normal commercial contract. RUPA made the partnership entity sufficiently stable to withstand a partner’s claim against it or against another partner. There is neither a dissociation nor a dissolution if a member takes her contractual or statutory claims to court. The Official Comment states that “no purpose of justice is served” by delaying the resolution of partner claims “on empty procedural grounds.”92 RUPA intended to eliminate “present procedural barriers to suits between partners,” and explicitly provided for “direct actions” against other partners or the partnership “for almost any cause of action arising out of the partnership business.”93 Stale claims are cut off by normal statutes of limitation,94 and time-barred claims are not revived by an accounting on winding up.95 To emphasize: no provision in RUPA restricts these direct actions.96 Nothing denies or delays any of a partner’s claims on the ground that they are derivative rather than direct.97

Uniform LLC Acts Adopt then Reject Easy Access to Remedies

The 1996 LLC Act Affirmed RUPA’s Easy Access to Judicial Remedies

Like RUPA, the 1996 Act intended to provide “the essence of the bargain” for “small entrepreneurs without the benefit of counsel.”98 Its default rules were “designed to operate an LLC without sophisticated agreements and to recognize that members may also modify the default rules by oral agreements designed in part by their own conduct.” Accordingly, section 410 of the 1996 Act echoed RUPA’s broad authorization of member suits against the LLC or another member for breach of the operating agreement, statute, or other member rights.99 Like RUPA, it clearly intended “broad judicial discretion to fashion appropriate legal remedies.”100 Finally, like RUPA, it provided that statutes of limitation are governed by other law and that a time-barred claim is not revived by a right to an accounting on winding up.101

Unlike RUPA, the 1996 Act authorized derivative suits by members.102 Section 1101 provided that a member “may maintain an action in the right of the company if the members or managers having authority to do so have refused to commence the action or an effort to cause those members or managers to commence the action is not likely to succeed.”103 These derivative action provisions, however, are merely enabling, not mandatory. Like RUPA, the 1996 Act does not delay or deny a member’s claims on the ground that they are derivative rather than direct.

RULLCA Removed Easy Access to Judicial Remedies

Importing the Direct/Derivative Distinction from Corporate Law

RULLCA reversed course on the issue of easy access to judicial remedies. It diverts a member’s claims to the derivative track unless the member can “plead and prove an actual or threatened injury that is not solely the result of an injury suffered or threatened to be suffered by the limited liability company.”104 In short, RULLCA adopts the “direct versus derivative” distinction from corporate and limited partnership law.105

The theory is that a derivative claim is the firm’s claim, not the member’s claim, and the firm can decide what to do with it.106 Before a member can bring a claim on behalf of the firm, it must give the firm a chance to decide what to do with it. To provide that chance, the member must demand that the firm pursue the claim, unless a demand would be futile.107 For example, it might be futile to make a demand if, in effect, the demand is that the firm sue all its controlling members.

If demand is made or forgiven and the member moves forward with a derivative suit, the LLC has the right to respond by appointing a special litigation committee (“SLC”) “to investigate the claims asserted . . . and determine whether pursuing the action is in the best interests of the company.”108 The SLC “must be composed of one or more disinterested and independent individuals, who may be members.”109 After “appropriate investigation,” the SLC may determine that it is in “the best interests” of the LLC that the proceeding continue under the control of the plaintiff, continue under the control of the SLC, settle on terms approved by the SLC, or be dismissed.110 The SLC must then file with the court a statement of its determination along with a supporting report.111 If the court concludes that the committee members “were disinterested and independent and that the committee acted in good faith, independently, and with reasonable care, the court shall enforce the determination of the committee.”112

The Usual Critique: No Policy Is Served by Applying the Direct Versus Derivative Distinction to Closely Held Businesses

In the context of publicly held corporations, direct actions are denied, and derivative actions are required, for any one of a number of policy reasons. Perhaps most importantly, recognizing that the claim belongs to the firm and not to a shareholder may preserve the role of the firm and its managers in resolving or disregarding a claim according to their best business judgment.113 Denying direct actions may also prevent multiple suits over the same cause of action, assure there is a fair distribution of any recovery among all interested shareholders, and avoid prejudice to firm creditors.114

Denying members standing and diverting them to a derivative track has long been criticized as inappropriate in the context of closely held corporations and LLCs.115 Distinguishing direct from derivative claims can be difficult, and the distinction has become one of the most litigated issues in LLCs.116 Numerous cases have denied members standing on the ground that their claims are derivative, even though no policy goals appear to be served by the denial.117 For example, there are many cases denying standing to one or more members of three- or four-member LLCs, even though all members are represented in the proceeding.118 These cases presented no risk of a multiplicity of suits by members and no risk of uneven recovery among members. Instead, they would have provided all members a chance to assert their claims, including any claims about the appropriate exercise of business judgment. They did not appear to impair the rights of creditors.119

Instead of the easy access to remedies they would have as partners or under the 1996 Act, members now face a daunting gauntlet of procedural obstacles.120 First, litigation may be necessary to accomplish what may be the difficult task of distinguishing direct claims from derivative claims. Second, if a claim is denied on the ground that it is derivative rather than direct, members must determine whether they must make a formal demand on the firm, and how that demand should be made, before filing a derivative proceeding. Third, if they proceed with derivative litigation on the theory that making a demand on the firm would be futile, they must then determine how to respond to any SLC the firm appoints in response. Indeed, a separate proceeding may be necessary to appoint the SLC or to challenge the disinterest and independence of any SLC the firm has appointed. Finally, depending upon the particular LLC act, there may be further litigation to challenge the work of the SLC or its recommendation. This procedural gauntlet is similar to the one that has been criticized as inappropriate in the context of closely held corporations.121 It is at least equally inappropriate in the context of closely held, member-managed LLCs, whose members may operate with even less formality and with no reason to expect the imposition of formalities normally associated with public corporations.122

Corporate Model Frustrates Presumptive Intent

There is nothing in the Official Comments to RULLCA suggesting that members intend to impose these procedural obstacles upon themselves. To the contrary, these obstacles seem inconsistent with their presumptive intent to operate informally123 and treat their agreement as a normal commercial contract. There is no fundamental policy in favor of the obstacles, as evidenced by the fact that they are default rules, not mandatory rules. Members who want to contract for easy access to judicial remedies may do so. A member’s right to maintain a derivative action is a mandatory rule only to the extent that the operating agreement may not “unreasonably restrict the right of a member to maintain” a derivative action.124 There is no restriction on the ability of the operating agreement to expand the right to bring direct actions.

The Official Comments do not explain why it is now necessary to prove a special contract to opt out of the procedural obstacles of derivative actions, even in the smallest of member-managed LLCs. At least in those LLCs, the default setting seems contrary to the presumed intent of members. It certainly was not necessary to restrict access to remedies to implement the elimination of buyout rights.125 Indeed, locking members in to perpetual entities calls for additional remedies, not fewer, as admitted by the Prefatory Note describing the inclusion of a “necessary” cause of action for oppression.126 On the other hand, the two changes fit together in the sense that they are both features of corporate law. So the question is, if it was not to effect presumptive intent, why did drafters import this remedy-restricting feature of corporate law?

The Prefatory Note and Official Comments are extremely brief. The Prefatory Note understates the significance of the change by stating only: “The new Act contains modern provisions addressing derivative litigation, including a provision authorizing special litigation committees, and subjecting their composition and conduct to judicial review.” By contrast, the Prefatory Note contains much more extensive discussion of the much less significant elimination of statutory apparent authority. The Official Comments add only that this “rule of standing [restricting direct actions] . . . predominates in entity law.”127 This Comment ignores the fact that the new rule of standing is in direct conflict with the easy access to remedies in partnership entities and under earlier LLC law. Unless the target group has changed, the imposition of the obstacles of derivative litigation cannot be explained on the basis of presumed intent.

The drafters of RULLCA sought to prevent the operating agreement from being treated like a normal commercial contract. The Official Comments admit that, “in ordinary contractual situations it is axiomatic that each party to a contract has standing to sue for breach of that contract.”128 However, the Comments then state that, “within a limited liability company different circumstances typically exist.”129 Without explaining why or how the “different circumstances typically exist,” the Comments conclude, oddly and without further explanation, that the distinction between direct and derivative claims “protects the operating agreement.” There is no indication how an agreement is “protected” by raising procedural barriers to its enforcement. At best, the Official Comment simply begs the conclusion:

A member does not have a direct claim against a manager or another member merely because the manager or other member has breached the operating agreement. Likewise, a member’s violation of this act does not automatically create a direct claim for every other member. To be able to have standing in his, her, or its own right, a member plaintiff must be able to show a harm that occurs independently of the harm caused or threatened to be caused to the limited liability company.130

In so stating, the Official Comment is revealing, if not explaining clearly, that the rule is not based on the presumptive intent of the target group. There is no indication that the drafters decided that members forming an LLC intend, or would intend if they thought about it, to deny themselves the remedies they would have under partnership law. Rather, the Comment can only mean that the drafters refused to treat the operating agreement as an ordinary commercial contract because of their intent to restrict member standing.131

Co-Reporter Daniel Kleinberger made this point more clearly in a subsequent article, in which he stated that “the distinction between direct and derivative claims follows necessarily from the concept of a legal person being separate and distinct from its owners.”132 However, both partnership law and early LLC law establish that it is incorrect to state that the direct/derivative distinction follows “necessarily” from the concept of an entity distinct from its owners. Rather, it only follows from the particular versions of business entity developed in the corporate and limited partnership contexts. Nevertheless, his fundamental claim is correct: the direct versus derivative distinction has no vitality unless you eliminate the expansive and easy access to member remedies of partnership law and early LLC law. He admits that the distinction occasionally “helps shelter a miscreant majority owner who has managed to harm a fellow owner indirectly,” conceding that in some states, “a plaintiff who makes a demand creates almost insurmountable obstacles to bringing a derivative claim if (typically when) the managers reject the demand.”133

There is no suggestion that the imposition of these “insurmountable obstacles” as default rules reflects the presumptive intent of our target group of entrepreneurs. Instead, adopting the default rules from corporate law presents a complex trap for unwary entrepreneurs. The members of our target group are unlikely to be aware of the need to contract away the machinery of corporate derivative litigation. They are likely to consider the issue only after a controversy has arisen. At that time, they will be put to the burden of establishing a contrary agreement, as they now must to establish liquidation or buyout rights.134 Here again, the question will be the necessary level of proof. It should not be necessary to show that the parties addressed and specifically set aside the rules of corporate derivative litigation. It should suffice to show that, either orally or by conduct, that they have agreed135 to treat their agreement as a normal commercial contract, to resolve their disputes as if they were partners136 or to treat the LLC as an instrument of an overarching partnership.137 In the process of resolving their claims, a court can rely on the statutory directive to consider principles of contract, agency, and equity to protect members from harsh, unintended consequences.138 Courts sympathetic to their plight should also use their authority to award lesser remedies in response to dissolution claims, including claims for dissolution in the event of oppression.139

Two Additional Concerns about SLCs

SLCs Are a Form of Pre-Dispute Binding Arbitration

The same factors that make derivative suits inappropriate in closely held LLCs also cut against the imposition of the extra machinery of an SLC. No policy goal is being served by the procedural obstacle140 and its imposition, even as a default rule, is contrary to the presumptive intent of the parties. However, there is an additional and even more specific critique of the imposition of an SLC as a default rule. RULLCA Official Comments refer to the SLC as an “ADR mechanism.” The SLC provisions effectively impose on the parties a pre-dispute binding arbitration agreement. Outside the corporate derivative action arena, the law is hostile to binding arbitration agreements unless there is informed consent.

Across a wide variety of disputes, courts, including the U.S. Supreme Court itself, are extremely divided on the validity of pre-dispute binding arbitration agreements.141 Even courts generally supportive of arbitration closely consider whether particular pre-dispute agreements should be enforceable. They look to see whether there was a knowing waiver of rights, especially the Seventh Amendment right to a trial by jury and the right to an appeal. Courts explore agreements to see whether they sufficiently inform the signatories of the practical differences between arbitration and litigation before a court. Depending upon the context, courts or regulators may require that a signatory’s attention be specifically drawn to the arbitration agreement, that it be in a separate document, and that a signatory be advised of the right to seek independent counsel about it. At the extreme, law firms with pre-dispute binding arbitration provisions in client retention agreements may be ethically obligated to put the arbitration agreement into a separate document and explain in writing to their clients that they should seek the advice of independent counsel because they are contracting away their constitutional right to a trial by jury, that only limited discovery may be available to them, that they will be required to pay up-front the fees of the arbitrator(s), and that they will have very little opportunity to appeal an adverse decision.142

Against this backdrop of controversy about the enforceability of pre-dispute agreements that are actually signed, it is surprising that RULLCA imposes such an agreement, as a default rule, on small groups of unwitting entrepreneurs who have not signed anything. To some extent, an SLC has even more discretion than an arbitrator. The SLC is empowered, if not primarily tasked, to apply its business judgment, and not just the law.143 The Official Comments state that “an SLC is intended to function as a surrogate decision-maker, allowing the [LLC] to make what is fundamentally a business decision.”144 It is true that the business judgment rule is part of the law arbitrators should apply. However, arbitrators generally apply the law to decisions others have made, not make the decision in the first instance.

It could be argued that the SLC is nevertheless an appropriate mechanism because courts have greater discretion to review the decisions of an SLC than they have to review the decisions of an arbitrator. Under the Federal Arbitration Act, there is extremely limited review of the decisions of arbitrators.145 Great deference is given to the arbitrator’s process regulation, finding of facts, and application of law, with the burden on the party challenging the arbitrator’s decision. By contrast, the Official Comments to RULLCA state that “a good deal of judicial oversight is necessary in each case” reviewing the work of an SLC, although “courts must be careful not to usurp the committee’s valuable role in exercising business judgment.”146 A court must consider not only whether the SLC members were “disinterested and independent,” but also “whether the committee conducted its investigation and made its recommendation in good faith, independently, and with reasonable care, with the committee having the burden of proof.”147 If these tests are satisfied, “it makes no sense to substitute the court’s legal judgment for the business judgment of the LLC.”148

SLC Selection Difficult in Small Firms

RULLCA states that an SLC “must be composed of one or more disinterested and independent individuals, who may be members.”149 To this extent, greater disinterest and independence is required than in the case of arbitrations, in which there may be some opportunity for parties to directly appoint a non-neutral, if they agree in writing.150 In the corporate area, there has been considerable concern, and litigation, about whether a member of an LLC is sufficiently independent. In the famous case of In re Oracle Corp. Derivative Litigation,151 the court rejected the argument that members of an SLC are sufficiently independent if they are free from the “dominion and control” of the interested parties. It set a much higher bar for independence by requiring consideration of a much broader range of personal and social relationships:

Delaware law should not be based on a reductionist view of human nature that simplifies human motivations on the lines of the least sophisticated notions of the law and economics movement. Homo sapiens is not merely homo economicus. We may be thankful that an array of other motivations exist that influence human behavior; not all are any better than greed or avarice, think of envy, to name just one. But also think of motives like love, friendship, and collegiality, think of those among us who direct their behavior as best they can on a guiding creed or set of moral values.152

Social institutions have norms and expectations that “explicitly and implicitly, influence and channel the behavior of those who participate in their operation.”153 The law cannot assume that corporate directors who serve on SLCs “are, as a general matter, persons of unusual social bravery, who operate heedless to the inhibitions that social norms generate for ordinary folk.”154 These same considerations also apply to closely held LLCs, which are so often organized among family members, friends, or other business or social relationships.

There is a threshold question about the disinterest and independence of SLC members that is particularly problematic in the case of closely held LLCs. To what extent must those who appoint the SLC be disinterested and independent? RULLCA itself says very little on this point. In the case of a member-managed LLC, an SLC may be appointed by “a majority of the members not named as parties in the proceeding,” or, if all members are named as parties, by “a majority of the members named as defendants.”155 In the case of a manager-managed LLC, an LLC may be appointed by a “majority of the managers not named as parties,” or, if all managers are named, “by a majority of the managers named as defendants.”156 To the extent that majorities of defendants may appoint SLCs, the statute has virtually no disinterest and independence standard on who may appoint.

Especially in the case of closely held LLCs, it is difficult to understand how majorities of defendants can appoint “disinterested and independent” individuals. Recent cases have expressed skepticism about the ability to appoint disinterested individuals in the context of small firms.157 Co-Reporter Daniel Kleinberger reports there is reason to be skeptical. He states that, “as a matter of fact, almost all SLCs decide in favor of dismissal (sometimes conditioned on changes in the entity’s policies or practices) and so recommend to the court.”158 In the broader world of arbitration, it is considered critical to have arbitrators who are considered impartial and independent. For this reason, providers of arbitration services have special rules for selecting arbitrators when the parties cannot agree.159 Here again, the statutory law of the SLC as a “dispute resolution” mechanism falls short of arbitration rules exogenous to RULLCA, although careful judicial review should bring it closer.

Conclusion

The default rules of LLC law have dramatically turned away from partnership law and much more fully embraced corporate law. RULLCA declared LLCs to be “perpetual entities” and denied members any right to liquidate or be bought out. While this change facilitated sophisticated estate planning for family businesses, it immediately raised concern among those who saw minority members in closely held LLCs being made as vulnerable to abuse as minority members in closely held corporations. Although RULLCA gave minority members the “necessary” concession of a cause of action for dissolution in the event of oppression, not every state has followed suit.160 More importantly, the grant of a cause of action for oppression was more than offset by the act’s imposition of the direct/derivative distinction from corporate law. Minority members are now denied standing to bring many of their claims, whether based on the operating agreement or based on the statute. Instead, those claims are diverted to a derivative track that promises high dispute resolution costs with little chance of success.

Most fundamentally, the new LLC default rules are contrary to the presumptive intent of the target group that was the primary concern of RUPA and of the first wave of LLC acts: small groups of entrepreneurs who, without the benefit of counsel, form businesses in which they invest significant personal and financial resources and which they manage informally. It seems unlikely that these groups, by filing a certificate of organization, intend to lock themselves into perpetual entities with no right to liquidate or be bought out. It further seems unlikely that they would intend to deny themselves the right to sue one another for breach of their agreement. The current LLC default rules are more suitable for sophisticated investors and for members of affluent families engaged in sophisticated estate planning. These individuals are, of course, equally worthy of rules that reflect their intent. However, because they are much more likely to form and operate with the benefit of counsel who will draft bespoke agreements for them, they should not displace our target group as the primary concern of the default rules.

The presumptive intent of our target group was better reflected in the liquidity and remedial rules that existed in the 1996 Act. If it is unrealistic for the pendulum of LLC law to swing back to all of the liquidity and remedial rules of the 1996 Act, its default rules could be reinstated at least for member-managed LLCs. In these situations, different buyout rights could be given in both at-will and term LLCs. Even if the buyout rights continue to be eliminated, there is no further need to deny the easy access to judicial relief available both in the case of partnerships and under the 1996 Act. No public policy is being served by imposing upon our target group the procedural obstacles of derivative litigation. The presence of a shield is not an adequate explanation. Easy member access to judicial relief is provided in the default rules for LLPs. It is the default rules of the LLC that miss the mark of the presumed intent of the owners, not the default rules for LLPs.

Until there is statutory reform to bring the default rules of LLCs closer to the presumptive intent of the parties, courts should identify and enforce the reasonable expectations that members have agreed upon among themselves. As they have in other areas of the law, courts will tend to avoid default rules they deem unfair. One statutory basis for relief is the new cause of action for dissolution or other relief in the event of oppression. Another statutory basis is the definition of the operating agreement, which can be written, oral, or inferred from conduct. The third statutory basis is the rule that the principles of law and equity apply, unless specifically displaced. The common law principles of agency and contract are the most important supplemental principles. At the level of the greatest generality, courts might find that members intend to treat their agreement as a normal commercial contract, operate their LLC as a partnership, or use the LLC as an instrumentality of an overarching partnership.

Notes

1 Unif. P’ship Act (Unif. Law Commn 1994), https://www.uniformlaws.org/ [hereinafter U.P.A.].
2 Unif. P’ship Act §§ 306(c), 1001–1003 (Unif. Law Commn 1997), https://www.uniformlaws.org/ [hereinafter R.U.P.A.]. The ULC subsequently promulgated a version of the partnership act designed to “harmonize” it with certain provision of the law of other business associations. See Unif. P’ship Act (Unif. Law Commn 2013), https://www.uniformlaws.org/ [hereinafter H.R.U.P.A.]. H.R.U.P.A. has received relatively few adoptions.
3 Unif. Ltd. Liab. Co. Act (Unif. Law Commn 1996), https://www.uniformlaws.org/ [hereinafter U.L.L.C.A.].
4 Rev. Unif. Ltd. Liab. Co. Act (Unif. Law Commn 2006) (last amended 2013), https://www.uniformlaws.org/ [hereinafter R.U.L.L.C.A.].
5 To a large extent, our target group had the characteristics normally associated with shareholders in closely held corporations, in which “a more intimate and intense relationship exists between capital and labor.” Robert B. Thompson, The Shareholder’s Cause of Action for Oppression, 48 Bus. Law. 699, 702 (1993). The shareholders “usually expect employment and a meaningful role in management, as well as a return on the money paid for [their] shares.” Id.
6 Here again, the similarity to the closely held corporation is significant. See Margaret M. Blair & Lynn A. Stout, Trust, Trustworthiness, and the Behavioral Foundations of Corporate Law, 149 U. Pa. L. Rev. 1735, 1805 (2001) (noting that “participants in closely held corporations often decline to draft complex contracts to control their future dealings, instead preferring to deal with conflicts informally as they arise”).
7 See infra Part II.A for a discussion of the RUPA buyout rules. The recent LLC rules are even longer and more complex. For example, the latest Uniform LLC Act has four separate provisions defining operating agreements and their effect. R.U.L.L.C.A. §§ 102(13), 105–07. The provisions are accompanied by extensive Official Comments.
8 ULLCA continued the focus on “small entrepreneurs without benefit of counsel” and continued default rules “designed to operate without sophisticated agreements and to recognize that members may also modify the default rules by oral agreements defined by their own conduct.” U.L.L.C.A., Prefatory Note.
9 U.P.A. § 25(1) (“Each partner is co-owner with his partners of specific partnership property holding as a tenant in partnership.”).
10 See, e.g., U.P.A. § 25(2)(a) (stating that a partner has no right to possess partnership property for personal purposes).
11 R.U.P.A. § 201(a).
12 See generally Donald J. Weidner, Three Policy Decisions Animate Revision of Uniform Partnership Act, 46 Bus. Law. 427 (1991).
13 R.U.P.A. §§ 306(c), 1001(c).
14 Id. § 404(a).
15 Email from Robert Keatinge, Esq., Holland & Hart, Denver, Col., to the author (Sept. 25, 2019, 04:32 MST) (on file with author).
16 I.R.C. § 754 (2018).
17 Id. § 743.
18 Id. § 704(b); Treas. Reg. §§ 1.704-1–4 (2012).
19 R.U.P.A. § 701(f).
20 RUPA section 701 does not contain a requirement that the dissociating partner make a written demand for payment, but a written demand triggers the limitation period.
21 Id. § 701(e). Four things must accompany the partnership’s tender, including financial statements, an explanation of how the written estimate was calculated, and “written notice that the payment is in full satisfaction of the obligation to purchase unless, within 120 days after the written notice, the dissociated partner commences an action to determine the buyout price.” Id. § 701(g).
22 The Official Comments oddly describe the 120 days as a “cooling off” period, even though it is a statutory limitation period. If it were a cooling off period, neither party could take any action.
23 Id. § 701(i).
24 Id. § 701 cmt. 8 (citing Model Bus. Corp. Act § 13.25(b) (Am. Bar Assn 2016)).
25 If an LLC adopts a corporate structure, courts may apply by analogy other corporate principles. Llamas v. Titus, CV 2018-0516-JTL, 2019 WL 2505374 (Del. Ch. 2019).
26 See Robert W. Hillman, Donald J. Weidner & Allan G. Donn, The Revised Uniform Partnership Act 569 (2020) [hereinafter Hillman, Weidner & Donn] (“Just as they may be unaware of the need to make a written demand for payment, partners may fail to appreciate that the more general written statements they do make may be interpreted as a demand for payment under Section 701(e). Identifying whether a communication is a written demand for payment is important to both the partnership and the dissociated partner. For the partnership, the demand triggers the 120 day period for arriving at an estimate of the amount due the dissociated partner and tendering payment. For the dissociated partner, the demand triggers a one year limitation period for initiating a judicial action to determine the buyout price.”).
27 R.U.P.A. § 101(8).
28 Id. § 801(1). This rule has for decades been regarded by some as giving too powerful a remedy to the departing partner.
29 Id. § 701(a). The buyout price is the amount that would have been distributable to the partner if, on the date of dissociation, the partnership had wound up its affairs and liquidated its assets, at the greater of liquidation value or the value based on a sale of the business as a going concern without the dissociated partner. Delaware replaced RUPA’s liquidation/going concern valuation approach with a more general standard: “The buyout price of a dissociated partner’s partnership interest is an amount equal to the fair value of such partner’s economic interest as of the date of dissociation based upon such partner’s right to share in distributions from the partnership.” Del. Code Ann. tit. 6, § 15-701(b) (2019). The buyout price is reduced for damages caused by the wrongful dissociation and other amounts owed by the dissociating partner, including any share of partnership liabilities. RUPA section 701(c) provides that the buyout price is reduced by “all amounts owing, whether or not due, from the dissociated partner to the partnership.” The partnership, in turn, “shall indemnify a dissociated partner whose interest is being purchased against all partnership liabilities, whether incurred before or after the dissociation.” R.U.P.A. § 701(d). To the extent the partnership must indemnify against liabilities that did not reduce the buyout price, the statutory requirement goes beyond its proper function of protecting the dissociated partner from being charged twice for a liability, first through a reduction in the buyout price and later when it is subsequently asserted. Hillman, Weidner & Donn, supra note 26, at 577.
30 Most simply, dissociation takes place upon “the partnership’s having notice of the partner’s express will to withdraw as a partner or on a later date specified by the partner.” R.U.P.A. § 601(1). It may be unclear when a partnership has notice of a dissociation, especially when a partner has dissociated by conduct or abandoned the partnership. The issue can be important because the value of assets, and of the overall business, can change dramatically. In Brennan v. Brennan Associates, 113 A.3d 957 (Conn. 2015), the court addressed when dissociation occurs if a partner was dissociated by court order but judgment was stayed pending the partner’s appeal of the order, which ultimately was unsuccessful. A divided court held that the dissociation date for the purpose of computing the buyout price was the later date on which the unsuccessful appeal was concluded. The partner had continued to participate in management during the pendency of the appeal. Courts attempt to avoid hindsight bias when determining value as of the time of dissociation. See, e.g., R4 Props. v. Riffice, No. 3:09-CV-400 JCH, 2015 WL 3770920, at *2 (D. Conn. 2015) (“At the threshold, the court points out that the date of dissociation was in the midst of the 2008 financial crisis. To the extent possible, the court’s goal is to find the value that a willing seller and a willing buyer would have agreed to on the date of dissociation, not knowing with any certainty what the coming months would bring. Put simply: the court does its best to avoid hindsight bias.”).
31 R.U.P.A. § 701(h).
32 R.U.P.A. § 701(f), (h). The latter specifically provides: “A deferred payment must be adequately secured and bear interest.” In general, the buyout provisions are subject to modification by agreement because they are not listed in section 103(b)’s mandatory rules. But see R.U.P.A. § 701 cmt. (suggesting that other principles of law may render unenforceable a complete waiver of the right to be bought out). An arbitration agreement has been held applicable to a statutory claim for a buyout. Wetli v. Bugbee & Conkle, L.L.P., 2015-Ohio-4213, 2015 WL 5918066 (Ct. App. 2015).
33 R.U.P.A. § 701(h).
34 As ULLCA was being finalized, RUPA was being amended to include the “shield” of a limited liability partnership. The shield states that a partner is not liable for the contracts or torts of the partnership solely by reason of being a member. Id. § 301(c).
35 U.L.L.C.A., Prefatory Note at 2–3. (emphasis added). ULLCA anticipated the “check the box” regulations from the Internal Revenue Service, which provided an “unincorporated” business entity will be taxed either as a partnership or as a disregarded entity unless it elects to be taxed as a corporation. In short, for tax purposes, the LLC was freer, although not required, to deviate more from a partnership model and more toward a corporate model.
36 Unless the articles of organization “reflect that a limited liability company is a term company and the duration of that term, the company will be an at-will company.” Id. It is therefore more difficult under ULLCA to become a term LLC than it is to become a term partnership, which can be established without a writing.
37 U.L.L.C.A., Prefatory Note at 3.
38 Or, as one economist puts it, “if an investor’s death or withdrawal can provoke the firm’s demise,” it “implies that firm-specific, illiquid investments may not realize their full return.” Timothy W. Guinnane, Creating a New Legal Form: The GmbH (Yale Univ. Econ. Growth Ctr., Discussion Paper No. 1070, Mar. 6, 2020), https://egcenter.ecoomics.yale.edu.
39 U.L.L.C.A., Prefatory Note at 3 (“[N]ew and important Internal Revenue Service Announcements . . . generally provide that a limited liability company will not be taxed like a corporation regardless of its organizational structure. Freed from the old tax classification restraints, the [final Act] modifies the Act’s dissolution provision by eliminating member dissociation as a dissolution event. This important amendment significantly increases the stability of a limited liability company and places greater emphasis on a limited liability company’s required purchase of a dissociated member’s interest.”).
40 U.L.L.C.A., Prefatory Note at 3. See also U.L.L.C.A. § 601 cmt. (citation omitted) (“Member dissociation from . . . an at-will . . . company, whether member- or manager-managed is not an event of dissolution of the company unless otherwise specified in an operating agreement. However, member dissociation will generally trigger the obligation of the company to purchase the dissociated member’s interest under Article 7.”). Similarly, U.L.L.C.A. § 701 cmt. provides that an at-will company “must cause the member’s distributional interest to be purchased under [Article] 7 when that member’s dissociation does not result in a dissolution of the company under [Article 8].” Partnership law does not use the term fair value.
41 Under the broad fair value standard, “a court is free to determine the fair value of a distributional interest on a fair market, liquidation, or any other standard deemed appropriate under the circumstances.” Id. § 703 cmt.
42 Id. § 203(5) cmt. (citations omitted). If an at-will LLC fails to purchase the interest of a dissociated member, that member may use the failure to purchase to seek judicial dissolution. Id. § 801(4)(iv). However, the dissociating member from an at-will LLC has no automatic right to a decree of judicial dissolution. The court must determine that it is “equitable” to wind up the at-will LLC at the request of a transferee. ULLCA section 801(5)(ii) provides that, on application by a transferee of a member’s interest, there is a dissolution and winding up on a “judicial determination that it is equitable to wind up the company’s business . . . at any time, if the company was at will at the time the applicant became a transferee by member dissociation, transfer, or entry of a charging order that gave rise to the transfer.” The Official Comment cautions that “a court should not grant involuntary dissolution of an at-will company if the applicant member has the right to dissociate and force the company to purchase that member’s distributional interest.” U.L.L.C.A. § 801 cmt. This Comment, somewhat inconsistently, also provides: “A dissociated member is not treated as a transferee for purposes of subsections (a)(4) and (a)(5).” Unfortunately, there are no subsections (a)(4) and (a)(5), and the Comment presumably means simply subsections (4) and (5). Subsection (5) appears to be an imperfect importation of RUPA section 801(6), which did not need to include partners dissociating from at-will partnerships because they had an absolute right to dissolve simply by giving notice of an intent to withdraw. R.U.P.A. § 801(1).
43 U.L.L.C.A. § 203(5) cmt. (citations omitted).
44 Id. § 203(5) cmt. (citations omitted); see also id. § 603 cmt. (“Dissociation from a term company that does not dissolve the company does not cause the dissociated member’s distributional interest to be purchased under Article 7 until the expiration of the specified term that existed on the date of dissociation.”). Note that here the dissociated member is apparently not being bound to a term changed after the dissociation. See also id. § 401 cmt. (“An agreement to contribute to a company is controlled by the operating agreement and therefore may not be created or modified without amending that agreement through the unanimous consent of all the members, including the member to be bound by the new contribution terms.”).
45 Id. § 203(5) cmt. (citations omitted).
46 ULLCA section 603(a)(2)(ii) provides that, if a term “company does not dissolve and wind up its business on or before the expiration of its specified term, the company must cause the dissociated member’s distributional interest to be purchased under [Article] 7 on the date of the expiration of the term specified at the time of the member’s dissociation.” Id. § 603(a)(2)(ii) (emphasis added).
47 R.U.L.L.C.A. § 108(c). The Prefatory Note to RULLCA also refers to “the perpetual duration” of LLCs. It does so by explaining why it introduces a remedy for oppressive conduct: “This provision is necessary given the perpetual duration of an LLC formed under this Act, Section 104(c), and this Act’s elimination of the ‘put right’ provided by U.L.L.C.A. § 701.”
48 Id. § 707(b).
49 See Styslinger v. Brewster Park, LLC, CV136039748S, 2014 WL 6843565 (Conn. Super. Ct. 2014).
50 The Prefatory Note states:

A Remedy for Oppressive Conduct. Reflecting case law developments around the country, the new Act permits a member (but not a transferee) to seek a court order “dissolving the company on the grounds that the managers or those members in control of the company . . . have acted or are acting in a manner that is oppressive and was, is, or will be directly harmful to the [member].” Section [701(a)(4)(C)(II)]. This provision is necessary given the perpetual duration of an LLC formed under this Act, Section [108(c)], and this Act’s elimination of the “put right” provided in ULLCA § 701.

R.U.L.L.C.A., Prefatory Note at 2.

51 Id. § 801(4)(v).
52 Id. § 701(a)(4) (limiting the availability of the oppression action to an action “by a member”).
53 See, e.g., Fla. Stat. § 605.0702(b)(3) (2019) (limiting the availability of a member’s dissolution action to situations in which the managers or members in control have acted “in a manner that is illegal or fraudulent”).
54 Certain scholars were resisting this change as it was being made. See Sandra K. Miller, What Buy-Out Rights, Fiduciary Duties, and Dissolution Remedies Should Apply in the Case of the Minority Owner of a Limited Liability Company?, 38 Harv. J. on Legis. 413, 440 (2001) [hereinafter Buyout Rights] (“At a minimum, a default buy-out right should be made available to LLC owners who find themselves in a dispute with the majority without any operating agreement or with ineffectual contractual protection.”); see also Douglas K. Moll, Minority Oppression and the Limited Liability Company: Learning (or Not) from Close Corporation History, 40 Wake Forest L. Rev. 883 (2005) [hereinafter Moll].
55 R.U.L.L.C.A. § 407(b)(4) (in the case of a member-managed LLC), § (c)(3)(B) (in the case of a manager-managed LLC).
56 Cf. Meiselman v. Meiselman, 307 S.E.2d 551, 559 (N.C. 1983), a famous discussion of illiquidity effects in closely held corporations:

[W]hen the personal relationship among the participants in a close corporation breaks down, the minority shareholder has neither the power to dissolve the business unit at will, as does a partner in a partnership, nor does he have the “way out” which is open to a shareholder in a publicly held corporation, the opportunity to sell his shares on the open market. Thus, the illiquidity of a minority shareholder’s interest in a close corporation renders him vulnerable to exploitation by the majority shareholders (citations omitted).

57 Robert R. Keatinge, Universal Business Organization Legislation: When Will It Happen? Why and When?, 23 Del. J. Corp. L. 29, 53 (1998).
58 I.R.C. § 2704(b) (2018).
59 Moll, supra note 54, at 938 n.179 (“Thus, the valuation under I.R.C. section 2704(b) will be determined by reference to the default provisions of the organic statute pursuant to which the organization is formed, rather than by considering the extent to which the owners could actually create liquidation rights less restrictive than those imposed by the organic statute or could actually liquidate the interest. As such, I.R.C. section 2704(b) encourages the development of organic statutes which contain default rules that restrict or eliminate the right of an individual to liquidate the individual’s interest.”).
60 Buyout Rights, supra note 54, at 432; see also Joseph M. Mona, Advantages of Using a Limited Liability Company in an Estate Plan, 25 Est. Plan. 167 (1998).
61 Laura Wheeling Farr & Susan Pace Hamill, Dissociation from Alabama Limited Liability Companies in the Post Check-the-Box Era, 49 Ala. L. Rev. 909, 936 (1998).
62 Professor Moll catalogued the avalanche of literature saying that minority members in LLCs are now as susceptible to oppression as minority members in closely held corporations. His solution was a responsive right to dissolve in the case of oppression, an approach ultimately adopted in RULLCA. He identifies the following four “seeds” of minority oppression: 1. the lack of exit rights; 2. majority rule; 3. the deference given by the business judgment rule; and 4. the lack of ex ante contracting. Oppression is generally defined as conduct that defeats the “reasonable expectations” of the minority member. Conduct can include eliminating or substantially restricting distributions, removing the minority member or her family members from management or employment, increasing the compensation or other payments to the majority members or their families. Moll, supra note 54, at 895–916. “In light of [the] apparent diverse use of LLCs, it may be more sensible to retain default buy-out rights in each state’s LLC statute while removing default buy-out rights in a different statute such as the state’s limited partnership statute.” Buyout Rights, supra note 54, at 442. A separate form for family businesses has also been suggested.
63 Treas. Reg. §§ 301.7701-1 to -3 (1996).
64 R.U.L.L.C.A. § 108(a).
65 Id. § 108(c). The RULLCA Official Comment to the “perpetual duration provision” also points out that the public record will not reveal whether or when a limited liability company has come into existence or “whether the company actually has a perpetual existence or has in fact dissolved.” RULLCA “provides several consent-based methods to dissolve a limited liability company,” and “none of these methods involve a public filing.” Id.
66 Model Bus. Corp. Act § 3.02 (Am. Bar Assn 2016) (providing that, unless the articles of incorporation provide otherwise, “every corporation has perpetual duration”).
67 Unif. Ltd. P’ship Act § 110(c) (Unif. Law Commn 2013) [hereinafter Re-R.U.L.P.A.] (“A limited partnership has perpetual duration.”).
68 R.U.L.L.C.A. § 108(c) cmt. The second of these statements is puzzling, given that ULLCA did not dissolve the entity on the dissociation of a member. The Re-RULPA Official Comments are virtually identical.
69 See infra Part III.
70 R.U.L.L.C.A. § 105(c)(2) cmt. (emphasis added).
71 Id. § 409(a). Although corporations are still regarded as entities even if their majority or controlling shareholders are held to be under fiduciary duties to other shareholders, the imposition of these fiduciary duties can be viewed adding an aggregate characteristic to the entity.
72 Id. § 105(a). Compare Delaware’s law providing that partnerships are entities unless otherwise provided. Del. Code Ann. tit. 6, § 201(a) (2019).
73 R.U.L.L.C.A. § 105(c).
74 Id. §§ 109, 105(c)(2).
75 Id. § 108(c) cmt. (“[D]issolution and winding up of a limited liability company may result from a term specified in the operating agreement or the affirmative vote or consent of all the members. See Sections 701 (events causing dissolution) and 702 (winding up required upon dissolution). An operating agreement is not a publicly filed document, and a member vote to dissolve a limited liability company is not a public event.”).
76 “If ‘over-trust’ (due to family or friendship ties) and unsophistication help to explain the failure of close corporation owners to recognize that contractual protections are needed, those rationales would seem to apply to LLC owners as well.” Moll, supra note 54, at 221–22.
77 They may also rely on the provision that, “[u]nless displaced by particular provisions of this [a]ct, the principles of law and equity supplement this [act].” R.U.L.L.C.A. § 111.
78 See id. § 407(b)(4), (c)(3); see generally Donald J. Weidner, Dissatisfied Members in Florida LLCs: Remedies, 18 Fla. St. U. Bus. Rev. 1 (2019).
79 See, e.g., Creel v. Lilly, 729 A.2d 385, 393–94 (Md. 1999) (noting jurisdictions that “have recognized the unfairness and harshness of a compelled liquidation and found other judicially acceptable means of winding up a partnership under UPA, such as ordering an in-kind distribution of the assets or allowing the remaining partners to buy out the withdrawing partner’s share of the partnership”). This is a longstanding criticism of an at-will liquidation rule: “While situational variants make it difficult to generalize, the liquidation right will be injurious to the business in many, perhaps in most, cases.” Allan R. Blomberg, Partnership Dissolution—Causes, Consequences, and Cures, 43 Tex. L. Rev. 631, 647 (1965).
80 The development of liquidity rights in LLCs may be seen as analogous to the development of a cause of action for dissolution in the event of oppression in the case of closely held corporations. See Harry J. Haynsworth, The Effectiveness of Involuntary Dissolution Suits as a Remedy for Close Corporation Dissension, 35 Clev. St. L. Rev. 25, 36 (1987) (“In recent years courts have increasingly focused on developing the concept of oppression, and proof of oppressive conduct is rapidly becoming the most likely avenue for minority shareholder relief in close corporations.”). To avoid the harshness of the full dissolution remedy, courts found the lesser-included remedy of the buyout. See, e.g., In re Superior Vending, LLC, 898 N.Y.S.2d 191, 192 (App. Div. 2010) (“Although the Limited Liability Company Law does not expressly authorize a buyout in a dissolution proceeding, the Supreme Court properly determined that the most equitable method of liquidation in this case was to provide” one.).
81 As a leading commentator stated: “Not uncommonly a participant in a closely-held enterprise invests all his assets in the business . . . .” F. Hodge O’Neal, Close Corporations: Existing Legislation and Recommended Reform, 33 Bus. Law. 873, 884 (1978).
82 See supra notes 5–6 and accompanying text.
83 R.U.L.L.C.A. § 111.
84 Id. § 111 cmt. (“For this act, the common law rules of contract and agency are among the most important supplemental ‘principles of law.’”).
85 See Marks v. Morris, 925 N.W.2d 112 (Wis. 2019) (suggesting that many LLCs have partnership features that begin with a pass-through of profits and losses that are reflected on separate capital accounts); see also infra note 135.
86 Even if an entity is formed under a statute other than RUPA, “its business or assets may be shown to be encumbered by an express or implied partnership agreement.” Hillman, Weidner & Donn, supra note 26, at 146.
87 RULLCA section 701(a)(4)(C)(ii) allows a member to seek judicial dissolution on the ground that “the managers or those members in control of the company . . . “have acted . . . in a manner that is oppressive and was . . . directly harmful to the applicant.” The Official Comment to this section states that oppression often “equates to or at least includes the frustration of the plaintiff ’s reasonable expectations,” but cautions against uncritically applying corporate precedent: “Close corporation law developed in part because the standard corporate governance structure exalts majority power and does not presuppose contractual relationships among the shareholders. In contrast . . . LLC governance is fundamentally contractual.” In a proceeding brought under this section, “the court may order a remedy other than dissolution.” Id. § 701(b). There is no provision to give any other remedy in the event of a traditional suit for dissolution on the ground that “it is not reasonably practicable to carry on the company’s activities and affairs in conformity with the certificate of organization and the operating agreement.” Id. § 701(a)(4)(B). The operating agreement may not “vary” either of these grounds for judicial dissolution. Id. § 105(c)(9).
88 U.P.A. § 22 cmt. (“Ordinarily, a partner is not entitled to a formal account, except on dissolution.”).
89 Id. § 22. UPA section 22 cmt. explains that “the total effect of this section is to emphasize the fact, that a partner, the partnership not being dissolved, has not, necessarily the right to demand formal accounts, except at particular times and under particular circumstances.”
90 R.U.P.A. § 405(b)(1), (2). In general, partners may contract away their remedies. However, to the extent that RUPA section 103(b) sets out mandatory duties and rights, it implicitly makes mandatory RUPA section 405(b) actions to enforce the corresponding liability and remedies. See the Official Comments to both sections and the discussion of the purposes and differences in Hillman, Weidner & Donn, supra note 26, at 83–89, 443–45. This is made explicit in HRUPA section 105 (c)(7).
91 R.U.P.A. § 405 cmt. 2. The adoption of RUPA marked “a significant departure from the previous view of intra-partnership actions” and a “rejection of the traditional view that actions between partners involving partnership affairs were exclusively equitable actions, a view that was the foundation of any remedy under the repealed [UPA].” Ex parte Master Boat Builders, Inc., 779 So. 2d 192, 195 (Ala. 2000).
92 Id. (quoting Auld v. Estridge, 382 N.Y.S.2d 897, 901 (Sup. Ct. 1976), aff ’d, 395 N.Y.S.2d 969 (App. Div. 1977)).
93 R.U.P.A. § 405(b) cmt. 2. HRUPA section 410 continues the substance of RUPA section 405.
94 RUPA section 405(c) provides that “the accrual of, and any time limitation on, a right of action for a remedy under this section is governed by other law.”
95 Specifically, RUPA section 405(c) provides: “The accrual of, and any time limitation on, a right of action for a remedy under this section is governed by other law. A right to an accounting upon a dissolution and winding up does not revive a claim barred by law.”
96 Id. § 405(b)(1), (2). In general, partners may contract away their remedies. However, to the extent that RUPA section 103 (b) sets out mandatory duties and rights, it implicitly makes mandatory RUPA section 405(b) actions to enforce the corresponding liability and remedies. See Hillman, Weidner & Donn, supra note 26, at 83–89.
97 Nor does RUPA contain any provisions authorizing derivative actions. As the Official Comments to RUPA section 405 explain: “Since general partners are not passive investors like limited partners, RUPA does not authorize derivative actions, as does RULPA Section 1001.” Compare Del. Code Ann. tit. 6, § 15-405(d) (2019) (authorizing a derivative action by a partner on behalf of the partnership).
98 U.L.L.C.A., Prefatory Note.
99 ULLCA section 410 had the same substance without using the term “direct action.”
100 U.L.L.C.A. § 410 cmt.
101 Id. § 410(b). Like RUPA section 405, ULLCA section 410 provides for access to courts to resolve member claims against the LLC and other members but, unlike RUPA section 405, it does not provide for corresponding actions by the LLC against a member.
102 U.L.L.C.A. §§ 1101–1104.
103 Id. § 1101. Subsequent provisions merely address the derivative claimant’s status as a member, the particularity of the pleadings, and the recovery of expenses. Id. §§ 1102–04.
104 R.U.L.L.C.A. § 801(b). The Official Comment refers to this as a “rule of standing.” Id. § 801(b) cmt.
105 Re-R.U.L.P.A. § 901.
106 R.U.L.L.C.A. § 802.
107 RULLCA provides that a member may bring a derivative action to enforce a right of the firm if:

(1) the member first makes a demand on the other members in a member-managed limited liability company, or the managers of a manager-managed limited liability company, requesting that they cause the company to bring an action to enforce the right, and the managers or other members do bring the action within a reasonable time; or

(2) a demand under paragraph (1) would be futile.

R.U.L.L.C.A. § 802(1), (2) (emphasis added).

108 Id. § 805(a).
109 Id. § 805(b). The SLC may move to “stay discovery [in the derivative suit] for the time reasonably necessary to permit the committee to make its investigation.” Id. § 805(a). If it does, the court shall grant the motion “except for good cause shown.” Id.
110 Id. § 805(d).
111 Id. § 805(e).
112 See RULLCA section 805(e), which also puts the burden of proof on the SLC. If the burden is not met, the court must dissolve any stay of discovery and allow the action to continue under the control of the plaintiff. Id. In some states, the court is not obligated to adopt the report of the SLC. See, e.g., Fla. Stat. § 605.0804(5) (2019) (providing that the court “may” enforce the determination of the SLC). The SLC provisions are default rules to the extent that an operating agreement may provide that the company may not appoint an SLC. RULLCA section 105(c)(12) provides that an operating agreement “may not vary the provisions of Section 805 [on SLCs], but the operating agreement may provide that the company may not have a special litigation committee.” In essence, the SLC is a dispute resolution mechanism that may be contracted away in the operating agreement. “An ‘SLC’ can serve as an ADR mechanism, help protect an agreed upon arrangement from strike suits, protect the interests of members who are neither plaintiffs nor defendants (if any), and bring the benefits of a specially tailored business judgment to any judicial decision.” Id. § 805 cmt.
113 See 1 Larry E. Ribstein & Robert R. Keatinge, Ribstein and Keatinge on Limited Liability Companies § 10:4 (2018); Principles of Corporate Governance: Analysis and Recommendations § 7.01(d) (Am. Law Inst. 2005).
114 See supra note 113.
115 Larry E. Ribstein, Litigating in LLCs, 64 Bus. Law. 739 (2009).
116 See generally Deborah A. DeMott, Shareholder Derivative Actions: Law and Practice (2017).
117 “A direct action should not be barred in an LLC, particularly where it would be the most efficient manner of resolving the dispute.” Buyout Rights, supra note 54, at 17.
118 See generally Donald J. Weidner, Dissatisfied Members in Florida LLCs: Remedies, 18 Fla. St. U. Bus. Rev. 1 (2019).
119 Courts should be alert for the possible disadvantage of creditors. In many cases, the issue is likely to be raised or obvious, given the personal guarantees members are typically required to make for firm obligations.
120 The Official Comment to RULLCA section 304(b) contrasts the formality of corporations with the informality of LLCs: “In the realm of LLCs . . . informality of organization and operation is both common and desired.” An empirical study of LLCs found that 40 percent of them were formed without any operating agreement. Sandra K. Miller, Penelope Sue Greenberg & Ralph H. Greenberg, An Empirical Glimpse into Limited Liability Companies: Assessing the Need to Protect Minority Investors, 43 Am. Bus. L.J. 609, 618 (2006).
121 See supra notes 115–16 & infra note 132.
122 See, e.g., Frances S. Fendler, A License to Lie, Cheat, and Steal—Restriction or Elimination of Fiduciary Duties in Arkansas Limited Liability Companies, 60 Ark. L. Rev. 643, 643 (2007) (“The vast majority of these LLCs appear to be small businesses, and many if not most of them are probably formed by persons relatively unsophisticated about the legal rules which govern the operation of LLCs.”).
123 See supra note 120; 1 Carter G. Bishop & Daniel S. Kleinberger, Limited Liability Companies: Tax and Business Law ¶ 6.03 (2020) (“Like most corporations, most LLCs are closely held, and, like most closely held corporations, most closely held LLCs are governed informally.”).
124 R.U.L.L.C.A. § 105(3)(11).
125 One leading treatise, commenting on RULLCA, ventured that “the parties to LLCs are more likely to have contracted for or selected their preferred exit mechanism than those in close corporations.” Larry E. Ribstein & Robert R. Keatinge, 3 Ribstein and Keatinge on Limited Liability Companies app. E-2 (2020).
126 See supra note 50.
127 R.U.L.L.C.A. § 801(b) cmt.
128 Id. § 801 cmt. b.
129 Id.
130 Id. This Official Comment’s “independently of the harm” to the company test is different from the “not solely the result of” test in the statute itself and appears to have been drawn from a leading Delaware case. Id. (citing Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1039 (Del. 2004)). Individual states may have more complex tests to draw the line between direct and derivative claims.
131 See Mohsen Manesh, Creatures of Contract: A Half-Truth About LLCs, 42 Del. J. Corp. L. 391, 398 (2018) (“[T]he singular aim of this Article, written to mark the 25th anniversary of the Delaware LLC Act . . . is to puncture the persistent fantasy that LLCs are ‘creatures of contract.’”); see also Joan MacLeod Heminway, The Ties that Bind: LLC Operating Agreements as Binding Commitments, 68 SMU L. Rev. 811, 829–30 (2015) (“LLC operating agreements are contracts or otherwise constitute valid, binding, and enforceable legal commitments in a given context if the applicable statute says so.”).
132 Daniel S. Kleinberger, How Can I Be a Party to a Contract and Yet Lack Standing to Sue Another Party for Breach?, Bus. L. Today, July 2018, at 4, https://www.westlaw.com/SharedLink/381cd033b1d248af8f8041f9d26e8546?VR=3.0&RS=cblt1.0 (citing El Paso Pipeline GP Co. v. Brinckerhoff, 153 A.3d 1248, 1259–60 (Del. 2016)).
133 Id.
134 See supra notes 75–81 and accompanying text.
135 At least one court has said that, in order to override a default rule, the operating agreement must be unambiguous. Marks v. Morris, 925 N.W.2d 112, 121 (Wis. 2019). Against a strong and lengthy dissent, the court in Marks also said that the operating agreement “unambiguously elected that [the LLC] is to be treated as a partnership where all the losses and gains of the LLC flow through to its individual members.” Id. As a consequence, “an injury to [the LLC] is not the same as an injury to a corporation,” given “the partnership-like mode of operating [the LLC] selected in its Operating Agreement.” Id. at 123–24. The court found this partnership-like mode of operation even though the LLC was manager-managed by “[d]irectors” who owned the LLC’s six members, themselves LLCs. The court said that “corporate principles of standing do not apply to LLCs,” particularly where “financial injury to [the LLC] flows through to its members just as it would if [the LLC] were a partnership rather than an LLC.” Id. at 125. The court also indicated that, unlike in the corporate form, the LLC’s “gains and losses are directly credited to or deducted from each member’s capital account, flowing through to each member’s partnership tax return.” Id. The court concluded: “For these reasons, there is generally a much closer financial connection between harm to an LLC and harm to its members than between harm to a corporation and harm to its shareholders.” Id. at 126.
136 To make this argument, it is not necessary to establish that they were partners, which would be much more difficult. See Wright v. Scales 925 Atlanta, LLC, 761 F. App’x 884 (11th Cir. 2019) (rejecting the argument that members became jointly and severally liable because they operated their LLC as a partnership).
137 See cases discussed in Hillman, Weidner & Donn, supra note 26, at 151–56.
138 See also R.U.L.L.C.A. § 111 (“Unless displaced by particular provisions of this [act], the principles of law and equity supplement this [act].” Its Official Comment explains: “For this act, the common law rules of contract and agency are among the most important supplemental ‘principles of law.’”).
139 Oppression has been defined in various ways, perhaps most famously in terms of the “reasonable expectations of the shareholders as they exist at the inception of the enterprise, and as they develop thereafter through a course of dealing concurred in by all of them.” Meiselman v. Meiselman, 307 S.E.2d 551, 563 (N.C. 1983) (citation omitted). A fuller discussion of the oppression remedy is outside the scope of this article. See generally F. Hodge O’Neal & Robert B. Thompson, O’Neal and Thompsons Close Corporations and LLCs: Law and Practice § 9:33 (rev. 3d. ed. July 2019 update) (concluding that “[i]nclusion in statutes of terms such as ‘oppression’ or ‘unfairly prejudicial’ and the courts’ tendency to focus on the reasonable expectations of shareholders undoubtedly have lowered the threshold at which courts will provide relief to minority shareholders”).
140 See Larry E. Ribstein & Robert R. Keatinge, 3 Ribstein and Keatinge on Limited Liability Companies app. E-2 (2020) (opining that the same considerations that make derivative suits inappropriate in most LLCs also “make the extra burden and formality of a special litigation committee even more dubious”).
141 Epic Systems Corp. v. Lewis, 138 S. Ct. 1612 (2018), a five-to-four decision, is the leading case upholding pre-dispute binding arbitration agreements.
142 See, e.g., Hodges v. Reasonover, 103 So. 3d 1069, 1077 (La. 2012) (stating that, “at a minimum,” the attorney must “disclose the following legal effects of binding arbitration, assuming they are applicable: Waiver of the right to a jury trial, Waiver of the right to an appeal; Waiver of the right to broad discovery . . . ; Arbitration may involve substantial upfront costs compared to litigation; Explicit disclosure of the nature of claims covered by the arbitration clause, such as fee disputes or malpractice claims; The arbitration clause does not impinge upon the client’s right to make a disciplinary complaint to the appropriate authorities; The client has the opportunity to speak with independent counsel before signing the contract.”); see generally ABA Comm. on Ethics & Prof ’l Responsibility, Formal Op. 02-425, Retainer Agreements Requiring the Arbitration of Fee Disputes and Malpractice Claims (Feb. 20, 2002).
143 “An ‘SLC’ can . . . bring the benefits of a specially tailored business judgment to any judicial decision.” R.U.L.L.C.A. § 805 cmt. The application of the business judgment rule to the work of SLCs has long been considered inappropriate in the context of closely held corporations. See Ralph A. Pee-ples, The Use and Misuse of the Business Judgment Rule in the Close Corporation, 60 Notre Dame L. Rev. 456, 463 (1985).
144 R.U.L.L.C.A. § 805(e) cmt.
145 Federal Arbitration Act, 9 U.S.C. § 10 (2018).
146 R.U.L.L.C.A. § 805(e) cmt. (quoting Houle v. Low, 556 N.E.2d 51, 58 (Mass. 1990) (discussing the various standards of judicial review of determinations of special litigation committees, particularly on their determinations of business judgment)). In Houle, a junior and minority shareholder in a medical corporation was appointed as a single-member SLC. The court refused to implement the determination of the SLC because there was a general issue as to “its independence, good faith, and procedural fairness.” Houle, 556 N.E.2d at 58; see also Einhorn v. Culea, 612 N.W.2d 78, 91 (Wis. 2000); In re Oracle Corp. Derivative Litig., No. 2017-0337-SG, 2018 WL 1381331 (Del. Ch. Mar. 19, 2018).
147 R.U.L.L.C.A. § 805(e).
148 Id. § 805(e) cmt.
149 Id. § 805(b). The SLC may move to “stay discovery [in the derivative suit] for the time reasonably necessary to permit the committee to make its investigation.” Id. § 805(a). If it does, the court shall grant the motion “except for good cause shown.” Id.
150 Commercial Rules R-18(a), (b), Am. Arb. Association (Oct. 1, 2013), adr.org/sites/default/files/CommercialRules_Web.pdf.
151 824 A.2d 917 (Del. Ch. 2003).
152 Id. at 938.
153 Id.
154 Id.
155 R.U.L.L.C.A. § 805(c)(1)(A), (B).
156 Id. § 805(c)(2)(A), (B).
157 See, e.g., Wenske v. Blue Bell Creameries, Inc., C.A. No. 2017-0699-JRS, 2019 WL 4051007 (Del. Ch. Aug. 28, 2019).
158 Daniel S. Kleinberger, How Can I Be a Party to a Contract and Yet Lack Standing to Sue Another Party for Breach?, Bus. L. Today, July 2018, at 3, https://www.westlaw.com/SharedLink/381cd033b1d248af8f8041f9d26e8546?VR=3.0&RS=cblt1.0. One study is more positive about how claimants fare before SLCs of larger corporations, demonstrating that:

(1) special litigation committees decide to pursue or settle claims much more frequently than heretofore recognized; (2) special litigation committees do not otherwise let defendants off the hook when pursuing or settling claims, in view of the financial recovery to the company in either scenario; (3) most shareholder claims subject to the authority of special litigation committees end up settled, not dismissed; and (4) claims subject to the authority of a special litigation committee are resolved faster than standard derivative claims, indicating that the special litigation committee may serve as a form of alternative dispute resolution.

Minor Myers, The Decisions of The Corporate Special Litigation Committees: An Empirical Investigation, 84 Ind. L.J. 1309, 1309 (2009).

159 See, e.g., International Institute for Conflict Prevention & Resolution, Non-Administered Arbitration Rule 6 (Mar. 1, 2018), cpradr.org/resource-center/rulesarbitration/non-administered.
160 See, e.g., Florida Revised Limited Liability Company Act, Fla. Stat. §§ 605.0101–605.1108 (2019).
https://www.researchpad.co/tools/openurl?pubtype=article&doi=10.928/ac.2021.03.25&title=LLC Default Rules Are Hazardous to Member Liquidity&author=Donald J. Weidner,&keyword=&subject=Articles,