April 2, 2020
by Bob Incollingo
As a small business owner in the time of coronavirus (COVID-19), you want to keep things running if you need to go out sick. Now is a good time to plan for temporary succession of management, and if you are doing business as an LLC, you’re in luck. Limited liability companies allow short term formal adjustments in management structure, with easy return to the previous chain of command.
Under the New Jersey Revised Uniform Limited Liability Company Act, N.J.S.A. 42:2C-1, et seq., an LLC is formed and operated either as a “member-managed” company or as a “manager-managed” company. Under the Act, a manager is defined as a person who is responsible (alone or with others) for management functions of the company under the terms of the operating agreement of a manager-managed LLC. That definition sounds redundant or even circular, but it just means to exclude someone informally called the manager in a member-managed company from the rights and responsibilities the Act elsewhere provides.
Manager-managed companies place the owners of the company (the members) at one remove from operational control. The members in a manager-managed company take a back seat and let the manager(s) run the company. This is one reason that manager-managed companies are infrequently used by small businesses. For another reason, the law provides that unless otherwise specified in the operating agreement, and where there is no operating agreement, a new LLC will default to a member-managed operation.
So, odds are good that your LLC is a member-managed company where the owners play a direct role in operations, much as if the company were a partnership or a sole proprietorship. Unless the operating agreement says otherwise, the owners of a member-managed company run its day to day affairs and make all the decisions. In a basic member-managed LLC, the following rules apply:
- The management and conduct of the company are vested in the members.
- Each member has equal rights in the management and conduct of the company’s activities.
- A difference arising among members as to a matter in the ordinary course of the activities of the company may be decided by a majority of the members.
- An act outside the ordinary course of the activities of the company may be undertaken only with the consent of all members.
- The operating agreement may be amended only with the consent of all members.
Imagine for a moment that you become incapacitated by illness. You may have a spouse or trusted employee who can step in and manage the company during your convalescence. This is good, but from experience you know that outsiders will not trust a subordinate with the negotiation of large or unusual purchase orders, extensions of credit, or other kinds of contracts which may need immediate resolution during your down time. Prudent business associates and customers will shrink from any informal delegation of authority. A lender or insurer may not even speak with your administrative assistant, let alone accept a decision or a signature which issues from anyone but a member/owner of the company.
How do you vest an alternate or subordinate with actual authority (in the legal sense) to run things in your absence? How will they persuade vendors, bankers, customers and others that they have binding authority to speak, act, and contract on behalf of the company? Most importantly, how can you break this logjam without making your alternate or subordinate a member of the company, and sharing out ownership?1
What you need to know is that the law allows you the flexibility to change over to a manager-managed company when circumstances change. For those small businesses who have avoided the formality of a written operating agreement, shame on you and you should have had one drawn up long ago. It’s not too late. When you do so, the company members can opt for manager-managed operations, and document that choice in the new agreement. Your manager(s) can then present the signed operating agreement as legally sufficient proof of authority to anyone concerned. If you already have an operating agreement, written amendment (or wholesale adoption of a new amended agreement) with the consent of all members will accomplish the same effect.
In a manager-managed limited liability company, the following rules apply:
- Except as otherwise expressly provided in the Revised Uniform Limited Liability Company Act, any matter relating to the activities of the company is decided exclusively by the managers.
- Each manager has equal rights in the management and conduct of the activities of the company.
- A difference arising among managers as to a matter in the ordinary course of the activities of the company may be decided by a majority of the managers.
If you are uneasy about handing over the reins to a manager, re-read provision (1) in the last paragraph. As that section provides, the law reserves some decisions to the members even in a manager-managed company. The consent of all members is still required to take actions outside the ordinary course of the company’s activities, or to amend the operating agreement.
When you are feeling better and get back to your business, you can amend the operating agreement a second time, thank and excuse your manager from further service, and return to the member-managed format. In the alternative, you can keep your new format and now formally designate yourself as a manager, alone or with other managers. Your membership status will not change.
As a managing member, you will wear two hats, with the designated responsibilities and rights of manager and member both. By contrast, you may decide to remain in a more passive role, although you still may retain some interest in the affairs of the company. These arrangements will be documented in the re-cast provisions of the operating agreement, as amended.
You can take steps to protect your small business right now by amending your operating agreement. After the present tribulations pass and circumstances change, you may wish to amend it again. As your business grows and your company takes in new members, as you plan for succession of management and ownership, seek to preserve rights to creative property, and work to retain or transfer control of the business, the operating agreement will deserve further review.
As always, let me know if I can help.
1 The more creative among you may consider appointing an attorney-in-fact for the LLC through a power of attorney. This is not recommended, insofar as the company’s formative documents – certificate of formation and operating agreement – may proscribe such extension of authority, or set conditions on the extension of authority which make it void from the outset. Moreover, execution of a power of attorney will be deemed inadequate to vest an attorney-in-fact with the authority of a "duly authorized officer" which certain statutes require. See, Diamond Beach, LLC v. March Associates, Inc., 457 N.J. Super 265 (App. Div. 2018).
Bob Incollingo is a South Jersey lawyer who forms, modifies, dissolves, defends and sues limited liability companies in Gloucester County, Burlington County, Camden County, and elsewhere in New Jersey from his office in Cherry Hill. More articles like this appear on RJILAW.com.