Unlike most other states, California imposes limitations on what business entities can qualify for LLC status. Under California Corporations Code Section 13401 et al, LLCs in California are generally not permitted for businesses that provide “Professional Services”.

Section 13401 (a) defines “Professional Services” as “…any type of professional services that may be lawfully rendered only pursuant to a license, certification, or registration authorized by the Business and Professions Code, the Chiropractic Act, or the Osteopathic Act.”

Section 13403.3 defines professional services as “any type of professional services that may be lawfully rendered only pursuant to a license, certification, or registration authorized by the Yacht and Ship Brokers Act.” Thus, if a license or certification is required to act in a professional capacity, then it is considered a professional service.

However, California does not consider all services performed pursuant to a license or permit as a professional service. The California Attorney General has stated that nonprofessional, occupational licensees can form an LLC. It is not always clear whether a licensee holds a professional or nonprofessional occupational license.

Some clarity can be derived from Section 17701.04(b) of the California Corporation Code which reads: “…A domestic or foreign limited liability company may render services that may be lawfully rendered only pursuant to a license, certificate, or registration authorized by the Business and Professions Code, the Chiropractic Act, the Osteopathic Act, or the Yacht and Ship Brokers Act, if the applicable provisions of the Business and Professions Code, the Chiropractic Act, the Osteopathic Act, or the Yacht and Ship Brokers Act authorize a limited liability company or foreign limited liability company to hold that license, certificate, or registration.”

Therefore, it is imperative to review the applicable sections of California law for applicability of the profession in question and, also, review with the licensing body of the profession, to fully determine whether services provided under the license or permit are certified professional or nonprofessional occupational in the field in question if the licensee seeks to form a limited liability company.

If you are a licensee who is considering organizing as an LLC, contact your business attorney who can help you determine whether California will permit you to do so.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.

In Hacker v. Fabe, the California Court of Appeal for the Second Appeals District affirmed the trial court’s piercing of an LLC veil where the managing member of the LLC manipulated LLC assets and destroyed the LLC’s records. The claim involved unpaid wages brought by the Labor Commissioner against Ms. Fabe’s former employer 1538 Cahuenga Partners, LLC. Hacker, the managing member of the LLC, testified that documents relating to Cahuenga’s earnings from 2005 through 2010 were in his possession and control at some point in time, but he had destroyed them. In piercing the LLC veil, the trial court decided Mr. Hacker’s complete control over Cahuenga, his control over the litigation, sharing of attorneys with Cahuenga, his transfer of the LLC to a third party immediately after judgment was entered, and destruction of the relevant records of the assets, supported the alter ego doctrine and piercing the LLC veil.

In Troyk v. Farmers Group, the court noted in California, two conditions must be met before the alter ego doctrine will be invoked. First, there must be a unity of interest in ownership between the corporation and its equitable owner so that the separate personalities of the corporation and shareholders do not, in reality, exist. Second, there must be an inequitable result if the acts in question are treated as those of the corporation alone.

In Associated Vendors, Inc. v. Oakland Meat Co. (1962), the court analyzed a number of cases in which the corporate entity had been disregarded and produced the following list of factual circumstances, which can serve as a checklist for
determining whether the alter ego doctrine might be applicable:

• Commingling of funds and other assets, failure to segregate funds of the separate entities, and unauthorized diversion of corporate funds or assets to other than corporate uses;
• Treatment by an individual of the assets of the corporation as his or her own;
• Failure to obtain authority to issue stock or to subscribe to or issue the same;
• Holding out by an individual that he or she is personally liable for the debts of the corporation;
• Failure to maintain minutes or adequate corporate records and confusion of the records of the separate entities;
• Having identical equitable ownership in the two entities, identical individuals having domination and control of the two entities, identical directors and officers of the two entities in supervision and management, or sole ownership of all of the stock in a corporation by one individual or the members of a family;
• Use of the same office or business location or employment of the same employees or attorney;
• Failure to adequately capitalize the corporation, or the total absence of corporate assets;
• Use of a corporation as a mere shell, instrumentality, or conduit for a single venture or the business of an individual or another corporation;
• Concealment and misrepresentation of the identity of the responsible ownership, management, and financial interests or concealment of personal business activities;
• Disregard of legal formalities and failure to maintain arm’s length relationships among related entities;
• Use of the corporate entity to procure labor, services, or merchandise for another person or entity;
• Diversion of assets from a corporation by or to a stockholder or other person or entity, to the detriment of creditors, or manipulation of assets and liabilities between entities so as to concentrate the assets in one and the liabilities in another;
• Contracting with another with intent to avoid performance by use of a corporate entity as a shield against personal liability or use of a corporation as a subterfuge for illegal transactions; and
• Formation and use of a corporation to transfer to it the existing liability of another person or entity.

Hacker v. Fabe suggests that the fifteen factors described in Associated Vendors should be increased by at least one more, the destruction of records. This factor suggested that there was no separate personality between Hacker and the LLC.

If any of the factors listed apply to your LLC or corporation, contact qualified business counsel to help put your business house in order so that, in the event of a claim, you do not lose your residential home and assets due to a claim against the company.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.

A Limited Liability Company (LLC) falls somewhere between a general partnership and a more formal corporation. It provides protection for individual members and offers significant tax incentives. Thus, LLCs are a common way to structure small businesses.

An LLC needs a strong operating agreement drafted with a specific understanding of small business needs. This contractual foundation is especially important for budding entrepreneurs. A well-drafted contract can mitigate some of the issues that new companies face.

An operating agreement is used by members or managers of an LLC. The operating agreement ensures that all of the rules are followed and that everyone understands how the company will proceed. An operating agreement for a limited liability company is, in essence, a contract. Except for a few statutory and modifiable rules, the drafter gets to design the majority of the rules that the entire company is to follow and abide.

One of the most important sections in the operating agreement is the capital contribution section. A capital contribution section usually addresses what happens if members fail to contribute their portion of the initial start-up capital. This section also addresses what happens if a member wants to withdraw their capital contributions, ownership of the assets in the company and whether or not the company can require additional contributions.

Many times, members want the ability to pull out money from their capital contributions. This can become a problem, where there is a large group of people pooling funds for a common purpose. If a member withdraws money at any time, it makes it difficult for the company’s management to make decisions such as purchasing real property, assets, taking on employees, etc. Management must then consider if the company can make such a significant financial commitment if members have the ability to constantly move funds out of the company. 5

The capital contribution section is also important if the Company owes money to a judgment creditor. It is possible that a charging order issues against their membership distributions. A clever manager of the Company might say that the member can pull out their capital contributions in the form of distribution. However in this case, if the LLC has protection in the operating agreement which explicitly states that members or managers do not have the authority to pull that money, the judgment debtor can find themselves in a better position.

An operating agreement should require that all assets acquired by the company be in the company name. This is to ensure that there is no dispute over the ownership of an asset, especially if there are many assets collected by the company and multiple members. This is usually done by either acquiring title in the name of the LLC or transferring title to the LLC shortly after purchase. Other times, an asset might be part of the capital contribution, if so, it is important to have clear ownership lines drawn.

Finally, the additional capital contribution clause is one that the drafter should make sure not to overlook. It is crucial for the drafter to understand each member’s financial position and ability to contribute additional funds should the need arise. If the drafter decides that the additional contribution clause is going to allow members or managers to request more contributions there should be a limit on the total capital contribution amount that can be requested in a certain period of time.

If you are creating an LLC, or have created a LLC, but do not have a written operating agreement, contact your business attorney and get one!

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.

In Friend of Camden, Inc. v. Brandt (2022) (“Brandt”) the California Court of Appeal for the Second District has answered the question whether, after the commencement of a dissolution lawsuit, does the affirmative vote of 50% of the members of a limited liability company to dissolve remove the objecting members’ right to purchase the initiating members’ ownership interest under Corporation Code Section 17707.03(c)?

Under Corp. Code §17707.03(c)(1), after a dissolution lawsuit has been filed, members opposing dissolution may avoid dissolution by purchasing the ownership interests of the members initiating the lawsuit, at fair market value (FMV). Should the parties be unable to agree on the FMV, the court, upon the application of the defendant, is required to stay the dissolution proceeding and establish the FMV. Once the court has granted defendant’s stay, plaintiff cannot prevent the buyout by dismissing the lawsuit.

In Brandt, plaintiff who owned a one-percent interest in a limited liability company (LLC) filed a lawsuit seeking judicial dissolution of the LLC. In response, defendants, the other members of the LLC who together held 50 percent of the membership interests, filed a motion to avoid the dissolution by purchasing plaintiff’s one-percent interest. In turn, plaintiff, together with other members owning 49 percent of the membership interests in the LLC, for a total of 50 percent, voted to dissolve the LLC 39 days prior to the hearing on defendant’s motion and the trial court’s eventual order imposing a stay. Thus, the issue in Brandt was whether plaintiff’s vote to dissolve the 4

LLC, after commencement of lawsuit and after defendants had filed their motion, extinguished defendants’ right to purchase plaintiff’s one-percent interest and avoid dissolution of the LLC.

The Brandt court held that since Plaintiff had voted to dissolve the LLC prior to the trial court’s issuance of a stay, the vote of 50 percent of the LLC membership interests to dissolve the LLC must be given effect and, thus, it instructed the trial court to dismiss the buyout proceeding as moot and direct the parties to wind up the activities of the LLC.

LLC Members have significant rights when it comes to involuntary dissolution of the LLC. If you are a member of an LLC divided with others over whether to continue to do business of the LLC, contact your business attorney to discuss how to best approach the situation.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.

Having a partner who has not put in his/her share of the required initial capital is a common LLC problem. The problem is often exacerbated when members sign a boilerplate operating agreement at the inception of business without first obtaining legal advice. The language of these form agreements ordinarily assumes all members have paid the required initial capital in exchange for their percentage interests stated in the agreements. Consequently, an LLC member who has not paid the required capital would be identified and listed as a member in the operating agreement with full voting and economic rights. When it comes time to distribute profits, such failure to contribute frequently results in discord between members and, in many cases, lawsuits, business disruptions, and potentially dissolution of the LLC.

One example of what can happen was discussed in the case of Blue Water Sunset, LLC v. Markowitz, an unpublished 2017 California Court of Appeals case. In Blue Water Sunset, LLC two partners started three LLCs as 50/50 owners. After a few years, one member alleged that the other member never paid the $1,000 initial capital to each LLC as required by the LLC operating agreements, and therefore was not a member. The allegedly noncontributing member contended that it had
transferred properties worth millions of dollars to the three LLCs, which should suffice as its initial capital contribution. The court held that the non-contributing member did not make the required initial capital contribution, and therefore was never a member. The court found that, pursuant to the operating agreement, the initial contribution is required for membership to the LLC, and the $1,000 initial contribution must be made in the form of cash (or check).

Unlike in Blue Water Sunset, LLC an LLC member’s failure to make the initial capital contribution does not necessarily result in reduction of his interest in the company.

A clearly drafted and well-thought-out LLC operating agreement is vital to an LLC’s continued success. LLC members should clearly define the required amount and form of the initial capital contribution in the operating agreement. A due date should also be specified. Provisions may be made in the operating agreements to penalize non-contributing members.

If properly structured in the operating agreements to cover the deficiency caused by a non-contributing member, a contributing member can elect among proscribed remedies in a well-drafted operating agreement to do any or some of the following:

• Withdraw the capital contribution
• Advance the fund as a loan to the non-contributing member
• Advance the fund as a loan to the LLC
• Advance the fund as a preferred contribution and receive preferential distributions
• Advance the fund and reduce the non-contributing member’s percentage interests in accordance with a predetermined adjustment formula.

These types of remedies may only be able to be enforced if set forth in the LLC operating agreement.\

A failure to make initial or additional capital contributions should be promptly documented and notices sent so that potential claims against the noncontributing member can be readily proven by LLC records.

Ultimately, LLC members should retain legal counsel when planning, drafting and enforcing remedies for a member’s failure to contribute required capital.

Implementation of many of these remedies involve complex income tax issues and can also lead to unintended consequences such as a “change in ownership” that triggers a reassessment of the real property owned by an LLC.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.

A purchase or sale agreement for limited liability company (LLC) interests requires due diligence to obtain a complete picture of the exchange in order to properly document the transaction.

One of the primary concerns is whether the transaction should be structured as a sale of membership interests from the departing member (“Departing Member”) to a remaining member, or a redemption (or “liquidation distribution”) of Departing Member’s interest by the LLC. The LLC operating agreement usually contains provisions that include transfer restrictions, procedures, and notice requirements. Additional requirements may apply if the transaction is a sale as opposed to a redemption. A transfer that violates provisions of the operating agreement can be deemed invalid.

Assuming that the LLC is treated as a partnership for federal income tax purposes, the Departing Member transfers the entire interest, and the partnership status of the LLC continues with two or more members (“Remaining Members”) after the transaction, then there may be the following tax consequences:
Under Subchapter K of the Internal Revenue Code (“IRC”), LLC members have some flexibility in the allocation of their tax burdens by structuring the transaction as a sale or a redemption. The tax differences between a sale and a redemption can be substantial. A Departing Member’s gain and Remaining Members’ tax basis will be treated differently. Tax treatment may also be affected should the LLC assets include the so-called “hot assets” as defined by IRC Section 751 (i.e. inventory and unrealized receivables); if the payments to the Departing Member are made in installments; if the LLC distributes property instead of cash (or a mixture of both) to the Departing Member; if goodwill is considered as part of the LLC assets; if the redemption of Departing Member’s interest is funded by a promissory note from the LLC; and if Departing Member’s contribution to the LLC was in the form of service instead of cash and property.

There are instances where the IRS may look behind the parties’ chosen form and recharacterize the transaction. Two scenarios in which this happens are when the redemption appears to be funded by a Remaining Member’s contribution to the LLC or when the Remaining Members’ interests do not increase pro rata after the transaction. In these circumstances, a rebuttable presumption of a disguised sale can arise under IRC Section 707.

The interest of the Departing Member will not necessarily align with the interest of Remaining Members when choosing between sale and redemption. All parties, including the LLC, should consult with their own tax advisors for a comparison of different tax scenarios before negotiating, so that the parties can reach an informed decision.

Sales and redemptions require intentional structuring and proper documentation. A failure to comply with the LLC operating agreement can result in disruption of business operations and costly legal disputes. Departing Member and Remaining Members should seek the advice of legal counsel to make sure the transaction complies with the LLC operating agreement, and to prepare documentation consistent with the parties’ intentions and informed decision.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.

What happens when an LLC manager engages in “questionable conduct” with third parties, such as, binding the LLC to transactions and obligations that are potentially beyond the manager’s authority to enter into without the consent of the majority of the LLC’s members?

The Operating Agreement ordinarily contains some limits on the authority of a manager. Most such agreements grant the manager authority over the LLC’s day to day operations, but require LLC member approval for extraordinary transactions, such as the ability to sell or encumber the LLC’s property or dissolve the LLC.

California Corporations Code section 17703.1 provides guidance on the consequences and rights of the parties when an LLC manager makes an “unauthorized” deal with a third party. Section 17703.01, a part of the Revised Uniform Limited Liability Company Act (“RULLCA”), sets forth the rules for a manager acting as an “agent” for the LLC in the LLC’s dealings with third parties.

For manager-managed LLCs (as opposed to member-managed LLCs), the members are not agents of the LLC, and cannot “bind or execute any instrument on behalf of” the LLC. (Section 17703.01(b)(1).)

The manager, on the other hand, is an agent of the LLC “for the purpose of its business or affairs,” and the manager’s signature on any instrument on behalf of the LLC will bind the LLC “unless the manager so acting has, in fact, no authority to act for the limited liability company in the particular matter and the person with whom the manager is dealing has actual knowledge of the fact that the manager had no such authority.” (Section 17703.01(b)(2).)

Subdivisions (c) and (d) of the statute continue:
(c) No act of a manager … in contravention of a restriction on authority shall bind the limited liability company to persons having actual knowledge of the restriction.
(d) Notwithstanding the provisions of subdivision (c), any note, mortgage, evidence of indebtedness, contract, certificate, statement, conveyance, or other instrument in writing, and any assignment of endorsement thereof, executed or entered into between any limited liability company and any other person, when signed by [the manager], is not invalidated as to the limited liability company by any lack of authority of the signing [manager] in the absence of actual knowledge on the part of the other person that the signing … manager had no authority to execute the same. (Section 17703.01(c)-(d), emphasis added.)

A manager’s “unauthorized” acts cannot categorically be invalidated. Under the statute, if a manager engages in an “unauthorized” transaction the members must prove that the third-party buyer had “actual knowledge” that the manager lacked authority to sell the property to invalidate the transaction. This rule protects the rights of the third party dealing with an LLC’s manager.

Under California law “actual” knowledge or notice consists of “express information of a fact” (Civil Code section 18 and is distinguished from “constructive” or “imputed” knowledge, where someone is held to “know” something because their agent knows it or because the fact is contained in a recorded document. However, some Courts have held that knowledge that could be gleaned from a recorded document is “actual” knowledge.

Even if the members cannot unwind the transaction, they may have remedies against the manager for breach of fiduciary duties. However, such remedies may be of little comfort if the unauthorized act of the manager transferred away the LLC’s main assets or other rights.

If you are an LLC manager or member and are concerned with liability over a transaction, contact legal counsel since such transactions are not automatically invalidated and there are ways to protect the LLC from such conduct if it has not yet occurred.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.

A single member Limited Liability Company is dissolved when its sole member dies unless:

1. The operating agreement allows for continuation of the LLC and sets forth a mechanism to install a successor to the deceased member; or
2. The heirs, successors, and assigns of the deceased member’s interest elect to continue the LLC within 90 days of the sole member’s death.

Consequently, a single member LLC can survive the death of its owner. The first exception must be set forth in the Operating Agreement. The second exception is set forth in the California Revised Uniform Limited Liability Company Act (“CRULLCA”) Section 17707.01:

Regarding the second exception, an heir, successor, or assign of the member’s interest can become a substituted member without the permission or consent of the heirs, successors, or assigns or those administering the estate of the deceased member.

Under the CRULLCA, the heirs, successors, and assigns of the membership interest are to be determined by either the deceased member’s estate plan, or if no estate plan exists, by the law of intestate succession.

If the single member wants to ensure the LLC is dissolved, the operating agreement should contain a provision with the proper instructions. Otherwise, the LLC will be subject to the provisions of Section 17707.01 of the CRULLCA allowing for the
potential of unwanted heir(s) to operate the LLC.

If you are the only member of a single member LLC and wish to identify a successor to your interest or require the LLC to dissolve upon your death, contact the LLC’s business attorney to assure that the LLC’s Operating Agreement conforms to your wishes.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.