Business Law Alert: What Business Owners and Entrepreneurs Need to Know: Changes to Illinois' Limited Liability Company Act

Effective July 1, 2017, the Illinois Limited Liability Company Act (805 ILCS 180/1-5 et seq.) has been substantially amended.  The Illinois LLC Act governs the manner in which limited liability companies organized in Illinois are formed, operated and dissolved; what terms shall, may or may not be included in the operating agreements that set forth how an Illinois LLC is to be operated; and how the members, managers, directors and officers of LLCs must interact with one another and parties with which the LLC does business. 

The amendatory act is designed to align the Illinois LLC Act with the Revised Uniform Limited Liability Company Act that has been adopted in many U.S. states.  While the amendatory act is lengthy and often technical, it contains significant changes that business owners and entrepreneurs in Illinois should understand.

1. An Illinois LLC will be member-managed unless the operating agreement provides that it is manager-managed.

A limited liability company can be designated as managed by its members (i.e., like a traditional general partnership) or by managers elected or appointed in accordance with the terms of the operating agreement.  The Illinois LLC Act currently has no default provision; organizers make the designation in the articles of organization submitted to the Secretary of State.  The amendatory act adds a new default rule (805 ILCS 180/15-1(a)), which provides that an Illinois LLC will be member-managed unless its operating agreement designates it as manager-managed.
2. Members of an LLC will no longer automatically be agents of the LLC.

The Illinois LLC Act provided that each member of a member-managed LLC is an agent of that company for purposes of its business, and that member’s actions (including the execution of documents) bind the company.  The amendatory act provides that a member of an LLC is not an agent of that company solely by reason of being a member (805 ILCS 180/13-5).  However, a member of a company may still be granted authority by a company, either by traditional company action or by the filing of a new “Statement of Authority” on the public record, and a member who holds himself, herself or itself out as having authority may bind the company under general legal principles of authority.
3. The amendatory act creates two new instruments of the public record---the “Statement of Authority” and the “Statement of Denial”—which are optional tools to help clarify the extent of a person’s authority to bind a limited liability company.

LLCs are now permitted to publicly announce a grant of authority by the company to a member, manager or other person or a limitation on that person’s authority by filing a Statement of Authority with the Secretary of State (805 ILCS 180/13-15).  The company may subsequently amend or cancel the Statement of Authority.  The scope of authority set forth in a Statement of Authority will override language in the operating agreement to the extent they conflict.  A person named in a Statement of Authority may effectively amend a grant of authority to him, her or it by filing a Statement of Denial with the Secretary of State (805 ILCS 180/13-20).  The use of Statements of Authority and Statements of Denial is optional and there is no statutory penalty for failing to file them.  Persons entering into significant transactions may wish to review the operating agreement of the company and check the public records before entering into a contract with a LLC in order to confirm that the signatory has the authority to bind the other party.
4. Members will be bound by the operating agreement of their LLC even if they have never signed it.

A person who becomes a member of an LLC will be deemed to have assented to the operating agreement of the company, regardless of whether such member has signed the document (805 ILCS 180/15-5(g)). Because approval is no longer contingent on a manual signature, investors should demand a signed copy of a company’s operating agreement for review as part of their diligence so that they are not bound by terms about which they have not been informed.
5. Oral or implied operating agreements will now be enforceable.

Members of an LLC often enter into an operating agreement to establish the terms upon which the members and, if applicable, the officers, directors and managers, will share the economic and governance rights and responsibilities associated with running the company.  Other jurisdictions sometimes call these documents “limited liability company agreements”.  The definition of “operating agreement” in the amendatory act provides that an operating agreement may be oral, implied or part of a written record (805 ILCS 180/1-5).  This change, together with related changes designed to facilitate the use of electronic records, should help businesses comply more easily with record-keeping obligations.  However, the possibility that an unwritten agreement or a course of dealing may be acknowledged as controlling in a dispute should make investors more skeptical of investing in a company that has no written operating agreement.
6. An operating agreement may now amend or eliminate many of the fiduciary duties which apply to members.

The Illinois LLC Act includes default rules about the fiduciary duties that members and managers owe to the company (805 ILCS 180/15-3).

In a manager-managed company, a manager owes duties of loyalty, care, good faith and fair dealing to the company.  On the other hand, a member owes no fiduciary duties to the company unless he or she exercises some or all of the authority of a manager, in which case he or she is held to the same standard of conduct as the manager. 

In a member-managed company, a member owes duties of loyalty, care, good faith and fair dealing to the company.  These duties cannot currently be eliminated or reduced by language in the operating agreement (although specific carveouts can be provided).  With the amendments, the operating agreement will be able to completely eliminate the member’s duties of loyalty and good faith and fair dealing provided that such elimination is “clear and unambiguous”.  The operating agreement will continue to be able to list specific activities which shall not constitute a breach of fiduciary duties.  The amendments also permit companies to restrict the member’s duty of care as long as such restrictions do not permit intentional misconduct or knowing violation of the law.  805 ILCS 180/15-5(c).

These changes are likely to appeal to companies trying to attract potential investors who may have competing financial interests or who are reluctant to assume legal risk in a member-managed LLC.
7. Parties that obtain title to membership interests but are not admitted as members will have rights to review information about the company in certain circumstances.

If a purchaser purchases a membership interest in an Illinois LLC, but if the purchaser is not admitted by unanimous consent of the members (or such other standard as is set out in the operating agreement), then the purchaser is a “transferee,” rather than a member, and he holds a “distributional interest” in the company.  A transferee is entitled to receive distributions, but is excluded from governance matters.  The amendatory act now provides a transferee with the right to review the company’s records, including membership ledger, tax returns and certain governance documents, but only if  the transferee can establish to the company that the request is for a “proper purpose” (805 ILCS 180/1-40(c))
8. As amended, the Illinois LLC Act provides a roadmap to creditors to obtain a lien on a debtor’s membership interest in an Illinois LLC.

A judgment creditor of a member or transferee may obtain a charging order (effectively, a lien) against the membership or distributional interest of a debtor member or transferee in order to enforce a  judgment from a court of competent jurisdiction (805 ILCS 180/30-20).  The court may appoint a receiver to collect the debtor’s distributions and apply them to the judgment.  The court may also effect a foreclosure of the membership or distributional interest, which may be sold, although the purchaser would become a transferee and not a member. 
9. The amendatory act identifies specific remedies which may be exercised against members who fail to make a required capital contribution. 

Although it is common for operating agreements to provide for specific remedies which may be exercised when a member fails to make a required capital contribution, the amendatory act specifically authorizes the inclusion of such remedies and provides an illustrative list of those which are deemed to be acceptable (805 ILCS 180/20-5).  The company may, for example, restrict the member’s voting rights or involvement in management, assess liquidated damages, call the member’s membership interests, dilute the member’s membership interest, subordinate or adjust the member’s right to receive distributions, or permit another member to lend the money necessary to meet the failed commitment.
10. LLCs are no longer required to repurchase the membership interests of a member who dissociates from the company.

The Illinois LLC Act previously included a default rule that the company must cause the distributional interest of a dissociated member to be repurchased.  It is therefore common for operating agreements to include language designed to override this rule and provide that the company, which may not have the liquidity necessary for unexpected redemptions, may, but is not required, to repurchase a distributional interest from a dissociating member.  The amendatory act removes this rule, although parties may continue to include contractual agreements in their operating agreements about how to handle repurchases in these circumstances.
11. Illinois LLCs may in certain cases be directly converted into other forms of business entities and other forms of business entities may be converted directly into Illinois LLCs.

The Illinois LLC Act permitted a general partnership or limited partnership to legally convert itself into an LLC, but corporations were prohibited from converting directly into Illinois LLCs, and Illinois LLCs were not authorized to convert directly into other entities.  Business owners and attorneys have used merger structures to achieve these conversions, which makes such a conversion complicated and unnecessarily expensive.  The amendatory act provides a process for converting entities into Illinois LLCs and Illinois LLCs into other forms of entities, provided that the law governing the other type of entity permits such conversion (805 ILCS 180/37-31).  A similar process was added to the Illinois LLC Act to permit an LLC organized under the law of another state to “domesticate”—that is, become an Illinois LLC—through a direct process (805 ILCS 180/37-31).  Both of these changes should provide more legal flexibility and efficiency to Illinois businesses and permit them to adapt to changing needs and circumstances in how their business is organized and operated.
12. Upon completion of the dissolution of an Illinois LLC, the members will file a Statement of Termination with the Illinois Secretary of State.

The Statement of Termination replaces Articles of Dissolution under the Illinois LLC Act, but will perform a similar function (805 ILCS 180 35-15).

As the amendatory act stretches to more than one hundred pages, this article summarizes only the most important changes which might affect Illinois businesses.  The attorneys at Gozdecki, Del Giudice, Americus, Farkas & Brocato LLP are prepared to answer any questions you might have regarding the Illinois LLC Act, as amended, and to assist you in reviewing or modifying your company’s articles of organization or operating agreement.  Information contained in this news alert should not be construed as legal advice or opinion.