Microsoft Word - 305_(504)_Jenson_Cotter_Turning MCAs into Operating Agreements.docx

2017 Real Estate Institute – November, 2017

SESSION 305

How to Update an Old Member Control

Agreement for Use Under the New LLC Act

(Effective January 1, 2018)

Anne P. Cotter

Stinson Leonard Street LLP

Minneapolis

David C. Jenson

Stinson Leonard Street LLP

Minneapolis

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TURNING CHAPTER 322B MEMBER CONTROL AGREEMENTS

INTO CHAPTER 322C OPERATING AGREEMENTS

Since August 1, 2015, all new Minnesota limited liability companies (“LLCs”) have been

formed under Chapter 322C of the Minnesota Statutes, the Minnesota Revised Uniform Limited

Liability Limited Company Act (the “Act”). Under Chapter 322C, LLCs are based on a

partnership model and governed by a single Operating Agreement. LLCs formed under Chapter

322B, the prior Minnesota LLC statute, are instead usually governed by several documents: their

Articles of Organization, a written Member Control Agreement (or “MCA”), and sometimes also

by written “bylaws” or an “operating agreement.” In connection with the transition to Chapter

322C, whether through early opt-in or mandatory application of the law beginning January 1,

2018, LLCs formed under Chapter 322B and their advisors will need to determine whether to

take action to update the LLC’s governance documents. Unless a Chapter 322B LLC is a single

member LLC that will not be accepting additional members (e.g., a single purpose LLC holding

a real estate project with a single member), we are advising that action be taken.

There are generally two approaches to transitioning from Chapter 322B governance

documents to a Chapter 322C Operating Agreement. The first approach is to use a standard

Chapter 322C “form” document that is complete and accurate, and then modify the form to

incorporate the particular business deal among the members reflected in the Chapter 322B

governance documents or other sources. However, some clients may be unwilling to authorize a

complete re-write of an LLC’s governance documents because of concerns about expenses

(which may be unfounded since we believe in most cases it will cost less to start over with

Chapter 322C documents), a lack of an understanding of the importance of updating documents,

a desire not to “rock the boat” and engage business partners in discussions about the governance

documents, or for other reasons.

This leads to the second approach to updating Chapter 322B governance documents,

which we call the “band-aid approach.” The band-aid approach is necessary when a client

directs her lawyer to make as few changes as possible to the existing Chapter 322B governance

documents. Carrying out the band-aid approach well requires an understanding of the key areas

to look for in analyzing the Chapter 322B governance documents through a Chapter 322C lens.

This outline provides a guide for engaging in that analysis and executing a band-aid update.

Chapter 322B contains a number of default rules that cannot be modified in an MCA, and

for that reason there was no need to include them in the text of the MCA itself. Those default

rules, which were silently incorporated by reference into MCAs, will drop away on January 1,

2018. Paradoxically, making as few changes as possible to the agreement among the members

therefore requires making a number of changes to the document encapsulating that agreement.

In fact, our experience is that the band-aid approach can be less efficient than preparing a fresh

Chapter 322C Operating Agreement. The remainder of this outline uses a few defined terms:

“322C Operating Agreement” means the Operating Agreement adopted by the members

under Chapter 322C, as defined in 322C.0102, Subd. 17.

“Act” means the Minnesota Revised Uniform Limited Liability Company Act, Chapter

322C of the Minnesota Statutes, to be distinguished from Chapter 322B.

“Chapter 322B” means the Minnesota Limited Liability Company Act, Chapter 322B of

the Minnesota Statutes, which will be repealed effective January 1, 2018.

“322B LLC” means a Minnesota LLC formed prior to August 1, 2015 that has not

already opted-in to the Act and adopted a 322C Operating Agreement.

“MCA” means a Member Control Agreement adopted pursuant to Section 322B.37 of

Chapter 322B.

“operating agreement” or “bylaws” means the bylaws adopted under Chapter 322B,

pursuant to Section 322B.603, which might be confusingly titled “Operating Agreement.”

“person managing the LLC” means a person with authority to manage an LLC under

the Act, which will change depending on the management structure of the LLC. A person

managing the LLC will be: a member in a member-managed LLC, a manager in a manager-

managed LLC, or a governor in a board-managed LLC.

1. Ensure Voting Rights and Distributions are Clearly Defined.

Perhaps the most fundamental questions relating to LLC governance are (i) who has the

right to appoint those with management authority, and (ii) who has the right to receive

distributions, and in what proportions. The first task in evaluating a 322B LLC’s MCA is to

check to see whether the voting and distribution provisions are clearly described. Chapter

322B’s default rules relating to voting and distributions were based on the relative value of the

contributions of the members to the LLC. This would be true even if the MCA were completely

silent on the topic of voting rights and distributions.

Section 322C.1204, Subds. 3(3)(iv) – (vi) preserve the Chapter 322B default rules for

322B LLCs into perpetuity. Technically, then, there is not a legal need to re-write (or initially

write) voting and distribution provisions even if the MCA is silent on the matters. But there are

good practical reasons to do so:

 As time moves on, the default rules of Chapter 322B will become increasingly

difficult to recall, and reference materials containing the repealed statute will

become scarce.

 The parties from time to time may have a need to refer to their LLC’s governance

documents to settle questions relating to voting rights and distributions, and when

they do, it will save everyone involved a lot of time and frustration (and legal

fees) if those provisions are clearly stated in the four corners of the governance

document.

 If the actual practices of a 322B LLC with respect to voting, distributions, record-

keeping, etc. have differed from their governance documents, or from the defaults

under Chapter 322B, then a member could make claims based on an unwritten

operating agreement.

For all of these reasons, the best practice is to clearly define the voting and distribution

rights in the body of the 322C Operating Agreement, even if maintenance of the Chapter 322B

status-quo is all that is required or appropriate for the LLC. In writing the voting provisions for

the 322C Operating Agreement, keep in mind that under Section 322C.0407 of the Act, specified

major actions require unanimous member consent unless the 322C Operating Agreement

provides otherwise (e.g., approval of a merger or the amendment of the operating agreement).

Under Chapter 322B, the same actions required approval by only a majority of the voting power

of the membership interests. If the organizers of a 322B LLC intended to operate under the

statutory default rule, the MCA will likely be silent with regard to the requisite vote required for

those major actions. Most LLCs will want to clarify what member vote is required to take

various actions, so it won’t be sufficient to simply codify the Chapter 322B default rules in the

322C Operating Agreement.

2. Consider Contractual Dissenters’ Rights.

Section 322B.383 provided for statutory dissenters’ rights in a variety of circumstances.

As has been well-publicized, the Act does not provide statutory dissenters’ rights for new LLCs

formed on or after August 1, 2015. The situation of 322B LLCs is more complex, though.

We have read articles and listened to presentations in which the author or presenter

claims that the Act preserves dissenters’ rights for 322B LLCs. You may have also heard or read

this claim. This is not accurate. The fact of the matter is that Section 322C.1204, Subd.

3(3)(vii) preserves only a very limited set of dissenters’ rights for 322B LLCs, and those rights

that are preserved are of little to no utility after January 1, 2018. It is easy to be confused by this

issue, in part because of the ridiculous subdivision numbering system that we use in the

Minnesota Statutes. Here is the actual text of Section 322C.1204, Subd. 3(3)(vii):

“(vii) sections 322B.383, subdivisions 1, clause (1), 2, and 3, and

322B.386 continue to apply to the limited liability company as if those

provisions had not been repealed; and” [emphasis added]

The text almost says that subdivisions 1 through 3 of Section 322B.383 are preserved for

322B LLCs. Almost, except for the inclusion of the reference to “clause (1).” In reality, the

only portion of subdivision 1 of Section 322B.383 that is preserved is clause (1). You might

think this is a minor technicality. But consider what is, and is not, included with subdivision 1,

clause (1) of Section 322B.383.

The dissenters’ rights triggers included within clause (1) are certain actions resulting

from “an amendment of the articles of organization, but not an amendment to a member control

agreement.” Under the Act, though, the 322C Operating Agreement is supreme; not the articles

of organization. After January 1, 2018, no LLC will amend its articles in order to make a change

in the rights and preferences of a class of its equity holders, because to do so would be

completely ineffective as against the 322C Operating Agreement (see Section 322C.0112, Subd.

4). In other words, clause (1) of subdivision 1 of Section 322B.383 contains an empty set.

There’s no there there.

Now consider the dissenters’ rights triggers that are outside of subdivision 1, clause (1),

of Section 322B.383: (i) a sale, lease, transfer, or other disposition of substantially all assets

requiring member approval; (ii) a merger; (iii) a plan of exchange; and (iv) a plan of conversion.

In other words, all of the important dissenters’ rights triggers – the ones that we can reasonably

anticipate may come into play, the ones that are typically at issue in dissenters’ rights cases – are

outside of clause (1) of subdivision 1 of Section 322B.383.

To summarize, the only dissenters’ rights that are preserved by statute for 322B LLCs are

those triggered by an amendment to the articles of organization, which, because amending the

articles of organization will not be a legally effective way to change the rights and preferences of

members of an LLC after January 1, 2018, are of extremely limited utility under the most

generous interpretation possible. Accordingly, if dissenters’ rights are desired then they must be

drafted into the 322C Operating Agreement. The MCA of a 322B LLC likely would not include

anything relating to dissenters’ rights, which applied as a matter of default under Chapter 322B,

so determining whether dissenters’ rights are desired on a going-forward basis will require

consultation with the articles of organization (which often contain a disclaimer of dissenters’

rights) and conversations with the client to determine the most appropriate course of action.

3. Clarify the Standards for Record Keeping and Access to Information.

Section 322B.373 provided a list of records required to be maintained by an LLC, and

then set forth the “absolute right” of members to inspect those records. Aside from the required

records, under Chapter 322B a member also had a right to inspect any other records of the LLC

by demonstrating a “proper purpose” (that is, a purpose reasonably related to the person’s

interest as a member) for such examination.

The Act takes a different approach. Section 322C.0410 does not provide a list of

required records that an LLC must maintain and make available for member inspection. Instead,

it provides members with a right to inspect “any record maintained” by the LLC if the

information sought is “material to the member’s rights and duties under the operating

agreement” or under the Act. Instead of an absolute right to inspect required records, the

members have a conditional right to inspect whatever records the LLC actually maintains.

Section 322C.0410 also adds a new component in the form of a duty of the LLC to

“furnish” to the members certain information. One category of information must be furnished

without demand – information concerning the LLC’s activities, financial condition, and other

circumstances that is “material to the proper exercise of the member’s rights and duties under the

operating agreement” or under the Act. A second category of information must be furnished

upon demand, so long as the demand is not “unreasonable or otherwise improper under the

circumstances.” The second category of information consists of “any other information”

concerning the LLC’s activities, financial condition, and other circumstances.

In the absence of anything to the contrary in the 322C Operating Agreement, 322B LLCs

will still be required to keep one category of particular records – those records relating to the

contributions of the members – pursuant to Section 322C.1204, Subd. 3(3)(i). However, the

Chapter 322B “absolute right” to inspect records will not be carried forward. In order to access

those records, a member would have to demonstrate that gaining access was material to the

exercise of the member’s rights under the 322C Operating Agreement or under the Act.

In light of the foregoing, consider whether the 322C Operating Agreement should

establish types of records that must be maintained by the LLC and whether the right of members

to inspect those records should be unfettered, subject to the conditions described in Section

322C.0410, or subject to different conditions or restrictions. Consider also whether to keep the

affirmative requirement in Section 322C.04110, Subd. 1(2) to furnish information to the

members, or whether instead to eliminate the requirement or replace it with a clearer requirement

that does not require judgments about materiality or the reasonableness of a demand.

4. Clarify Member Authority in a Board-Managed or Manager-Managed LLC.

Under Chapter 322B the members had the authority to take any action that was otherwise

within the authority of the Board of Governors by unanimous member vote or written action.

Because this was a Chapter 322B statutory default rule, it may not be specifically written into

MCAs. There is no similar provision in the Act providing members with the ability to take

action otherwise within the purview of the board or a manager, and Section 322B.606, Subd. 2 is

not one of the provisions the Act carries forward for 322B LLCs. If a member-action override

mechanism is desired after January 1, 2018, it must be specifically included in the 322C

Operating Agreement.

If the 322B LLC is going to be a member-managed company under the Act, then this is a

moot point. But if the 322B LLC will remain board-managed or will transition to be a manager-

managed LLC under the Act, then the members may desire a member-action override

mechanism. They may also need such a mechanism in order to continue functioning as they have

been functioning in the past, as we have encountered a number of LLCs that purported to be

“member-managed” under Chapter 322B by reason of the member-action override mechanism

despite the fact that a truly member-managed structure was not permitted under Chapter 322B.

The flexibility of the Act not only allows for the member-action override to be carried forward

via the 322C Operating Agreement, but it also allows for the threshold for valid action to be

varied from the unanimous consent required under Chapter 322B.

5. Tailor the Fiduciary Duties.

Although the two statutes use different language, there is little conceptual difference

between the fiduciary duties that apply to governors under Chapter 322B and those that apply to

the persons managing the LLC under the Act. However, the way that the Act parses out the duty

of loyalty, in particular, brings to the forefront aspects of the duty of loyalty that may have been

overlooked when a 322B LLC’s MCA was drafted. Further, the Act allows for tailoring of the

fiduciary duties that was not possible under Chapter 322B. Because tailoring under Chapter

322B was not possible, it is very likely that a 322B LLC’s MCA is completely silent with regard

to the standard of conduct of the governors, making fiduciary duties a key topic that should be

added and addressed as the MCA is transformed into a 322C Operating Agreement.

Competitive Activities. Consider authorizing the persons managing the LLC to

engage in activities that compete with the LLC. Without such an authorization, Section

322C.0409, Subd. 2(3) prevents persons managing the LLC from engaging in activities that are

competitive with the LLC. It is often the case that competitive activities are specifically

contemplated, particularly in the context of businesses that operate through multiple

complementary subsidiaries or utilize special purpose entities to manage projects.

Dealings with the Company. Consider whether to disclaim Section 322C.0409,

Subd. 2(2), which prohibits a person managing the LLC from dealing with the LLC as a person

with an adverse interest. This may be necessary in order to ensure that related party transactions

can be executed without violations of the duty of loyalty. For example, suppose that the majority

member of the LLC is one of three governors of the LLC. The member also happens to own a

building with commercial office space and has leased office space in the building to the LLC. In

negotiating that related party lease, the member has breached his duty of loyalty (unless it is

modified to eliminate the adverse dealings aspect).

Company Opportunities. Consider whether to disclaim the company opportunity

doctrine in the 322C Operating Agreement. Otherwise, Section 322C.0409. Subd. 2(1)(iii)

imposes the company opportunity doctrine. This would likely be contrary to the expectations of

the members, particularly with regard to real estate development.

“Other Constituency” Considerations. In 322B.663, Subd. 5 governors are

expressly permitted, in discharging their fiduciary duties, to consider the interests of

constituencies other than the LLC and its members (e.g., the interests of employees, the

economy, societal considerations, etc.). The Act does not include a similar provision, which

means that consideration of other constituencies will not be permitted unless the concept is

reflected in the 322C Operating Agreement.

Further Tailoring. The Act permits additional customization of the fiduciary

duties, including certain specifically authorized types of modifications, subject to a few limits, all

as expressed in Section 322C.0110:

The Operating Agreement . . .

CAN CANNOT

 eliminate particular aspects of the duties of

loyalty and care

 identify specific types or categories of conduct

that do not violate the duty of loyalty

 prescribe standards by which to measure the

performance of the contractual obligation of

good faith and fair dealing



completely eliminate the fiduciary duty

 authorize intentional misconduct or

knowing violations of law (these always

violate the duty of care)

 eliminate the contractual obligation of

good faith and fair dealing

 adopt any modification to a fiduciary duty

that is “manifestly unreasonable”

6. Consider Conflict of Interest Transactions and Cure Mechanisms.

Chapter 322B contains a curious provision, at Section 322B.666, relating to transactions

between an LLC, on the one hand, and a governor or an entity in which a governor has a material

financial interest, on the other hand. Under Chapter 322B, these transactions were “not void or

voidable” by reason of the conflict of interest or by reason of the conflicted governor’s presence

at a member or board meeting at which the transaction was approved, so long as one of three

alternative cure mechanisms was employed (generally characterized by full disclosure and

approval by disinterested persons).

As a starting point, the importance of the 322B.666 safe harbor is not entirely clear. It

was based on a sister provision in the Minnesota Business Corporation Act (MBCA), Section

302A.255. Commentary on the MBCA provision indicates that failure to comply with the safe

harbor does not necessarily make a transaction void or voidable, leaving the courts to answer that

question on a case by case basis.

Regardless of the ultimate effectiveness of the 322B.666 safe harbor or the exact nature

of the risk of engaging in interested-governor transactions without its benefit, the safe harbor is a

part of the status quo for 322B LLCs. In order to maintain that status quo the safe harbor, or cure

mechanisms, must be specifically included in the 322C Operating Agreement.

7. Add a Standard of Conduct for Officers.

Chapter 322B set forth a statutory standard of conduct for the “managers” (the Chapter

322B term for officers) of an LLC, imposing on managers the same fiduciary duties that apply to

governors via Section 322B.69. The Act does not provide a statutory standard of conduct for

officers; on January 1, 2018, the Chapter 322B statutory standard of conduct for officers will

drop away. The prudent approach is to incorporate a standard of conduct for officers into the

322C Operating Agreement. The exact statutory language from Chapter 322B could be used, as

could any number of variations.

8. Limit Indemnification and Advancement of Expenses.

The indemnification and advancement of expense provisions of the Act do not make a

substantive change from Chapter 322B: the default rule is that the company must indemnify and

advance expenses to covered persons under the circumstances set forth in the statute, unless

limited by the company’s governing documents. However, updating to the Act presents a good

opportunity to dig in to the indemnity and advancement of expense provisions to determine

whether they really reflect the desires of the members.

Indemnification

Begin by determining who exactly is entitled to indemnification under the MCA of the

322B LLC. It’s possible that the MCA relies on the default Chapter 322B position, which

provides that governors, managers (that is, officers), members of board committees, and

employees are entitled to indemnification (provided the other statutory requirements are

satisfied). Chapter 322B places employees – not just officers or executive employees, but

employees generally – within the class of persons entitled to indemnification. Depending on the

business of the LLC, the class of employees generally may present an undue indemnification risk

for the LLC. Think of a business that utilizes summer help from high school students, for

example – do the owners of the LLC really want to have indemnity obligations triggered by

proceedings relating to the actions of those very inexperienced and temporary workers? Board

committee members are also covered by the default Chapter 322B indemnity provisions. In

some situations, the MCA may provide that only governors can serve on board committees, but

in other situations board committees may include persons who are not members, governors,

managers, or employees.

The Act does not change the class of persons who are entitled to indemnification, but it

does provide the opportunity to modify the default rule through the 322C Operating Agreement.

In most cases, it will be appropriate to include a provision in the 322C Operating Agreement

providing that the only employees who are entitled to indemnification from the LLC are the

elected officers or other executive employees of the LLC, as well as a provision eliminating

indemnification for committee members who are not members of the LLC or in the position of a

person managing the LLC.

Beyond determining the classes of persons entitled to indemnification, consider whether

other conditions or limitations should be imposed. Both Chapter 322B and the Act contain a

number of conditions that must be met before a covered person is entitled to indemnification

(see, for example, Section 322C.0408, Subd. 2). But perhaps other conditions or limitations are

appropriate, such as per-occurrence or lifetime limitations on the amount that a covered person

may recover through indemnification. Any manner of additional conditions or restrictions is

permissible, provided that all members of a particular class of individuals are treated uniformly.

For example, Section 322C.0408, Subd. 4 would prohibit the LLC from imposing restrictions or

conditions on only certain governors, but it would allow a provision eliminating indemnification

where the person seeking indemnification initiated the proceeding from which the claim for

indemnification arises.

Advancement of Expenses

The same classes of persons who are entitled to indemnification under Chapter 322B and

the Act are also entitled to payment or reimbursement of expenses while the “proceeding” that

may ultimately give rise to an indemnity obligation is still pending. As with indemnification, the

key determinations are whether the class of persons entitled to advancement of expenses should

be limited in some way, and whether additional conditions or restrictions should be enforced, in

each case by adding language to the 322C Operating Agreement. For the sake of uniformity and

simplicity many LLCs may wish to apply restrictions and limitations uniformly between the

indemnification and advancement of expenses provisions, but there is no statutory reason the two

could not diverge.

9. Revisit the Partnership Tax Provisions and Add Language for the New

Partnership Audit Rules.

The Bipartisan Budget Act of 2015 made changes to the way the IRS interacts with

entities treated as tax partnerships (such as LLCs with more than one member) that take effect in

2018. The changes are complex and a full description of the new audit rules is beyond the scope

of this outline. In general, though, the updated rules are designed to facilitate IRS audits of

entities taxed as partnerships, especially when those entities are multi-tiered (i.e., where an entity

taxed as a partnership is an owner of an entity taxed as a partnership). To that end, the new

rules generally establish a procedure by which the IRS may audit the LLC directly and collect

any underpayment and impose any penalty directly on the LLC rather than calculating the

amount that would be owed by each member. The MCA of a 322B LLC probably contains

language relating to the “tax matters partner” or “tax matters member,” but the new audit rules

establish a different role, the “partnership representative,” with greater authority to act for and

bind the LLC with respect to audit matters.

Importantly, the new audit rules also provide some flexibility to LLCs. There is a

provision that allows LLCs to opt-out of the new regime and maintain the status quo provided

the LLC issued fewer than 100 K-1s and the members of the LLC meet certain requirements

(generally speaking, none of the members can be entities taxed as partnerships (e.g., another

LLC)). Taking advantage of the exemption requires an annual filing. There is also an election

that can be made to pass through any imputed underpayment to the members rather than pay it at

the LLC level.

As a result of this major change in rules relating to LLC audits, when updating the MCA

of a 322B LLC into a 322C Operating Agreement you should consider adding language that (i)

allows or requires the LLC to opt-out of the new audit rules if the LLC qualifies for the opt-out;

(ii) provides for the appointment of a “partnership representative” if the LLC is subject to the

new audit rules for any year and authorizes the partnership representative to act appropriately for

the LLC and receive reimbursement of expenses; and (iii) provides the option for, or requires, an

election to pass-through an imputed underpayment to the members rather than pay it at the LLC

level.

Beyond adding language to address the new audit rules, review the general partnership

tax provisions relating to capital accounting, allocations of profits and losses, and distributions to

determine whether (i) they are sufficient to establish substantial economic effect in the event of

an audit, (ii) they provide enough flexibility and guidance to the LLC’s members and accounting

professionals, and (iii) they accurately reflect the business arrangement among the members. It

may well be that the existing language in the MCA is lacking or incomplete in some respect, and

the transition to the Act presents a perfect opportunity to remedy any such shortcoming.

10. Limit the Equitable Powers of Courts.

Section 322B.38 broadly provided that a member could bring a legal action relating to the

breach of Chapter 322B by the LLC, a governor, or a manager (i.e., officer), and that in such

action the court could grant “any equitable relief it considers just and reasonable in the

circumstances.” The substance of the equitable remedies available to members under the Act has

not changed much from Chapter 322B, but the procedural path differs and there is new flexibility

to clamp down on the availability of equitable remedies if desired.

Section 322C.0701, Subd. 1(4) allows a member to apply to a court for dissolution of the

LLC in the event of a dispute among the members relating to certain topics. After a member

asks for dissolution, the court is empowered by Section 322C.0701, Subd. 2 to order any remedy

other than dissolution that the court deems is appropriate under the circumstances (such as a buy-

out at fair value). The equitable remedies language mirrors that found in Chapter 322B, but in

order to get to the point where a court could grant that remedy, a member must first invoke the

nuclear option by asking the court for dissolution. This may have the effect of deterring member

lawsuits and encouraging non-judicial resolution of ownership disputes.

If you represent a majority owner, consider adding a provision to the 322C Operating

Agreement that eliminates the power of the court to order a remedy other than dissolution in the

event of a judicial action initiated under Section 322C.0701, Subd. 1(4). This limitation on court

authority is permitted under the Act. The short list of limitations on the power of the 322C

Operating Agreement in Section 322C.0110, which includes (at subdivision 3(7)) a prohibition

on varying the power of the courts to order dissolution under Section 322C.0701, is silent with

regard to ability of the 322C Operating Agreement to vary the other powers of the court under

Section 322C.0701, which means that such variance is permitted.

11. Add Representations Regarding Member Expectations.

Consider including representations in the 322C Operating Agreement that seek to

establish the written 322C Operating Agreement as the sole source of the expectations of the

members. This is especially relevant in the representation of a majority owner, and it operates to

limit the grounds for a later lawsuit seeking dissolution or an equitable remedy.

The Act introduces the concept of oppressive conduct into the parlance of Minnesota

LLCs. Oppressive conduct has two main components. The first component is that the conduct is

engaged in by a person managing the LLC and it affects the aggrieved person in the aggrieved

person’s capacity as a member, manager, governor, or (with respect to an LLC with 35 or fewer

members) employee. The second component is that the conduct must have “frustrated an

expectation” of the aggrieved person, so long as that expectation meets four requirements: (i) the

expectation is reasonable in light of the reasonable expectations of the other members, (ii) the

expectation was material to the aggrieved party’s decision to become a member of the LLC or

for a “substantial time” has been material to the aggrieved party’s continued membership in the

LLC, (iii) the expectation was known to the other members or the other members had a reason to

know of the expectation, and (iv) the expectation is not contrary to the 322C Operating

Agreement applied consistently with the obligation of good faith and fair dealing.

Oppressive conduct can provide a basis for a lawsuit in which a member seeks

dissolution of the LLC as well as equitable remedies under Section 322C.0701, Subd. 1(5)(ii)

(unless the ability to obtain such equitable remedies has been eliminated as described in item 10

of this document).

As you can see, the concept of oppressive conduct is complex and multi-faceted, but the

expectations of the members form the basis for the entire idea. Consider using the 322C

Operating Agreement to place a box around those expectations. This can be done by adding a

provision specifying that the written 322C Operating Agreement contains or reflects all

expectations and considerations that are material to the continued membership in the LLC by

each member executing the 322C Operating Agreement.

12. Add Amendment and Entire Agreement Clauses.

Under Chapter 322B an MCA was only enforceable if it was in writing (see Section

322B.37, Subd. 2). For this reason, MCAs sometimes did not include language that is

considered standard in many other contracts – language specifying that the agreement contains

the entire understanding of the parties and that the agreement can only be modified through a

written instrument signed by the parties. It was not necessary for an MCA to include that

language because Chapter 322B essentially supplied it.

By contrast, the Act specifically defines the “operating agreement” as the agreement

among the members “whether or not referred to as an operating agreement and whether oral, in a

record, implied, or in any combination thereof.” In our experience, it is not uncommon for

parties to occasionally deviate in practice from the exact nature of their written agreements. This

becomes a problem for 322B LLCs on January 1, 2018. On that day, the written MCA will

suddenly become just one piece of information for determining what the “operating agreement”

among the members is under the Act, to be considered alongside other records, evidence of oral

agreements, and evidence of implied agreements.

In order to prevent this potentially calamitous state of affairs, add a provision to the 322C

Operating Agreement specifically stating that the written 322C Operating Agreement expresses

the entire agreement of the members, and that it completely supersedes all prior and

contemporaneous agreements, whether in a record, oral, or implied. Then add a provision

specifically stating that, notwithstanding anything to the contrary in the Act, the written 322C

Operating Agreement can only be amended through a writing signed by the members (or by a

particular threshold or group of members). Note that unless modified, the statutory default under

the Act will require unanimous member consent to amend the Operating Agreement.

13. Consolidate Separate Agreements or Incorporate them by Reference.

322B LLCs may have bylaws, which may be titled (confusingly) the “operating

agreement,” and the Articles of Organization may contain operative provisions. Operating

agreements under Chapter 322B were, by and large, corporate-style bylaws relating to matters

such as the rules for conducting meetings. Frankly, the operating agreements for Chapter 322B

LLCs almost never matter because they relate to overly formalistic procedures based on a fiction

that the LLC was akin to a corporation. When updating a 322B LLC into the Act, it is very

likely that you can simply leave out the existing bylaws or operating agreement. You should

review them, of course, but most likely there will be only a few relevant items (if any) that can

be easily incorporated into the 322C Operating Agreement.

However, if you have been instructed to only do what is quickest and easiest and to upset

the status quo as little as possible, then consider the following course of action: (i) if the bylaws

document is titled “operating agreement,” rename it “bylaws” to avoid confusion, (ii) attach the

bylaws as an appendix or exhibit to the 322C Operating Agreement, (iii) add a provision to the

322C Operating Agreement incorporating the bylaws by reference, and (iv) add a provision

stating that the terms contained in the body of the 322C Operating Agreement control to the

extent there is any conflict with any term contained in the bylaws.

14. Make Housekeeping Updates.

There are a few general housekeeping updates that will need to be made to the MCA of a

322B LLC in order to turn it into a 322C Operating Agreement. For starters, the document

should be retitled “Operating Agreement.” There may be some appeal to calling the updated

document an amended and restated member control agreement, but doing so would be inaccurate

and confusing. The concept “member control agreement” does not exist under the Act.

Recitals should be added to the 322C Operating Agreement to provide context. Ideally,

the recitals should state: (i) the LLC was formed under Chapter 322B, (ii) the matters relating to

the governance of the LLC are currently reflected in the MCA (and, potentially, the bylaws or

operating agreement), (iii) the LLC is now governed by the Act (if after January 1, 2018) or that

the LLC’s members are electing to be governed by the Act (if before January 1, 2018), and (iv)

the 322C Operating Agreement is being adopted as the Operating Agreement of the LLC within

the meaning of the Act and in replacement of any and all prior agreements (with specific

reference to the prior MCA and bylaws/operating agreement).

Identify all references to Chapter 322B or the Minnesota Limited Liability Company Act

and update them appropriately. Find statutory references to Chapter 322B and eliminate them or

replace them with the appropriate references to the Act. Identify language that is specific to

Chapter 322B and revise it accordingly – for example, replace references to “managers” with

references to “officers.”

15. Complete the Documentation Package.

Once the 322B LLC’s MCA has been turned into a 322C Operating Agreement, you

should consider preparing amended and restated articles of organization and a joint written

action of the current members and governors. Neither of these documents is required by the Act,

strictly speaking, but both are recommended.

Prior to January 1, 2018, an LLC elects to be governed by the Act by the same action

required to amend its operating agreement or bylaws. For most LLCs, the statutory default rule

for amendments to the operating agreement or bylaws will apply, requiring only board approval.

However, Section 322B.603, Subd. 3 provides the members with the power to repeal a bylaw

amendment adopted by the board. In light of this provision and the significant change

represented by a transition to the Act, the best course of action is to obtain approval of both the

board and the members in one step. The most efficient way to accomplish this is through a joint

written action signed by the board and each member.

On and after January 1, 2018, there is no action needed by the board or the members in

order to elect to be governed by the Act – the new statute will automatically apply, whether the

members are ready for it or know about it or not. At that point, the only question will be what

proportion of members is needed in order to adopt a written 322C Operating Agreement. The

answer to that question will be provided by the LLC’s 322C Operating Agreement as it exists at

the time. Remember that if a 322B LLC has not taken any action, then as of January 1, 2018 its

322C Operating Agreement consists of its MCA, its articles of organization, its operating

agreement / bylaws, any other relevant written records, any relevant oral agreements, and any

implied agreements, all considered together. It could be quite a mess to untangle – even the

ostensibly simple task of determining the number of signatures necessary to approve a written

322C Operating Agreement could be prohibitively complex and uncertain.

An amendment to the articles of organization is not necessary in order to elect to be

governed by the Act, but best practice is to fully amend and restate the articles of organization in

connection with the transition. Under the Act, the 322C Operating Agreement binds the

members, regardless of what might be contained in the articles of organization. But since the

articles of organization will be utilized by any party conducting due diligence on the LLC,

leaving unnecessary language in the articles of organization can create confusion at best and

claims of detrimental reliance by a third party at worst. Leaving outdated articles of organization

on file with the Secretary of State’s office only has the potential for negative consequences.

When preparing the amended and restated articles of organization, be sure to include an

article indicating that the LLC has elected to be governed by the Act (if you are filing before

January 1, 2018). While such language is not technically required, our experience is that unless

this is specifically mentioned in the articles, the Secretary of State’s office is unlikely to update

its database to reflect that the LLC is governed by the Act (which will result in the LLC

continuing to appear as a Chapter 322B company in online searches). In fact, even when

including the specific opt-in language in the articles, a follow up call to the Secretary of State’s

office may be necessary in order to ensure that its database is updated appropriately. After

January 1, 2018, the specific reference to the Act in the articles of organization should not be

necessary.

EXAMPLE MEMBER CONTROL AGREEMENT

OF A CHAPTER 322B LLC

MEMBER CONTROL AGREEMENT

REI2017, LLC

THIS MEMBER CONTROL AGREEMENT (“Agreement”) is made as of the ___ day of

_________, _____, by and among REI2017, LLC, a Minnesota limited liability company

(“Company”), and Member 1, LLC, Member 2, LLC, Member 3, Member 4, and Member 5 and

any other person or entity which acquires any Membership Interest of the Company at any time

in the future (the “Members”).

In consideration of the mutual promises contained in this Agreement, the parties agree as

follows:

ARTICLE 1.

DEFINITIONS

Section 1.1 Definitions. The terms defined in this Article 1 (except as may be

otherwise expressly provided in this Agreement or unless the context clearly requires otherwise)

shall, for purposes of this Agreement, the Articles of Organization and the Operating Agreement

of the Company have the following stated meanings:

1.1.1 “Act” means the Minnesota Limited Liability Company Act contained in

Minnesota Statues, Chapter 322B.

1.1.2 “Agreement” means this Member Control Agreement, and all amendments

and modifications hereto, including any schedules, amendments or

supplements to the Agreement.

1.1.3 “Articles of Organization” means the Articles of Organization of the.

Company, as the same may be amended from time to time.

1.1.4 “Board” or “Board of Governors” means the board of governors of the

Company.

1.1.5 “Capital Account” means the account of a Member which is established

and maintained in accordance with the provisions of Section 4.1 hereof.

1.1.6 “Code” means the Internal Revenue Code of 1986, as amended.

1.1.7 “Company” means REI2017, LLC, a Minnesota limited liability company.

1.1.8 “Contribution” means the total amount of money and the value accorded

by the Board of Governors to property or services contributed by a

Member to the Company with respect to the Membership Interest of the

Member.

1.1.9 “Distribution” means the total amount of cash and the fair market value of

property distributed by the Company to Members from time to time with

respect to their Membership Interests.

1.1.10 “Financial Rights” means those rights associated with a Membership

Interest to share in Net Income, Net Losses and Distributions with respect

to Membership Interests, and the right to assign such rights, in accordance

with the terms of this Agreement, the Articles of Organization and the

Operating Agreement.

1.1.11 “Governance Rights” means all rights associated with a Membership

Interest in the Company other than Financial Rights, including, without

limitation, rights to vote, receive notices and attend meetings of Members.

1.1.12 “Governor” means a person serving on the Board of Governors.

1.1.13 “Manager” means a person elected, appointed, or otherwise designated as

a manager by the Board of Governors, and any other person considered

elected as a manager pursuant to the Act.

1.1.14 “Member” means a person reflected in the Required Records of the

Company as the owner of a Membership Interest. in the Company who has

signed this Agreement, such person’s heirs, executors, administrators,

personal representatives and successors and any assigns of a Membership

Interest, Governance Rights or Financial Rights as permitted by the Act,

the Articles of Organization, the Operating Agreement, and this

Agreement and as reflected in the Required Records of the Company.

When the Governance Rights and Financial Rights attributable to a

Membership Interest have been separated and such separation is reflected

in the Required Records of the Company, references to Member shall

mean the holder of the Governance Rights or Financial Rights related to

such Membership Interest as appropriate in the context.

1.1.15 “Membership Interest” means a Member’s ownership interest in the

Company consisting of Governance Rights and Financial Rights. When

the Governance Rights and Financial Rights attributable to a Membership

Interest have been separated and such separation is reflected in the

Required Records of the Company, references to Membership. Interest

shall mean the Governance Rights or Financial Rights related to such

Membership Interest as appropriate in the context. A Member’s

Membership Interest may be designated in Units of Membership Interest.

1.1.16 “Net Income” and “Net Losses” mean the profits and losses of the

Company, as the case may be, as determined for federal income tax

purposes.

1.1.17 “Operating Agreement” means the Operating Agreement of the Company,

as adopted by the Board of Governors and as amended from time to time.

1.1.18 “Percentage Interest” means the ratio of the number of Units held by such

Member divided by the total number of Units issued by the Company and

outstanding.

1.1.19 “Required Records” means those records required to be maintained by the

Company pursuant to Section 322B.373 of the Act.

1.1.20 “Units” means Units of Membership Interests.

1.1.21 “Voting Interest” means the ratio of the number of Units held by such

Member divided by the total number of Units issued by the Company and

then outstanding.

ARTICLE 2.

GOVERNORS

The initial Governors of the Company shall be the following persons who shall serve

until their successors are elected and qualified pursuant to the Operating Agreement of the

Company:

Member 3, Member 4, and Member 5

ARTICLE 3.

CONTRIBUTIONS AND MEMBERSHIP INTERESTS

Section 3.1 Membership Interests and Board Authority as to Additional Membership

Interests. The names of the initial Members and their respective Contributions and the agreed

value thereof, to be transferred by each Member to the Company in exchange for their respective

Units of Membership Interest in the Company, are reflected on Schedule A, attached hereto and

incorporated herein by reference. The Board of Governors, in its discretion and for services or

such consideration as it deems adequate, may issue additional Units at any time in accordance

with the provisions of Minnesota Statutes and this Agreement. If additional Units of Membership

Interests are issued by the Company, Schedule A and the Required Records of the Company

shall be appropriately amended. As a condition of the issuance of any Units, the person to whom

the Units are issued shall agree to become subject to this Agreement and to the Buy-Sell

Agreement among the Members and the Company of even date herewith.

Section 3.2 No Right to Return of Contribution. No Member shall have the right to

withdraw or to demand the return of all or any part of the Member’s Contribution, except as

otherwise expressly provided herein. The Company shall not be liable to the Members for

repayment of their Contributions.

Section 3.3 Loans from Members to Company. Subject to any other restrictions

contained herein, the Company may borrow money from one or more Members at such interest

rate or rates and upon such other terms as are agreed upon by the Company and the lending

Member; provided that the interest rate payable with respect to any such loans shall not exceed

the rate that would apply to the Company borrowing on similar terms from an unrelated lender.

Section 3.4 No Interest on Contributions. No interest shall be paid to any Member

with respect to Contributions.

Section 3.5 Nonassessability. Except as may be unanimously agreed in writing by the

Members, no Member shall be required to make any Contributions in excess of the Amount

stated on Schedule A.

Section 3.6 Voting. Members shall be entitled to vote on all matters in proportion to

their Voting Interests, as set forth on Schedule A.

ARTICLE 4.

ALLOCATIONS OF NET INCOME

AND NET LOSSES AND DISTRIBUTIONS

Section 4.1 Capital Accounts. A separate Capital Account shall be established and

maintained by the Company for each Member in accordance with Treasury Regulation Section

1.704-1(b)(2)(iv). The Capital Account for each Member shall be increased by such Member’s

Contributions and shall be decreased by Distributions made to such Member. Each Member’s

Capital Account shall also be increased or decreased, as the case may be, to reflect allocations of

Net Income and Net Losses to such Member.

Section 4.2 Allocations of Net Income and Net Losses. Net Income and Net Losses

shall be allocated annually among the Members in proportion to their Percentage Interests as

reflected on Schedule A.

Section 4.3 Preferred Distributions. The Board of Governors shall determine from

time to time whether to make any Distributions to the Members. The first $500,000 of non-

liquidating Distributions made by the Company to the Members in any calendar year shall be

distributed. among the Members in proportion to their respective initial capital contributions to

the Company and any non-liquidating Distributions made by the Company in excess of $500,000

in any calendar year shall be distributed among the Members in accordance with Section 4.4

below, provided, however, that all non-liquidating Distributions made by the Company to the

Members from and after the date on which the Company has distributed the aggregate amount of

$1,000,000 of Preferred Distributions to the Members shall be distributed among the Members in

accordance with Section 4.4 below.

Section 4.4 Distributions Following Preferred Distributions and Prior to Liquidation.

Except as provided in Section 4.3 hereof, other than liquidating distributions pursuant to Section

4.5, all Distributions shall be distributed among the Members based upon their Percentage

Interests as reflected on Schedule A.

Section 4.5 Distributions Upon Dissolution and Winding Up. Upon the dissolution and

winding up of the company, the proceeds of the liquidation of the assets of the Company and/or

such tangible or intangible assets of the Company as the Board may determine to distribute in

kind, after paying all debts and liabilities of the Company, shall be distributed to the Members as

follows: first, to the Members in proportion to, and to the extent of, the positive balances in their

Capital Accounts; and second, to the Members in accordance with their Percentage Interests as

set forth on Schedule A.

Section 4.6 Effect of Assignment on Allocation of Net Income and Net Losses and

Distributions. Net Income and Net Losses allocable to any Membership Interest transferred or

assigned during a fiscal year shall be allocated between the assignor and assignee based upon the

length of time during any fiscal year, as measured by the effective date of the assignment, that

the Membership Interest was owned by each of them, or, in the discretion of the Board of

Governors, based upon a cut-off of the Company’s books as of the effective date of the

assignment.

ARTICLE 5.

TAX MATTERS

Section 5.1 Tax Characterization and Returns. The Member agrees that the Company

shall be treated as a partnership for tax purposes. Within ninety (90) days after the end of each

fiscal year, the Company will deliver to each person who was a Member at any time during such

fiscal year a Form K-1 and such other information, if any, with respect to the Company as may

be necessary for the preparation of such Member’s federal or state income tax returns, including

a statement showing each Member’s share of income, gain, or loss and credits for such fiscal

year for federal or state income tax purposes.

Section 5.2 Accounting Decisions. All decisions as to accounting matters shall be

made by the Board of Governors. The Company, at the sole discretion of the Board, may make

or revoke such elections as may be allowed pursuant to the Code, including the election referred

to in Section 754 of the Code to adjust the basis of Company property.

Section 5.3 Tax Matters Partner. The Board shall designate a Manager to act on behalf

of the Company as the “tax matters partner” within the meaning of Section 6231(a)(7) of the

Code. Absent a different designation, the Chief Manager shall be the “tax matters partner”.

ARTICLE 6.

MEMBER MANAGEMENT

Pursuant to the provisions of Section 322B.606, subd. 2 of the Act, the Members may, by

unanimous affirmative vote of those with voting power, take any action under the Act which the

Board may take thereunder.

ARTICLE 7.

AMENDMENTS

No amendment of this Agreement shall be valid or binding unless such amendment is

contained in a writing signed by all Members.

ARTICLE 8.

TRANSFER OF MEMBERSHIP INTEREST

No member may transfer any portion of its Membership Interest except in accordance

with the terms of the Buy-Sell Agreement of even date herewith.

ARTICLE 9.

MISCELLANEOUS

Section 9.1 Governing Law. Notwithstanding the fact that the Company may conduct

business in states other than Minnesota, and notwithstanding the fact that some or all of the

Members may be residents of states other than Minnesota, this Agreement and the rights of the

parties hereunder will be governed by, interpreted, and enforced in accordance with the laws of

the State of Minnesota.

Section 9.2 Binding Effect. This Agreement will be binding upon and inure to the

benefit of the Members, and their respective heirs, executors, administrators, personal

representatives, successors and assigns.

Section 9.3 Severability. If any provision of this Agreement is held to be illegal,

invalid, or unenforceable, such provision will be fully severable, and this Agreement will be

construed and enforced as if such illegal, invalid, or unenforceable provision had never

comprised a part of this Agreement, and the remaining provisions of this Agreement will remain

in full force and effect and will not be affected by the illegal, invalid, or unenforceable provision

or by its severance from this Agreement.

Section 9.4 Counterparts. This Agreement may be executed in any number of

counterparts, each of which will be deemed an original, but all of which will constitute one and

the same instrument.

Section 9.5 Additional Document and Acts. Each Member agrees to execute and

deliver such additional documents and instruments and to perform such additional acts as may be

necessary or appropriate to effectuate, carry out and perform all of the terms, provisions, and

conditions of this Agreement.

Section 9.6 No Third Party Beneficiary. This Agreement is made solely and

specifically. among and for the benefit of the parties hereto, and their respective successors and

assigns, and no other person will have any rights, interests, or claims hereunder or be entitled to

any benefits under or on account of this Agreement, whether as third party beneficiary or

otherwise.

Section 9.7 Notices. Any notice permitted or required under this Agreement must be

in writing sent by United States mail, registered or certified postage prepaid, or by a reputable

overnight courier service (such as Federal Express), with such notice addressed to the recipient

and. the Company at the recipient’s address set forth below. Such notices will be effective on

receipt by the party to be notified as evidenced by the return receipt or upon delivery by

reputable overnight courier service as indicated in the records of such service. Any party may

change the address to which such notices may he mailed from time to time by a giving written

notice to each of the other parties to this Agreement in accord with the provisions of this Section

9.7.

Section 9.8 Headings and Titles. Article and section hearings and titles are for

descriptive purposes and, convenience of reference only and shall not used to construe the

meaning of this Agreement.

Section 9.9 Dispute Resolution Mechanism. In the event a dispute arises between any

Members with respect to any issue involving the Company, all Members shall undertake for a

period for thirty (30) days following receipt of notice setting forth the nature of the dispute and.

the desire to have said dispute resolved, to exchange all relevant information and use best efforts

in good faith to attempt to resolve the dispute so described in the above-referenced notice. The

efforts to resolve the dispute during such thirty (30) day period shall include at a minimum a

meeting of all the Members at the principal place of business of the Company, or such other

location as may be mutually agreed.

[signatures on following page]

IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the date

first above written.

THE COMPANY:

REI2017, LLC

Its Chief Manager

THE MEMBERS:

MEMBER 1, LLC

Its Chief Manager

MEMBER 2, LLC

Its Chief Manager

Member 3

Member 4

Member 5

SCHEDULE A

Member Contribution Units Percentage Interest Voting Interest

Member 1, LLC $100,000 25 25% 25%

Member 2, LLC $100,000 25 25% 25%

Member 3 $52,000

Services

25 25% 25%

Member 4 Services 15 15% 15%

Member 5 Services 10 10% 10%

100 100% 100%

Note: During the “Preferred Distributions” phase described in Section 4.3, Member 1 and

Member 2 will each receive approximately 39.7% of distributions and Member 3 will receive

approximately 20.6% of distributions.