Ohio’s Revised Limited Liability Act – Considerations for secured lenders
On February 11, 2022, the Ohio Revised Limited Liability Act became effective and applicable to all limited liability companies (LLCs) in Ohio. Ohio Revised Code (ORC) §§ 1706.01 – 1706.84 (collectively, the “Revised LLC Act”). The Revised LLC Act replaces Chapter 1705 of the ORC, the former Ohio Limited Liability Company Act.
The Revised LLC Act contains numerous revisions to the laws governing LLCs in Ohio. The following summary highlights certain provisions of the Revised LLC Act that secured lenders should consider when reviewing their existing loan documents and/or making new loans to an Ohio LLC.
The Revised LLC Act now permits an Ohio LLC to organize as a series LLC (Series LLC). The LLC’s Articles of Organization must contain an attached statement to state that the LLC may have one or more series of assets. Each Series LLC, in its own name, may:
- Enter into contracts.
- Sue or be sued.
- Hold and convey title to assets of the series, including real property, personal property, and intangible property.
- Grant liens and security interests in assets of the Series LLC.
This structure provides liability protection to each series, as assets owned by one series are shielded from the risk of liability of others within the same Series LLC.
The LLC’s operating agreement must provide that:
- The debts, liabilities, obligations, and expenses incurred, contracted for, or otherwise existing with respect to a series shall be enforceable against the assets of that series only, and shall not be enforceable against the assets of the LLC generally or any other series thereof.
- None of the debts, liabilities, obligations, and expenses incurred, contracted for, or otherwise existing with respect to the LLC generally or any other series thereof shall be enforceable against the assets of a series.
- The records maintained for a specific series account for the assets of that series separately from the other assets of the LLC or any other series.
- Each Series LLC must have at least one member. The management of each Series LLC can have different personnel, structure, or duties depending on the management terms set forth in the LLC’s operating agreement.
One of the primary benefits of a Series LLC is the ability to create an unlimited number of series under the umbrella of a single LLC. Real estate investors and private equity funds use Series LLCs to segregate the assets and liabilities of each series to create internal liability shields. Assets of a series may be owned directly or indirectly, including in the name of the series, in the name of the LLC, through a nominee, or otherwise. In addition, a Series LLC can conduct its affairs under its own name.
6 considerations for secured lenders
1. Operating Agreement - The operating agreement of a LLC and its Articles or Organization will need to be closely scrutinized to confirm that each comply with the requirements of the Revised LLC Act. A lender will need to confirm whether the Operating Agreement adequately provides for the separateness of assets and segregation of liabilities. It will also need to understand any prohibitions in the operating agreement prohibiting the incurrence of indebtedness and/or the granting of liens and security interests by one series to repay indebtedness incurred by a separate series. With respect to asset-based loans using a borrowing base, lenders will need to establish on a series-by-series basis what eligible working capital assets are included in the borrowing base.
2. Legal Separateness of a Series - As Ohio’s Revised LLC Act just became effective, there is no legal precedent regarding a conflict of law with another State that does not have laws permitting a Series LLC and the segregation of assets and liabilities within each series. It is also less than clear whether a series may file for bankruptcy protection independent of the other series of the Series LLC or the Series LLC itself. The application of the equitable doctrine of substantive consolidation may influence a bankruptcy court’s decision as to whether or not a particular series is truly separate from the other series in the Series LLC. Substantive consolidation is an equitable doctrine that permits a bankruptcy court, under certain circumstances, to disregard distinctions between parent companies, subsidiaries, and affiliates that operate together as a corporate group.
3. Governance of the Series LLC or a Series - Under the Revised LLC Act, the activities and affairs of a LLC shall be under the direction, and subject to the oversight, of its members. A majority of the members of the LLC may decide a matter in the ordinary course of activities of the LLC, but the consent of all members is required to do any of the following:
- Amend the operating agreement.
- File a petition of the LLC for relief under the Bankruptcy Code, or a successor statute of general application, or a comparable federal, state, or foreign law governing insolvency.
- Undertake any act outside the ordinary course of the LLC’s activities.
- Undertake, authorize, or approve any other act or matter for which Chapter 1706 of the ORC requires the consent of all members.
The activities and affairs of a series shall be under the direction, and subject to the oversight, of the members associated with the series. A majority of the members associated with the series may decide a matter in the ordinary course of activities of a series. The consent of all members associated with a series is required to do either of the following:
- Undertake any act outside the ordinary course of the series' activities.
- Undertake, authorize, or approve any other act or matter for which Chapter 1706 of the ORC requires the consent of all the members associated with a series.
The operating agreement may list the persons authorized to act as the agent of the LLC or a series thereof. In addition, the LLC, on behalf of itself or a series thereof, may deliver to the secretary of state for filing on a form prescribed by the secretary of state a statement of authority. Such statement of authority may state the authority of a specific person, or, with respect to any position that exists in or with respect to the LLC or series thereof, of all persons holding the position, to enter into transactions on behalf of the LLC or series thereof.
A lender must review and scrutinize the operating agreement and any statement of authority filed by the Series LLC and/or a series with the secretary of state, to confirm who has legal authority to act on behalf of the Series LLC and/or a particular series.
4. Granting of Liens and Security Interests - A series of a Series LLC may not be an organization or person, which has material consequences under the Uniform Commercial Code (“UCC”) and the Bankruptcy Code. If a series is not an entity or a person, it may fall outside of the scope of Article 9 of the UCC. Consequently, a secured lender must consider whether the Series LLC and one or more series should be included as a grantor in the security agreement or pledge documentation and in the UCC-1 financing statement filings. Another consideration is whether the lender should file a UCC-1 financing statement against the Series LLC where it is organized and each series where such series is located and where its assets are located. A secured lender must analyze the attachment of its security interests to make sure such security interests are granted properly and the perfection of any lien on the assets of a series of a Series LLC.
5. Membership Interests as Collateral - After the formation of a LLC, a person may be admitted as a member of the LLC as provided in the operating agreement, or with the consent of all the members of the LLC or in the case of a LLC having only one member, the consent of the member. Under the Revised LLC Act, the only interest of a member that is assignable is the member's membership interest. A membership interest is personal property. A certificate of membership interest issued by the LLC, or a series thereof, may evidence a membership interest, but the membership interest is not required to be certificated. The assignment of a membership interest does not entitle the assignee to participate in the management or conduct of the activities of the LLC, or a series thereof, or have access to records or other information concerning the activities of the LLC, or a series thereof. An assignee has the right to receive, in accordance with the assignment, distributions to which the assignor would otherwise be entitled.
Secured lenders must review the operating agreement to confirm whether there are provisions contained therein that would not permit the granting of a security interest in the LLC’s membership interests. The Revised LLC Act gives priority to contractual provisions of the LLC’s operating agreement restricting pledges or transfers of equity interests over certain UCC provisions that may otherwise override such restrictions (UCC 9-406 and 9-408). However, the Revised LLC Act only overrides the UCC as adopted in the State of Ohio. To the extent that a security agreement and/or pledge agreement is governed by the law of a different jurisdiction that includes the UCC override provisions, the override provisions might be given effect notwithstanding the Revised LLC Act.
6. Covenants - A secured lender should require a Series LLC to agree to specific covenants in its loan documents to require prior lender approval and notice of:
- An amendment to a LLC’s Articles of Organization to permit a series or the creation of a new series.
- Any change to the name or structure of an existing series.
- Any amendment to the operating agreement with respect to a series.