Corporate Housekeeping – Your Pennsylvania LLC and Common Mistakes to Avoid

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by Natalie Y. Ohana, Esq. & Seth R. Tipton, Esq.  

Most business owners gravitate towards structuring their business as a limited liability company (“LLC”) because of the phrase “limited liability.” However, in the pursuit of security and clarity, many people skip the crucial step of understanding exactly what is required under Pennsylvania law to protect their interests, both personal and professional, and to take advantage of what an LLC has to offer. 

The Basics 

To create an LLC under the Pennsylvania Uniform Limited Liability Company Act of 2016 (“ULLCA”), a Certificate of Organization must be filed with the PA Department of State (“DOS”), which must contain: (i) the name of the LLC; (ii) the street address of the LLC’s initial registered office in Pennsylvania or the name of the commercial registered office provider and county for venue.  

While an LLC is not legally required to adopt an operating agreement pursuant to the ULLCA, it is often necessary in avoiding and addressing conflict between the owners of the LLC, especially when it establishes agreements and responsibilities early in the life of the company. Operating agreements may be orally implied, written, or a combination thereof, and typically govern the following: relations among members; the rights and duties of the person or persons who may manage the affairs of the LLC; the business activities that the LLC may engage in; the rules for amending the operating agreement; and the requirements for the LLC to approve a sale, merger, exchange, conversion, or division. Operating agreements come in handy when LLC members are forced to navigate a difficult and perhaps uncomfortable situation because they provide rules set for the members in advance of an event taking place. In other words, they reduce confusion and add clarity.  

In addition to those who make the mistake of thinking that an operating agreement is not necessary, there are others with operating agreements who fail to consider the default provisions established in the ULLCA that apply to the LLC when the LLC either fails to adopt an operating agreement or does not include certain terms in an operating agreement. Examples include changing the governing law of the LLC from Pennsylvania law to that of another jurisdiction, providing indemnification in excess of the ULLCA’s limitations for members or managers, and eliminating the duty of loyalty or the duty of care of managing members or managers except as permitted by the ULLCA. In order to avoid unintentionally subjecting the company to these default provisions which are in the ULLCA, is important to carefully review the ULLCA to make sure that the operating agreement adopted by the LLC addresses all of the topics in the ULLCA. 

Annual Filings 

  A very common, yet avoidable mistake is not keeping up with required filings. A Pennsylvania LLC is required to file an annual report with the Department of State before October 1st. Details of what must be included in the annual report, as well as specific requirements for restricted professional limited liability companies, are established in the ULLCA. Failure to file the document and pay the required fee could result in the loss of good standing for the LLC, and could cause a delay in any significant transaction, such as a loan closing.  This is a straightforward process that can easily be taken care of with a simple calendar reminder and use of the DOS website to submit the annual report and pay the fee. 

Hot Topics – Liability and Fiduciary Duties   

As noted above, an LLC is often the entity structure of choice for many business owners because typically, members and managers are not liable for an LLC’s debts, obligations, and liabilities, except as provided in the ULLCA. For example, an operating agreement may provide that a manager or managing member is not personally liable for monetary damages to the LLC or the other members for a breach of the duty of care, except for an act that constitutes recklessness, willful misconduct, or a knowing violation of law. However, these sometimes unknown and misunderstood exceptions often lead to problems for an LLC and its managers or members.  There is no absolute safe haven from liability when there is a breach of duty. 

Under the default provisions of the ULLCA, members and managers owe the fiduciary duties of care and loyalty to the company and are required to always act with the contractual obligation of good faith and fair dealing. The duty of loyalty includes the duties to: (i) account to the LLC and hold as trustee any property, profit, or benefit derived from the member in the conduct of (or winding up) of the LLC’s activities and affairs, from a use of the LLC’s property, or from the appropriation of a company opportunity; and (ii) to refrain from dealing with the LLC in the conduct or winding up of its activities and affairs as or on behalf of a person with an adverse or competitive interest.  

In conducting or winding up the LLC’s activities, each member of a member-managed LLC has a duty to refrain from gross negligence, recklessness, willful misconduct, and a knowing violation of the law. In a manager-managed LLC, attempting to squeeze out or expel a member, or controlling members, to appropriate benefits from minority members by exercising selling control could be considered a breach of a general duty of good faith. Members may also have a duty of disclosure in transactions with each other, such as in the case of the sale of an interest in the LLC. 

An operating agreement may not eliminate the duties of loyalty or care of a manager or managing member, but rather, it may specify a method of authorizing or ratifying a specific act or transaction that would otherwise violate the duty of loyalty. In permitting an operating agreement to modify fiduciary duties only if manifestly unreasonable, the ULLCA is attempting to balance freedom of contract against the dangers with an imbalance of power, while rejecting the notion that a fiduciary duty within a business organization is simply a default set of rules.  

Whether a missed filing, neglecting to execute an operating agreement, or breaching a duty owed to a limited liability company, all are examples of instances that can harm an LLC. Yes, some are fixable while others are not, but it is best to avoid the missteps all together. Rather than a businessperson navigating the law alone, it is always wise and recommended to work with an experienced and knowledgeable attorney who can guide LLC members and managers in the right direction, steering them away from common pitfalls and mistakes that can cause substantial harm.