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Do Not Form an LLC in California

It is Bad for Business

January 1, 2014 a New LLC law was enacted in California

The new California LLC Act could be called “the plaintiff attorney’s full employment act.” California has opened the floodgates for dissatisfied LLC members to sue for anything they think is “manifestly unreasonable” in the LLC Operating Agreement. Given that California Courts are not known for business decisions, sometimes referring to the LLC as a Limited Liability “Corporation” rather than Company, it would not be wise to leave the fate of your business in these hands. You will lose predictability.

If you have a business in California, you should consider converting your California LLC to a Delaware LLC immediately. There are several glaring problems in the new California LLC Act, which even its drafters acknowledge. The most significant is where members have the “freedom of contract” to agree to what they want, but with major exceptions. In particular, anything “manifestly unreasonable” can be determined to be void. On the surface this seems innocuous, but the California Courts may consider almost anything causing a dispute or inequity among members, in hindsight, can be manifestly unreasonable. The bottom line is you have no assurances that California Courts will respect your Agreement. In contrast, Delaware Courts will respect your Operating Agreement. The Delaware LLC Act has no such exception.

Lawmakers in California intended to modify old California law so that it would no longer be in favor of LLC management, which is precisely why forming an LLC with new California law is bad for business. While many may argue that California’s population, economy, and innovation make it a popular place for business, the new California law suggests your LLC should be formed elsewhere, even if you use it in California. All individuals and businesses should be aware of the California Revised Uniform Limited Liability Company Act and how the law affects LLC members in California.

According to Section 17701.10, a list is provided as to what an operating agreement may not do. This list restricts the freedom to enforce certain provisions in a contract, even when all parties negotiated the contract extensively with equal bargaining power.

For example, an operating agreement in California shall NOT:

  • Eliminate the duty of loyalty, the duty of care, or any other fiduciary duty or reduce these duties in any way that is unreasonable (Delaware, in contrast, allows for modification or elimination of fiduciary duties).

By forming an LLC in Delaware and operating it in California, you have a better chance of having your business deal respected among the management and owners of your LLC, thereby adding predictability and value to your Company. While there is a risk California will not follow the internal affairs doctrine and follow Delaware law for internal disputes, you will have access to the Delaware Court of Chancery. Forming a Delaware LLC for use in California gives you predictable protection and competent outcomes. Delaware is rated the highest in the country by the U.S. Chamber of Commerce for liability systems and CNBC rated Delaware the best for business friendliness.