Pennsylvania Act 170 of 2016: Implications for Real Estate Transactions
Real Estate Update
In late 2016, Act 170 of 2016 (“Act 170”) was signed into law, heralding changes to the existing laws covering unincorporated entities in Pennsylvania. Act 170 went into effect on February 21, 2017, for newly formed general partnerships, limited partnerships, and limited liability companies, and on April 1, 2017, with respect to any of such entities formed prior to February 21, 2017. The goal was to modernize Pennsylvania’s code to adopt (with some Pennsylvania-specific revisions) the most current version of the Uniform Limited Partnership Act (“ULPA”), the Uniform Limited Liability Company Act (“ULLCA”), and the Uniform Partnership Act, to update the limited liability partnership and limited liability limited partnership laws, and to make conforming changes to the general corporations and nonprofit corporations laws. In implementing Act 170, the Department of State has updated a number of forms, which are publicly available on the website for the Bureau of Corporations and Charitable Organizations. This article will focus on the major revisions affecting limited partnerships and limited liability companies.
Limited Partnerships and Limited Liability Companies Generally
The revision that is perhaps most applicable to real estate transactions in Pennsylvania and affects all domestic associations other than a business corporation, is the addition of Section 114 to Title 15. Section 114 brings the law applicable to non-business corporation domestic associations in alignment with the law applicable to business corporations by extending Section 1510 to all other domestic associations. The effect is two-fold. First, the limitations on the use of the defense of usury to an action or proceeding to recover damages, enforce payment, or enforce other remedies with respect to an obligation (including an installment sales contract) of a corporation now apply to all other domestic associations.1 Second, certain prepayment premiums and yield maintenance premiums are deemed liquidated damages and not a penalty with respect to all domestic associations and not strictly with respect to business corporations.2 In addition, a new subsection (g) has been added to Section 402, which provides that Section 150 also applies to foreign associations with respect to obligations that are governed by Pennsylvania law or affect real property located in Pennsylvania.3
Another provision that applies generally to limited partnerships and limited liability companies is Section 8106. Section 8106 provides that “[t]he failure of a limited liability partnership, limited partnership, limited liability limited partnership, electing partnership, or limited liability company to observe formalities relating to the exercise of its powers or management of its activities and affairs is not a ground for imposing liability on a partner, member, or manager of the entity for a debt, obligation, or other liability of the entity.”4 The Committee Comments from the Pennsylvania Bar Association Section on Business Law, Title 15 / Business Associations Committee, note that the corporate formalities established by corporate statutes distinguish corporate formalities from formalities governing a limited liability company or limited partnership.5 Rather than formalities created by statute, limited liability companies are often organized and operated informally, and the informality is often a desired feature of this structure.6 Similarly, the governance features of limited partnerships are largely derived from agreement among the partners rather than by statute.7 As such, the Committee noted that failure to observe formalities in the management of limited partnerships, limited liability companies, and similar non-corporate entities should not be a factor in “piercing the veil” of those entities.
Act 170 repealed the limited partnership provisions set forth in Chapter 85 of Title 15 and created a new Chapter 86, which now largely follows the ULPA. Although Act 170 generally applies to all limited partnerships as of April 1, 2017, the transition provisions in Sections 8811(d) and (e) provide transitional provisions that exempt partnerships in existence prior to February 21, 2017, from some provisions of Chapter 86. These transition provisions affect, among other things, duration of the partnership, rights and powers to dissociate, events causing dissolution, and liabilities to third parties. Limited partnerships in existence prior to February 21, 2017, should review the transition provisions to determine whether it would be beneficial to amend the partnership agreement to incorporate any of the provisions.
A significant change in Act 170 is the treatment of the partnership agreement. The definition of “Partnership Agreement” specifically provides that an agreement may be “oral, implied, in record form, or in any combination thereof.”8 Moreover, the Committee Comments suggest that as soon as a partnership comes into existence, a partnership agreement exists.9 In the absence of a formal agreement, the statutory provisions will apply.10 To avoid the “implied” agreement, the partners should enter into a formal written partnership agreement.
When drafting a partnership agreement, it should be noted that a number of provisions of the ULPA cannot be altered by a partnership agreement.11 Provisions that cannot be altered include, for example, 1) a limited partnership's capacity to sue and be sued in its own name, 2) except as specifically provided in Act 170, elimination of the duty of loyalty or the duty of care or the contractual obligation of good faith and fair dealing, 3) the restrictions on indemnification in Sections 8648(g) and 8649(i), 4) the procedures for a general partner to dissociate as a general partner under Section 8664(a) (other than to require notice to the partnership), 5) the dissolution events under Section 8681(a)(6), and 6) the requirements for winding up a partnership.12 Notwithstanding the foregoing restrictions, Section 8615(d) does permit a partnership to make some alterations to the duty of loyalty, the duty of care, and other fiduciary duties; provided that the revisions are not “manifestly unreasonable.”13 The difficulty, however, is that determination of which revisions are “manifestly unreasonable” is made by a court as a matter of law.14
Although the legal standard is that a general partner owes the partnership certain duties of care and loyalty, Section 8635 of Act 170 applies this standard to limited partners as well, to the extent that a limited partner has any duties to the partnership or the partners under the partnership agreement, but otherwise provides that a limited partner has no duty to the partnership solely due to its status as a limited partner.15 In addition, Act 170 codifies duties of care and loyalty for general partners, the discharge of which must be consistent with the contractual obligations of good faith and fair dealing.16 However, Section 8649 clarifies that there is no presumption of a violation of the duty of loyalty or duty of care solely due to the fact a general partner’s actions on behalf of the partnership might benefit the general partner.17
Prior to the enactment of Act 170, courts relied on the law of fraudulent conveyances to determine whether a distribution to partners violated the law.18 Section 8654 provides that a limited partnership may not make a distribution (including one in connection with winding up) if 1) after the distribution, the partnership would not be able to pay its debts as they become due or 2) if its total assets would be less that its total liabilities plus the amount that would be needed, if it were dissolved at the time of the distribution, to satisfy any preferential rights of partners or transferees whose preferential rights are superior to the rights of those receiving such distribution.19 Section 8654 provides additional guidance on the acceptable methods of valuation, excluded liabilities, and the treatment of subordinated debt, distribution debt, and distributions made in connection with winding up a partnership.20
The addition of Sections 8631 and 8641 bring more flexibility to Pennsylvania’s limited partnership law. Section 8631 permits a person to become a limited partner without having to acquire an economic interest or make an economic contribution to the partnership.21 Section 8641 allows a general partner to have no economic interest and no obligation to make contributions to the partnership.22 However, Section 8672 provides that only “transferable interests” can be transferred to a non-partner absent explicit provisions in a partnership agreement or consent of the partners to such transfer.23 A “transferable interest” is defined as “the right, as initially owned by a person in the person’s capacity as a partner, to receive distributions from a limited partnership, whether or not the person remains a partner or continues to own any part of the right.”24 Therefore, if a limited partnership elects to have non-economic partners and desires that those interests be transferable, the partnership agreement must specifically address the transfer rights or, otherwise, transfers will require consent of the partners.
Although charging orders are not a new remedy, under Section 8673, charging orders are the sole remedy available to a judgment creditor of a partner or transferee to access the relevant partnership interest or transferable interest, as applicable.25 Section 8673 allows the court to enter a charging order “against the transferable interest of the judgment debtor for the unsatisfied amount of the judgment.”26 The judgment creditor does not have the right to participate in the management of the partnership; however, the court may appoint a receiver that has the power to make all inquiries of the partnership that the judgment debtor may have and can make “all other orders necessary to give effect to the charging order.”27 If the court determines that the distributions necessary to settle the judgment will not be paid in a reasonable time, the court may foreclose on the lien created by the judgment and order the sale of the transferable interest (but not the governance interest).28 Pursuant to subsection (e), the partners whose interests are not subject to the charging order may, prior to foreclosure, pay the judgment creditor in full and succeed to the rights under the charging order.29
Act 170 also revises rights and procedures of dissolution and dissociation for limited partnerships. Under Act 170, dissolution no longer requires unanimous consent of all partners. Pursuant to Section 8681, a limited partnership can now be dissolved with the consent of all of the general partners and a majority of the limited partners owning rights to receive distributions at the time of the consent.30 Under Act 170, the default rule is that a limited partner may not dissociate from the partnership until completion of the winding up.31 Subsection 8661(b) specifies events that result in dissociation, and specifically includes “an event stated in the partnership agreement as causing the person’s dissociation as a limited partner,” which provides flexibility to the partnership to specify events that will result in dissociation and also permits prohibiting a limited partner from dissociating from the partnership.32 In contrast, general partners cannot be prohibited from the right to dissociate from the partnership.33
Limited Liability Companies
With respect to limited liability companies, Act 170 repealed Subchapters A, B, C, D, E, F, I, and K of Chapter 89 and replaced them with a new Chapter 88. A number of the revisions mirror revisions to the limited partnership statutes.
Similar to its treatment of limited partnerships, Act 170 favors an implied operating agreement for limited liability companies.34 Section 8815(c) limits a limited liability company’s ability to alter certain statutory provisions and closely tracks Section 8615 of the ULPA, while subsections (d) and (e) permit some modifications to the fiduciary duties subject to the same “manifest unreasonableness” standard promulgated under the ULPA. The fiduciary duties imposed on members and the company include a duty of care, a duty of loyalty, and an obligation to act in good faith and fair dealing; however, in a limited liability company managed by a manager rather than its members, the members owe no specific duties to the company or other members solely by being a member.35 With respect to member-managed companies, Section 8849.2 outlines more specific obligations imposed on a manager with respect to the duty of loyalty.36 Specifically, a manager must 1) account to the company for certain property, profits, and benefits the manager derives from the company’s activities, 2) refrain from competing with the company prior to completion of the winding up of the company, and 3) refrain from dealing with the company on behalf of someone with an adverse interest to the company during the winding up of the company.37 As with limited partnerships, a written operating agreement is the best protection from having any implied agreements among members.
The transferability of membership interests and the ability to have non-economic members also parallels the Sections 8631, 8641, and 8672 of the ULPA. “Transferable interest” is defined as “the right, as initially owned by a person in the person’s capacity as a member, to receive distributions from a limited liability company, whether or not the person remains a member or continues to own any part of the right.”38 Section 8841 allows a limited liability company to have non-economic members and Section 8851 prohibits the transfer to a non-member of interests other than “transferable interests” absent an express provision in the operating agreement or consent of the members.39
Under Section 8853, a court may enter a charging order against the transferable interest (but not the governance interest) of a judgment creditor of a member or transferee as the sole remedy against the transferable interest.40 Subsections (b) and (c) parallel the ULPA and permit the court to appoint a receiver, make other necessary orders, and foreclose and sell the transferable interest.41 Additionally, the members whose interests are not subject to the charging order may pay the judgment creditor in full and the judgment creditor’s rights under the charging order will inure to the purchasing member.42
Section 8871 updates rights and procedures for dissolution of limited liability companies and provides provisions for the dissolution of a company, which operate, by default, if and to the extent the operating agreement is silent. Except for Section 8871(a)(4) (dissolution by court order), an operating agreement may amend the “default” provisions of Section 8871, including by requiring the consent of fewer than all of the members.43 These default provisions include the following dissolution events: 1) the occurrence of an event specified in the operating agreement, 2) consent of all members, 3) the company ceasing to have any members for 180 days, and 4) upon entry of a court order under the events specified in subsection (a)(4).44
The dissociation procedures set forth in Section 8861 may be specifically amended in an operating agreement. Unlike limited partnerships, there is no rule prohibiting dissociation prior to completion of the winding up of the company.45 Rather, Section 8861 lists events that cause dissociation of a member, including 1) any event specified in the operating agreement; 2) a foreclosure of a member’s entire transferable interest in connection with a charging order; 3) where the member is expelled from the company either pursuant to the operating agreement or pursuant to Section 8861(5); 4) where the member is an individual, the death of the member; or 5) in a member-managed company in which the member is a natural person, (i) the incompetency of the member as evidenced by a court order or appointment of a guardian, (ii) the member becoming a debtor in a bankruptcy, or (iii) the member making an assignment for the benefit of creditors.
In conclusion, Act 170 significantly overhauls Pennsylvania’s laws on unincorporated entities. While this article presents an overview of provisions that should be considered in structuring limited partnerships and limited liability companies in Pennsylvania for real estate transactions, it does not cover every provision of Act 170 that may affect a particular transaction. In your planning for a transaction, we recommend that you conduct a more in-depth analysis of how the Act 170 statutory revisions may affect the transaction structure.
- 15 Pa.C.S. §1510(a).
- 15 Pa.C.S. §1510(b).
- 15 Pa.C.S. §402(g).
- 15 Pa.C.S. §8106.
- See Bus. Ass’n Comm. Of the Section on Bus. Law of the Pa. Bar Ass’n,, Amendments to the Pennsylvania Consolidated Statutes with Committee Comments Adopting Uniform Partnership Act of 1997 (last amended 2013), Uniform Limited Partnership Act of 2001 (last amended 2013), Uniform Limited Liability Company Act of 2006 (last amended 2013), and Revising Chapter 82 of Title 15 on Limited Liability Partnerships and Limited Liability Limited Partnerships to Accompany House Bill 1398 (Sep. 12, 2016), Lines 3577-3593, available at www.pabar.org/public/sections/BUS03/Committee%20Comments%20for%20Unincorporated%20Entities%20Act.pdf (last accessed April 21, 2017).
- See, e.g., Bus. Ass’n Comm. Of the Section on Bus. Law of the Pa. Bar Ass’n, Amendments to the Pennsylvania Consolidated Statutes with Committee Comments, supra note 5, Lines 3581-3582.
- Committee Comments, lines 3589-3591.
- 15 Pa.C.S. §8612.
- See, e.g., Bus. Ass’n Comm. Of the Section on Bus. Law of the Pa. Bar Ass’n, Amendments to the Pennsylvania Consolidated Statutes with Committee Comments, supra note 5, Lines 10653-10654.
- 15 Pa.C.S. §8615(b).
- 15 Pa.C.S. §8615(c).
- 15 Pa.C.S. §8615(c).
- 15 Pa.C.S. §8615(d)(3).
- 15 Pa.C.S. §8615(e).
- 15 Pa.C.S. §8635.
- 15 Pa.C.S. §8649(a)-(d).
- 15 Pa.C.S. §8649(e).
- See, e.g., Bus. Ass’n Comm. Of the Section on Bus. Law of the Pa. Bar Ass’n, Amendments to the Pennsylvania Consolidated Statutes with Committee Comments, supra note 5, Lines 14148-141532.
- 15 Pa.C.S. §8654(a).
- 15 Pa.C.S. §8654(b)-(h).
- 15 Pa.C.S. §8631.
- 15 Pa.C.S. §8641.
- 15 Pa.C.S. §8672.
- 15 Pa.C.S. §8612.
- 15 Pa.C.S. §8673(g); See, e.g., Bus. Ass’n Comm. Of the Section on Bus. Law of the Pa. Bar Ass’n, Amendments to the Pennsylvania Consolidated Statutes with Committee Comments, supra note 5, Lines 15553-15557.
- 15 Pa.C.S. §8673(a).
- 15 Pa.C.S. §8673(b).
- 15 Pa.C.S. §8673(c).
- 15 Pa.C.S. §8673(e).
- 15 Pa.C.S. §8681.
- 15 Pa.C.S. 8661(a).
- 15 Pa.C.S. §8661(b)(2).
- 15 Pa.C.S. §8615(c)(14).
- 15 Pa.C.S. §8812; §8815.
- 15 Pa.C.S. §8849.1(b) - (d) and (i).
- 15 Pa.C.S. §8849.2(b).
- 15 Pa.C.S. §8849.2(b).
- 15 Pa.C.S. §8812.
- 15 Pa.C.S. §8851.
- 15 Pa.C.S. §8853(a) and (g).
- 15 Pa.C.S. §8853(b) - (c).
- 15 Pa.C.S. §8853(e).
- 15 Pa.C.S. §8815(c)(15); See, e.g., Bus. Ass’n Comm. Of the Section on Bus. Law of the Pa. Bar Ass’n, Amendments to the Pennsylvania Consolidated Statutes with Committee Comments, supra note 5, Lines 22171-22173.
- 15 Pa.C.S. §8871(a).
- See 15 Pa.C.S. 8661(a).
© 2017 Blank Rome LLP. All rights reserved. Please contact Blank Rome for permission to reprint. Notice: The purpose of this update is to identify select developments that may be of interest to readers. The information contained herein is abridged and summarized from various sources, the accuracy and completeness of which cannot be assured. This update should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.