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Why The CSL's Application To The Sale Of LLC Membership Interests May Be Unknown And Unknowable At The Time Of Sale

The California Corporate Securities Law of 1968, like the federal Securities Act of 1933 and Securities Exchange Act of 1934, define "security" by providing a list.  Because limited liability companies did not exist when these laws were enacted, none of these three laws included LLC interests in its list of securities.  When the California legislature enacted the state's first LLC law, it amended Corporations Code Section 25019 to add interests in an LLC to the California list of securities.  Stats. 1994 ch. 1200 § 29 (SB 469). This would seem to have brought each and every membership interest in an LLC within the definition of "security".

Perhaps recognizing that some LLCs would operate more as general partnerships, the legislature included an exception for membership interests in an LLC when "the person claiming this exception can prove that all of the members are actively engaged in the management of the limited liability company".  This exception was narrowed by a proviso that evidence that members vote or have the right to vote, or the right to information concerning the business and affairs of the limited liability company, or the right to participate in management, shall not establish, without more, that all members are actively engaged in the management of the limited liability company. 

California's apparent lenity comes with a price because it depends on what the members do or don't do after the membership interest is acquired.  Consequently, coverage of the CSL would in most cases be unknown and unknowable to the parties when the interest is sold.  It was for this reason that the U.S. Supreme Court rejected the "sale of business" doctrine in Landreth Timber Co. v. Landreth, 471 U.S. 681 (1985).  Uncertainty is not simply a problem for issuers.  As Justice Powell observed in a companion case to Landreth:

"Moreover, the parties' inability to determine at the time of the transaction whether the Acts apply neither serves the Acts' protective purpose nor permits the purchaser to compensate for the added risk of no protection when negotiating the transaction."

Gould v. Ruefenacht, 471 U.S. 701, 706 (1985).  

 

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