BILL ANALYSIS Ó
SENATE JUDICIARY COMMITTEE
Senator Hannah-Beth Jackson, Chair
2015 - 2016 Regular Session
SB 177 (Wieckowski)
Version: February 9, 2015
Hearing Date: April 28, 2015
Fiscal: Yes
Urgency: No
RD
SUBJECT
Alarm companies: limited liability companies
DESCRIPTION
Existing law, until January 1, 2016, authorizes a limited
liability company (LLC) to be issued an alarm company operator's
license, if, among other things, certain insurance requirements
are met. This bill would extend the sunset date on the
authorization to January 1, 2022.
BACKGROUND
Under the Beverly-Killea Limited Liability Company Act (the LLC
Act) (SB 469 (Beverly and Killea, Ch. 1200, Stats.1994)), a
foreign or domestic limited liability company (LLC) is
prohibited from rendering professional services in this state
unless expressly authorized under applicable provisions of law.
"Professional services" are services for which a license,
certification, or registration is required under specified
statutes.
The rationale for the exclusion was that service providers who
harm others by their misconduct, incompetence or negligence
should not be able to limit their liability by operating as a
LLC or LLP and, thus, become potentially judgment-proof.
Generally, a limited liability company is a legal entity that
allows one or more owners to conduct a business without any
owner having personal liability for the obligations of the
business. The salient nontax characteristics of an LLC are
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limited liability for its owners (as in a corporation) and
freedom to structure management rights and financial interests
in the entity in virtually any configuration the parties wish
(as in a partnership). An LLC most often elects to be treated
as a partnership for income tax purposes, so that the income,
gains, losses, deductions, and credits of the LLC generally will
flow through to its members for reporting on their personal tax
returns, the distribution depending on the terms of the LLC
agreement, not necessarily the ownership interest of the
individual members.
Until the creation of LLCs, the limited partnership and the
subchapter S corporation were the primary forms of business
entity used to achieve the tax status and limited liability
features now offered by the LLC. Each of those forms has its
drawbacks, but the LLC can provide the advantages of both
without the disadvantages of either.
A limited partnership allows pass-through tax treatment,
flexibility in financial structuring, and limited liability for
the "limited" partners (as long as they do not take part in the
control of the business), but requires at least one person (the
"general" partner) be fully liable for the obligations of the
business. In contrast, no member of an LLC is required to be
personally liable for the company's obligations, and yet, each
member is permitted to manage the company and to take part in
the control of the business without losing the member's limited
liability. (Corp. Code Sec. 17703.04.)
Although an S corporation allows pass-through tax treatment and
limited liability for its owners, S corporation status limits
the parties' flexibility in structuring their financial
arrangements. Furthermore, only limited persons and entities
can be S corporation shareholders, and an S corporation will
lose its pass-through tax treatment if an ineligible entity
becomes a shareholder. An LLC, on the other hand, can have
different classes of ownership, and income, gain, loss, and
other items may be allocated disproportionately to ownership
without affecting the LLC's pass-through tax treatment. Any
person can be a member of an LLC (thus sidestepping the
restrictions on shareholders in the case of an S corporation).
Under the Beverly-Killea LLC Act, an LLC cannot provide
professional services unless permitted by the Business and
Professions Code. Since the Act was enacted, contractors,
private cemeteries, repossessors, alarm companies, and, most
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recently, private investigators have been authorized to operate
as LLCs. In 2008, SB 1225 (Harman, Ch. 114, Stats. 2008)
authorized private cemetery LLCs, however, it also prohibited
licensees of professional services rendered in connection with
the operations of a cemetery authority from having any ownership
interest in the LLC. In 2009, SB 392 (Florez, Ch. 698, Stats.
2009) authorized LLCs to be issued contractors' licenses and
imposed minimum levels of liability coverage. These
requirements for a minimum amount of liability coverage were
based on bills that authorized attorneys, accountants,
architects, engineers, and land surveyors to operate as the only
limited liability partnerships (LLPs) in California.
In 2012, SB 1077 (Price, Ch. 291, Stats. 2012), among other
things, allowed for an LLC to be issued an alarm company
operator's license, as is permitted in 49 other states. This
Committee conditioned its approval of SB 1077 on similar
liability coverage that was included in other LLC and LLP bills,
and added a three year sunset to its provisions. Together, the
insurance requirements and the sunsets are intended to provide
this Committee with the opportunity to evaluate whether
liability for judgments against the conditionally-authorized
LLCs have been sufficiently covered by insurance and whether the
mandated insurance levels are sufficient to meet potential
future claims. This bill now would extend the sunset on the
alarm company LLC provisions to January 1, 2016.
This bill was heard in the Senate Business, Professions &
Economic Development Committee on April 13, 2015, and was passed
out on a vote of 9-0.
CHANGES TO EXISTING LAW
Existing law , the Beverly-Killea LLC Act, generally prohibits
domestic and foreign limited liability companies from rendering
professional services, as defined, in California. Existing law
provides that an LLC may render services that may be lawfully
rendered only pursuant to a license, certificate, or
registration authorized by the Business and Professions Code if
the applicable provisions of the Business and Professions Code
authorize a limited liability company to hold that license,
certificate, or registration. (Corp. Code Sec. 17701.04.)
Existing law defines professional service as those services that
may only be lawfully rendered pursuant to a license,
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certification, or registration under the Business and
Professions Code, Chiropractic Act, Osteopathic Act, or Yacht
and Ship Brokers Act. (Corp. Code Secs. 13401, 13401.3.)
Existing law provides that the debts, obligations, or other
liabilities of a limited liability company, whether arising in
contract, tort, or otherwise, are solely the debts, obligations,
or other liabilities of the limited liability companies to which
the debts, obligations, or other liabilities relate. They do
not become the debts, obligations, or other liabilities of a
member or manager solely by reason of the member acting as a
member or manager for the limited liability company. (Corp.
Code Sec. 17703.04(a).) Existing law provides for the liability
of a member of an LLC under the common law theory of alter ego
liability, and under any judgment of a court for any debt,
obligation, or liability (whether arising from contract, tort,
or otherwise) of the LLC, to the same extent as a shareholder
may be personally liable for any debt, obligation, or liability
of the corporation, except as specified. (Corp. Code Sec.
17703.04(b).) Existing law provides that a member may otherwise
agree to be personally obligated for any or all debts,
obligations, and liabilities of the LLC in writing in the
articles of incorporation or written operating agreement, as
specified. (Corp. Code Sec. 17703.04(e).)
Existing law establishes the Alarm Company Act, which provides
for the licensure, registration, and regulation of alarm company
operators and alarm agents by the Bureau for Security and
Investigative Services (BSIS). (Bus. & Prof. Code Sec. 7590 et
seq.)
Existing law defines a licensee to include a business entity,
whether an individual, partnership, limited liability company,
or corporation licensed under the Alarm Company Act. (Bus. &
Prof. Code Sec. 7590(i).)
Existing law , in relevant part, permits the director of Consumer
Affairs to deny a license, certificate, or registration
regulated by the Alarm Company Act on specified grounds,
including, among other things, that the applicant has been
managing member of an LLC that has been refused a license under
this chapter or whose license has been suspended or revoked.
(Bus. & Prof. Code Sec. 7590.10(a)(7).)
Existing law , in relevant part, authorizes the director of
Consumer Affairs to suspend or revoke an alarm company operator
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license, if the director determines that any of the LLC's
managing partners has engaged in certain acts, including acts in
violation of the Alarm Company Act, among others. (Bus. & Prof.
Code Sec. 7599.61(a).) Existing law, in relevant part, provides
that the director of Consumer Affairs may deny a license,
certificate, or registration regulated by the Alarm Company Act
on the grounds that the applicant was a managing member who has
been refused a license under the Act or whose license has been
suspended or revoked. (Bus. & Prof. Code Sec. 7591.10(a)(7).)
Existing law, in relevant part, also authorizes the director of
Consumer Affairs to refuse a license to an applicant pending
final disposition of an investigation of criminal activity or of
a disciplinary action previously filed against the person or
applicant or against a managing member of the applicant. (Bus.
& Prof. Code Sec. 7593.6(a).)
Existing law , in relevant part, prohibits, except as specified,
an individual from being in active charge of the business if the
individual has ever had a license revoked for cause or been
disqualified from further employment in the alarm company
operator business pursuant to the Alarm Company Act, or was a
managing partner of a business whose license has been revoked.
(Bus. & Prof. Code Sec. 7594.4(a).)
Existing law , in relevant part, prohibits a licensee from
conducting a business as an LLC unless the licensee holds a
valid license issued to that exact same LLC, subject to a $100
fine for each violation. Existing law provides, specific to
alarm company LLCs, that as a condition of the issuance,
reinstatement, reactivation, or continued valid use of a license
under the Alarm Company Act, an LLC must maintain a policy or
policies of insurance against liability imposed on or against it
by law for damages arising out of claims based upon acts,
errors, or omissions arising out of the alarm company services
it provides, as follows, subject to suspension:
For an LLC licensee with five or fewer persons named as
managing persons pursuant to specified provisions, the total
aggregate limit of liability under the policy or policies
required under the Act shall not be less than $1,000,000.
For an LLC with more than five persons named as managing
members pursuant to specified provisions, an additional
$100,000 of insurance shall be obtained for each person named
as managing members of the licensee except that the maximum
amount of insurance is not required to exceed $5,000,000 in
any one designated period, less amounts paid in defending,
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settling, or discharging claims. (Bus. & Prof. Code Sec.
7599.34(b), (c), (f).)
Existing law provides that, prior to the issuance,
reinstatement, or reactivation of an LLC license under the Alarm
Company Act, the applicant or licensee must submit the
information and documentation required by this section relating
to insurance coverage requirements, demonstrating compliance
with the specified financial security requirements. (Bus &
Prof. Code Sec. 7599.34(d).)
Existing law requires that, for any insurance policy secured by
a licensee in satisfaction of this section, a Certificate of
Liability Insurance be submitted to the BSIS, as specified. The
insurer must report to the BSIS the following about any policy
required: name, license number, policy number, coverage dates,
the date and amount of any payment of claims, and cancellation
date, if applicable. (Bus. & Prof. Code Sec. 7599.34(e).)
Existing law provides that where an LLC's license is suspended
for failure to maintain sufficient insurance pursuant to the
above provisions, each member of the LLC shall be personally
liable up to $1,000,000 each for damages resulting to third
parties in connection with the company's performance, during the
period of suspension, of any act or contract where a license is
required by the Alarm Company Act. (Bus. & Prof. Code Sec.
7599.34(g).)
Existing law , in relevant part, requires that within seven days
after receiving a final civil court judgment filed against the
licensee of any managing member or employee of a licensee for an
amount of more than $500 pertaining to any act done within the
course and scope of his or her employment that may be in
violation of the Alarm Company act, the licensee or his or her
manager must deliver to the BSIS chief a copy of the judgment,
subject to fines. Existing law requires similar requirements
for violent incidents involving a dangerous weapon, as
specified. (Bus. & Prof. Code Sec. 7599.42(a).)
Existing law extends other provisions of the Alarm Company Act
to managing members of LLCs. (Bus. & Prof. Code Secs. 7593.1,
7599.32(b), 7593.7(a), 7599.48(a).)
Existing law sunsets the above authorizations for alarm
companies to operate as an LLC on January 1, 2016.
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This bill would extend the authorization for an LLC to be issued
an alarm company operator license, and the related provisions,
above, until January 1, 2022.
COMMENT
1. Stated need for the bill
According to the author:
Business and Professions Code [Sec.] 7590.1 currently allows
alarm companies to form Limited Liability Companies (LLC) for
the purposes of operating their businesses. Under an agreement
to ensure legislative oversight of the LLC corporate form, the
enabling statute for this industry is set to expire in 2016.
Under [the] Business [and] Professions Code there are several
professional businesses that are prohibited from becoming
LLCs. When the state first authorized businesses to
incorporate as LLCs, alarm companies were one of the
businesses that were originally prohibited from forming or
operating a[n] LLC. The prohibition stems from broad language
in the B&P code that was originally targeted at keeping law
firms and accounting firms from becoming LLCs. Those
professions are now allowed to become Limited Liability
Partnerships (LLP). Subsequently, other industries were
statutorily authorized to form LLCs as well. Today, near all
other states allow alarm companies to organize as LLCs.
SB 177 extends the sunset for alarm companies to form LLCs
from 2016 to 2022.
The California Alarm Association, the sponsor of this bill, adds
that "SB 1077 also granted the Bureau of Security and
Investigative Services (BSIS) greater authority to cite and fine
alarm companies operating without a license. It is illegal to
operate an alarm company without a license issued by the BSIS.
Part of the licensing process is a thorough background check on
the owners and employees of the alarm company. However, under
previous law the BSIS lacked the direct authority to regulate
unlicensed alarm companies. When discovering an alarm company
was operating illegally without a proper license, the BSIS had
to rely on the local District Attorney to enforce the Alarm
Company Act. Securing the support of the local DA was
difficult, as they often have more pressing issues to deal with.
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Granting the BSIS direct authority to deal with unlicensed
alarm companies as provided under SB 1077, provides greater
protection for consumers. SB 177 [also] seeks to extend the
sunset on this provision."
2. Significance of insurance liability coverage requirements
of LLC and LLP bills
California's LLP law has always sought to strike a balance
between allowing professional licensed service providers to
operate in a mode offering both tax and liability-limiting
advantages while preserving to an appropriate degree the ability
of a party injured by professional negligence to recover damages
for that injury. Thus, an insurance requirement has always been
imposed upon professional licensees wishing to operate as an
LLP. Similarly, over the years, insofar as the Legislature has
authorized LLCs to hold various professional licenses, insurance
requirements have been imposed upon professional licensees
wishing to operate as an LLC. (See Background.)
The rationale behind the insurance requirement is to ensure that
a person who is injured by an LLP or LLC is likely able to
collect his or her judgment. Because of the limited liability
attributes of these business entities, the injured person can no
longer rely on the joint and several liability of the partners
and their personal assets, but must look to the assets of the
LLP or LLC. To ensure adequate but not necessarily complete
recovery in all claims, the insurance requirement is added as a
condition of being permitted to operate as a LLP or LLC. Thus,
even if the LLP or LLC has few assets because the profits are
regularly distributed to its members, the required insurance is
available to pay tort damages.
The difficulty has always been in the setting of the minimum
level of required insurance in an appropriate amount. While the
law has never sought to cover all potential claims, since that
would obviate the need and benefit for operating as a LLP or
LLC, the law has always sought to ensure that most predictable
claims are covered. Hence, the Committee has always sought and
used the available insurance claims data in determining the
appropriate level of minimum insurance.
According to the author and sponsor, they are unaware of any
problems resulting from the current authorization for alarm
companies to form Limited Liability Companies. At the same time,
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this Committee has not been provided any information or
insurance data that would indicate whether any judgments against
alarm companies operating as LLCs have been sufficiently covered
by insurance and whether the mandated insurance levels are
sufficient to meet potential future claims. As noted above and
in this Committee's analysis of prior sunset reviews of
legislation for similar entities, evaluating the sufficiency of
insurance levels is critical to ensuring the ability of a party
injured by professional negligence to recover damages for that
injury.
3. Incomplete data is not a new problem
In 1998, in evaluating the authorization for architecture LLPs,
this Committee's analysis stated:
The scanty available claims data provided by the sponsor does
not provide a clear picture of the types of judgments assessed
against architects for professional negligence.
(See AB 469 (Cardoza, Ch. 504, Stats. 1998), extending the
sunset for architecture LLPs.)
Again in 2001, that precise information is not available. (AB
1596 (Shelley, Ch. 595, Stats. 2001).) And in 2006, only
partial information was made available when the architecture LLP
authorization once again came up for review. (AB 2914 (Leno,
Ch. 426, Stats. 2006).) As noted then, at the very least, the
lack of complete data justifies the policy of extending the
sunset for the LLP law for moderate periods of time, to enable
periodic review, rather than its complete repeal. This bill
would appear to be consistent with that policy, by extending, as
opposed to repealing, the sunset date.
Arguably, however, given the lack of data available at this time
(see Comment 2 above), the Committee may wish to consider a
shorter, three-year sunset period, to allow the sponsor and BSIS
to collect more information that could assist in the evaluation
of the mandated insurance levels.
Suggested Amendment :
Replace the January 1, 2022 sunset in the bill with January 1,
2019 sunset
4. Potential future issue
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The current insurance coverage required in the alarm company LLC
laws provide that for an LLC with more than five persons named
as managing members pursuant to specified provisions, an
additional $100,000 of insurance shall be obtained for each
person named as managing members of the licensee except that the
maximum amount of insurance is not required to exceed $5,000,000
"in any one designated period, less amounts paid in defending,
settling, or discharging claims as set forth under this
section." (Bus. & Prof. Code Sec. 7599.34(c)(2).)
In short, the required insurance is a "wasting assets" policy
that could well be depleted by defense costs and multiple claims
in a coverage year so that the more difficult claims to resolve,
usually the larger claims, could result in no payment at all to
the tort victim because the required insurance assets for the
covered year has been exhausted.
While at this time there is no information suggesting the
possibility of the required insurance being exhausted in a
coverage year (which would require an increase in the mandated
insurance liability coverage), the issue of the "wasting asset"
insurance policy and whether there should be an obligation on
alarm company LLCs to replenish the policy during the course of
the year deserves re-visiting in the future as defense and
claims costs increase year after year.
Support : None Known
Opposition : None Known
HISTORY
Source : California Alarm Association
Related Pending Legislation : SB 284 (Cannella, 2015) would
repeal the sunset provisions on professional engineer and land
surveyor LLPs, thereby extending the operation of those
provisions indefinitely. That bill is also scheduled to be
heard in this Committee on April 28, 2015.
Prior Legislation :
AB 1608 (Olsen, Ch. 669, Stats. 2014), among other things,
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authorized the Bureau of Security and Investigative Services
within the Department of Consumer Affairs to issue a private
investigator's license to LLCs if, among other things, certain
insurance requirements are met. The bill included a January 1,
2020, sunset date.
SB 1077 (Price, Ch. 291, Stats. 2012), among other things,
authorized LLCs to be issued alarm company operator licenses if
certain liability insurance requirements are met. The bill
included a January 1, 2016, sunset date.
SB 560 (Gorell, Ch. 291, Stats. 2011) extended the sunset for
architecture LLPs to January 1, 2019, under the continuation of
the insurance levels required in AB 1596 (Shelley, Ch. 595,
Stats. 2001). The bill, as introduced, proposed to remove the
sunset entirely.
SB 1008 (Padilla, Ch. 634, Stats. 2010) authorized licensed
engineers and land surveyors to organize and operate as LLPs, as
specified, and requires engineers and land surveyors organizing
as LLPs to carry insurance liability coverage, as specified.
This authorization is set to sunset on January 1, 2016.
SB 392 (Florez, Ch. 698, Stats. 2009) authorized the State
Contractors' License Board to issue to an LLC a license to
provide contactor services, if the LLC met the liability
coverage requirements provided in the bill (and met other
licensing requirements).
SB 1337 (Correa, 2008) was similar to SB 392, but lacked the
insurance and/or escrow deposit requirements for the LLC and its
members. The bill died in this Committee.
SB 1225 (Harmon, Ch. 114, Stats. 2008) permitted an LLC to
obtain a license as a cemetery authority provided it conformed
to the insurance requirements for professional LLPs and provided
no licensee practicing his or her profession becomes an
owner-member of the LLC.
SB 414 (Corbett, Ch. 80, Stats. 2007) increased the liability
coverage amounts for accountancy and law LLPs.
AB 2914 (Leno, Ch. 426, Stats. 2006) extended the sunset date of
architecture LLPs until January 1, 2012, and increased the
amount of insurance that such LLPs must hold.
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AB 180 (Jerome Horton, 2005) was substantially similar to SB
1008 (Padilla, Ch. 634, Stats. 2010) in its provisions of the
organization of engineers and land surveyors as LLPs, and
contained a sunset date. That bill passed this Committee but
was ultimately gutted and amended to deal with a different
topic.
AB 1265 (Benoit, 2003) would have permitted professional
engineers and land surveyors to organize as an LLP and would
have required that, depending on the number of partners, the LLP
have between $500,000 and $5 million in insurance. This bill
was held in this Committee.
AB 1596 (Shelley, Ch. 595, Stats. 2001) extended the sunset date
of statutes permitting architects to organize as LLPs, to
January 1, 2007.
AB 469 (Cardoza, Ch. 504, Stats. 1998) authorized architects to
form a LLP provided the partnership had between $500,000 and $5
million in insurance depending on the number of partners in the
LLP. Only partnerships with a net worth of $10 million or more
were allowed to become LLPs. This bill included a January 1,
2002, sunset date.
AB 2401 (Miller, 1996) would have allowed contractors to operate
as LLCs. The bill died in this Committee.
SB 141 (Beverly, Ch. 57, Stats. of 1995) would have added
numerous categories of state regulated professional service
providers to the types of businesses that could operate as LLCs.
However, opponents of SB 141 and that bill's sponsor were
unable to agree as to whether or not professional or licensed
LLC service providers should carry adequate insurance to ensure
their financial ability to respond to legal judgments for
contract or tort claims. Consequently, those additional classes
of businesses were amended out of SB 141 prior to its enactment.
SB 513 (Calderon, Ch. 679, Stats. 1995) authorized the
establishment of LLPs for licensed attorneys and licensed
accountants, as long as the LLP purchased a liability insurance
policy or maintained bank deposits of least $100,000 per limited
liability partner (or an aggregate of not less than $500,000 for
fewer than five partners and not more than $5 million for all
others). Only partnerships with a net worth of $10 million or
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more were allowed to become LLPs.
SB 469 (Beverly and Killea, Ch. 1200, Stats. 1994) See
Background.
Prior Vote : Senate Business, Professions and Economic
Development Committee: (Ayes 9, Noes 0)
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