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 SB 177 (Wieckowski) Page 2 of ? 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 SB 177 (Wieckowski) Page 3 of ? 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, SB 177 (Wieckowski) Page 4 of ? 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 SB 177 (Wieckowski) Page 5 of ? 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, SB 177 (Wieckowski) Page 6 of ? 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. SB 177 (Wieckowski) Page 7 of ? 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. SB 177 (Wieckowski) Page 8 of ? 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, SB 177 (Wieckowski) Page 9 of ? 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 SB 177 (Wieckowski) Page 10 of ? 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, SB 177 (Wieckowski) Page 11 of ? 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. SB 177 (Wieckowski) Page 12 of ? 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 SB 177 (Wieckowski) Page 13 of ? 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) **************