Thursday, April 10, 2008

Removal of LLC member

Single member LLCs are really sole proprietorships for which the law gives limited liability protection traditionally enjoyed by corporations. An LLC with two or more members is, at its core, a business marriage. And we know marriages can, and often do, go bad. The best course of action is to plan for a potential breakup. Amicable LLC breakups are easy enough to draft for in an LLC operating agreement. Either one member withdraws (see below article on member withdraw) or the members mutually agree to dissolve their LLC. What if there is no agreement between the members? Then we are faced with a contested business divorce and it can get ugly. When there are just two members, each with 50% ownership interest, there really is no way to resolve the issue. There is no majority owner with voting power to oust the minority. Dissolution based upon management deadlock is the ultimate resolution of the impasse unless the two members can agree on a course of action.

The most common situation I encounter involving a desire to remove a member is one where a member does not live up to his or her commitments to provide money or services to the LLC. See post on the topic. It is common for state LLC laws to prohibit removal of a member unless there is a written LLC operating agreement that specifically provides for removal. I should back up and emphasize the importance of your operating agreement specifically detailing what cash payments and services are to be provided by each member. A written operating agreement that leaves out these provisions is fatally defective.

You're first option, assuming the operating agreement plainly states that the member is to provide money or a service, is to sue the member for breach of contract. It's difficult to continue in business with a person who you had to sue in order to force him or her to live up to their commitments. The logical resolution of the problem is removal of the deadbeat member. And that is a sticky wicket to negotiate. First, the operating agreement must provide for removal under these circumstances. Second issue, can the moving members gather sufficient votes to remove the member? Here is the rub. Operating agreements commonly provide for removal of a member only upon a supermajority vote is required. Supermajority is generally anywhere from 60 to 90 percent. If the member you are trying to remove holds at least 41% of the ownership in the LLC, under some LLC operating agreements, you cannot remove him or her even if they have failed to provide the required capital contribution or services.

An alternative way to draft the operating agreement is that the member up for removal is barred from voting on the motion. Thus, if it takes supermajority for removal, this is determined without inclusion of the ownership interest of the member up for removal. For example, assume ABC LLC has three owners, two of whom (A & B) own 40% and last (C) holding 20%. Further assume ABC LLC has a provision in the operating agreement for removal of an LLC member who fails to provide services upon a 66% vote of members in interest. If the operating agreement excludes the ownership interest of the member up for removal from the calculation, then A and C members could vote to remove member B for failure to pay the required capital contribution. Although A & C together own only 60% of the interest in the LLC, they own 100% when the interest of B (the member up for removal) is not taken into consideration.

The downside of excluding the ownership interest of the member up for removal from the calculation of supermajority? A majority own is likely not to agree to such a provision. By doing so, he or she has agreed to summary mechanism for the majority member's removal from the LLC. Bottom line: if your LLC has more than one member, deal with the issue of removal of a member up front in your LLC operating agreement. The operating agreement should detail (a) the grounds for removal, (b) the actual mechanism for removal, and (c) compensation to the member upon removal for his or her LLC interest.

12 comments:

Anonymous said...

Do you have any suggestions for removing a member of a Delaware LLC when there is no operating agreement in place? The member we wish to remove is a 50% owner and refuses to communicate or participate in any business activity with the other members.

Anonymous said...

do you know if an operating agreement give one member 51% voting rights and another member 49% voting rights, even if they both have a 50% ownership interest?

jjray said...

Reply to September 18 post. If the member you wish to remove is a 50% owner, then I think the only move to be made is going to court to seek a dissolution of the LLC due to management deadlock. The only passing thought I have is sue the recalcitrant member for breach of fiduciary duties by failing to participate in good faith in the management of the LLC.

jjray said...

Reply to January 5 post. It would be unusual for an LLC operating agreement to grant one member greater voting power than another member, both of whom have an equal ownership interest. But can it happen? Members can agree to anything so 'yes', it is possible. Perhaps the member who owns 50% but has 51% voting power contributes more important services to the LLC.

Catherine said...

I am involved with a two member LLC in PA. One member wants to leave, and both members have agreed to this. There is no operating agreement in place. What is the process for withdrawing the mamber, and is there a waiver of some sort to release the departing member of any liability?

Anonymous said...

I'm a member of a 2 member LLC in New Jersey and I want to get out.We both agreed on that what need to be done to accomplish this withdraw ?
I don't want to be connected to the llc in any way

Anonymous said...

My husband is 10% owner in LLC construction business. He does the majority of the work and recently has stopped accepting payment, trying to help with financial resposibility to company. 1 partner is 80% owner, who does not put anything buy money into it and 1 partner is 10% owner and just does nothing, in general, but collect a paycheck. My husband feels he is responsible to the 80% owner for financial obligations he has contributed,my question is: Is that true? and How does he get released from any responsibility?

Transformer said...

I would like to set up an LLC with my wife as the single, non-operating member. The intention is that she is the owner and I am a non-member manager.

I have a good handle on all aspects of this except where and how to indicate that she is a non-operating member.

Thoughts anyone?

EPICAC77 said...

I hope everyone takes away from this post the importance of an Operating Agreement (and not just Articles of Organization as they are NOT the same thing) when forming an LLC. Even if you have an existing LLC, whether or not it is time to remove a member, create an Operating Agreement IMMEDIATELY. Those of you asking how to remove a member without an Operating Agreement when both members are in agreement (amicable split) simply need to draft the document to make the process "official". It is much easier than a non-amicable split and the Operating Agreement that is drafted is useful to the LLC after the departing member leaves even if the LLC then has a sole member. Remember that like any business entity, an LLC is subject to modification over the years and it is completely within the law to amend the Operating Agreement or create a new one as long as the majority of member ownership agrees (again subject to the same supermajority clause in some cases). When you do not agree on the split, then sadly the courts must get involved.

And to anyone in the situation of the last poster, I would suggest you think LONG AND HARD before you vest sole ownership of a business for which you will be the primary driving force (meaning you invest ALL the sweat equity necessary to start and run the business) in someone who is a non managing member, even if they are a spouse. As the article emphasizes, MARRIAGES CAN AND DO GO BAD so it is simply not good business to trust that yours never possibly could. It doesn't mean you don't trust your wife or husband; it simply means that you don't need that one more thing complicating a divorce, however remote a possibility that may seem.

Anonymous said...

Our LLC has 5 members. The managing member has a capital account at 80% (valued at 7 million)and the others sit at 5% each. The managing member wants to edit the operating agreement to place his estate as the beneficiary of our key man insurance policy, valued at 5 million. The other members are blocking this action under the position that the policy has been written for the sole purpose of continuing the company business in the event of the passing of the managing member. In the end the policy would be used to assist pay off the capital account of the managing member, but under a 5 year plan. This plan would permit the LLC to remain in business. All annual premiums have been paid by the LLC (60k per year). We are questioning if any action taken by the managing member to alter the policy beneficiary to anything other than the LLC is an act of bad faith, and would likely end up putting the company into liquidation should the managing member die. As he was upset that we are blocking his plan, there is a very probable result that he will cancel the key man policy all together, this also placing the future of the company in jeopardy. Any brief thoughts?

StrangeSavant said...

Hello,

What if the member withdraws willingly? What forms need to be completed in order for this to occur and where can I obtain such forms?

Joel Fairbank said...

I am the managing member of a New York State LLC with 2 members. My former partner in the LLC decided in July 2010 to voluntarily "leave" the company for new employment with a company in NYC. He has been gone for 20 months (his last day was Oct 1, 2010) and he has not done ANY day-to-day business mgmt for the LLC since. We have an operating agreement but it doesn't deal elaborately with a voluntary withdrawal of a member. We need to resolve his withdrawal legally but there is a couple of outstanding financial liabilities (bank loan and private promissory note) for which we are both persoanl guarantors. He wants to be relieved of his secured obligation but I cannot payoff or re-finance the loans presently. He also wants a share of the profits of the LLC to pay for these debts because the company statrted showing a profit last year (2011) and he says he is due any "occasional blessings" from the LLC.

I am just trying to find out what a withdrawn member has rights to.


Terms of the Operating Agreement:
Termination or Dissolution of Company
SECTION 10.1. The Company shall be terminated prior to the date of expiration of the term as
provided in Section 2.4 if (a) a majority in interest of the Members consent that the Company should be
terminated and dissolved, or (b) the Company is dissolved pursuant to this Agreement.
SECTION 10.2. The Company shall he terminated in the event any Member (i) withdraws,
resigns or is expelled from the Company; (ii) makes an assignment for the benefit of creditors, is the
subject of an order for relief under Title 11 of the United States Code, files a petition or answer seeking
for himself any reorganization, arrangement, composition, readjustment, liquidation, dissolution, or
similar relief under any statute, law or regulation, files an answer or other pleading admitting OJ' failing to
contest the material allegations of a petition filed against him in any proceeding of this nature, seeks,
consents to, or acquiesces in the appointment of a trustee, receiver or liquidator for of all or any
substantial part of his properties; (iii) dies; or (iv) a judgement is entered by a court of competent
jurisdiction adjudicating him incompetent to manage his person or his property.
SECTION 10.3. If the Company is dissolved, the owners of a majority in interest of the remaining
Members may elect to reconstitute and continue the Company as a Successor Company upon the same
conditions as are set forth in this Agreement. Any such election to continue the Company will not result
in the creation of a new Company among the remaining Members, nor will such election require the
amendment of this Agreement or the execution of an amended Agreement.