Friday, September 26, 2008

Walking Away From Your LLC & Taking the Customers

Every lawyer will say plan up front in the member operating agreement for LLC breakups. Be that as it may, I know the majority of LLCs with more than one member do not have operating agreements that plan for member withdrawal or removal of a member who fails to perform promised services. Typically, I hear from an unhappy LLC member who feels he/she is doing all the work and the other member is free-loading. However, the operating agreement provides for an equal distribution of LLC income regardless of the level of work put in by each member on behalf of the LLC. The first step, of course, is to attempt to reach agreement with the other member for their withdrawal. What happens when no agreement between the members can be reached?

One option is for the unhappy member to leave the LLC and allow it to fail. That's a drastic step with some down-side risk. Let's first look at potential benefits of walking. This approach can be attractive where the LLC is a service business. The main issue in service businesses is who controls the bulk of the customer contacts and new business leads? If it is the same member who is disgruntled and wishes to bolt the LLC, then it may make sense to walk and take the business with you. If the LLC owns equipment that is vital to providing the service, this becomes problematic. A member cannot walk away with key assets. That's theft.

Risks In Walking Away From LLC While Talking Lion's Share of LLC Business
  1. Up top has to be dealing with LLC debts for which the departing member is personally liable. Does the LLC have a lease for office space that is personally guaranteed by the members? What about equipment leases? Bank loans? Credit cards?
  2. As stated above, a departing member cannot bring with him or her any assets of the LLC. The LLC customer list is an asset. You should leave it with the LLC records. If the LLC has a small number of key customers, no big deal. But if the list if voluminous, you may have a difficult time recreating the customer list from secondary sources such as the Yellow Pages.
  3. Stealing key employees. If the LLC has employees with a written contract, legal issues arise when a former member steals an employee from the LLC (i.e., tortious interference with a contractual relationship).
  4. Fiduciary duties LLC members owe to one another. The extent of fiduciary duties owed by LLC members to each other varies from state to state and can often be modified by the operating agreement. A common fiduciary duty owed by LLC members to each other is one of loyalty. That means the LLC member never acts against the interest of the LLC. If a member plans on bolting the LLC and scooping up key customers / employees in the process, overt actions to further than plan should not occur while the individual is still an active member of the LLC. By "overt", I mean don't contact the customers / key employees asking them to join you in the new venture until you are already out the door. Why? Recruiting away customers and employees from the LLC to the new business could violate the duty of loyalty. See blog post from my commercial site for more info on topic.


Anonymous said...

Great article. One additional question: Do fiduciary duties continue beyond a member's resignation from a member managed LLC?

jjray said...

To my knowledge, fiduciary duties imposed by state law on LLC members cease when the member withdraws from the LLC. However, the LLC operating agreement (if the LLC has one) could extend contractual obligations such as non-compete for a certain period of time beyond the point where the member withdraws from the LLC.