Let’s say you’re one of the many thousands of business owners who have opted to organize their business as a limited liability company (LLC) rather than as a traditional shareholder corporation. Let’s also say you have a business partner, Member X, who has a 25% membership interest in the business. Time passes and, unfortunately, Member X has become an impediment to the business’s success to the point you conclude that the business can’t continue with Member X. Finally, let’s say Member X rejects every reasonable offer you make to buy him out of the business.
What are your choices? Do you have to hire a lawyer to bring an expensive legal action to be rid of Member X? Is that possible? Wouldn’t it be much easier if, as Brooklyn Dodger fans famously taunted, you could just “Throw da bum out!”?
Utah is a long way from Brooklyn, but a recent decision by that state’s highest court got me thinking about the issue.
In the Utah case, Duke v. Graham, 2007 UT 31, 158 P3d 540 (2007), the issue was whether an arbitrator was legally authorized to expel LLC members as a remedy for breach of their duties owed to the remaining members. In upholding the expulsion, the court examined Utah law that expressly authorizes LLC members to expel another member either when so authorized by the parties’ Operating Agreement or by applying to a court based on the member’s misconduct.
Unlike Utah, New York’s LLC Law (LLCL) has no express provision authorizing non-judicial member expulsion or authorizing one member to bring a legal proceeding to expel another. The only tangential mention of the issue is in Section 701(b) of the LLCL under which, absent contrary provision in the operating agreement, member expulsion is one of several occurrences that do not result in dissolution unless the other members agree to dissolve.
So where does that leave you and Member X? As with most issues surrounding the internal affairs of LLCs, the answer lies in the operating agreement. A carefully drafted operating agreement should include dispute resolution and buy-sell provisions that enable the parties to separate their interests when they no longer can get along. The key is, at the outset of the business relationship, to create efficient exit mechanisms that provide all parties with a fair degree of financial security and business continuity. If the operating agreement provides for expulsion of a member under specified circumstances or by a specified majority vote, to avoid disruption and legal expense it also should provide the expelled member with payment for the fair value of his or her membership interest. At the same time payment terms must ensure the company’s future viability. Absent such agreement, the fate of the business will be dictated by negotiating muscle or expensive legal proceedings including possible dissolution.