Breaking Up Is Hard to Do: Expulsion of an LLC Member

“Change the changeable, accept the unchangeable, and remove yourself from the unacceptable.”
—Denis Waitley

It’s hard to argue with this advice from Mr. Waitley, a Naval Aviator turned business consultant and motivational speaker. When faced with an LLC member or members that have become toxic, disagreeable or just plain useless, converting Waitley’s advice into action is essential.

First, Identify the Problem

Defining the problem presented by your fellow Limited Liability Company (LLC)  member(s) is the first step, and cannot be overlooked. Often the problem is obvious, but keep in mind: it won’t be obvious to outsiders (such as a Court or Arbitrator), and the ability to articulate the problem clearly and concisely will focus your thinking and that of those advising you. A well-articulated identification of the problem should look something like this:

  • I have a minority member that no longer shows up to work.

  • The majority member has failed to live up to his promises to keep the company capitalized.

  • I have a minority member that is suing me and/or the company.

  • I have a minority member that no longer provides the valuable things that formed the consideration for their equity position in the company.

Changeable or Unchangeable?

There is almost always a way to “change the changeable” in a LLC. Each state has its own LLC Act, or functional equivalent, and they offer a substantial amount of flexibility to customize your company’s operating agreement. Unlike corporations, there are very few absolute rules imposed by state legislatures and courts that prevent kicking a problem member to the curb. In most cases, the provisions of your operating agreement will govern, so the overriding question is: do you have the votes? If so, your situation is changeable. If not, there are still options available.

Voting a Member Out

If your operating agreement contains a clear mechanism to expel a member before the problem arises, the process is straightforward. Follow the process established by your operating agreement to the letter. It is worth engaging experienced counsel to help you through the process, because if you fail to abide by the terms of your own operating agreement, you may leave the member with their own remedies. Courts may be reticent to second-guess your operating agreement, but they will enforce its terms just like any other contract.

A common problem with many closely held LLCs is a lack of planning as to how, or why, a fellow member may be expelled. Operating agreements are negotiated during the “honeymoon” stage for most companies, and unless you bear the scars of a prior member conflict, expulsion is likely the last thing on the agenda for a young venture. Once things have gone sour, amending the operating agreement to provide for expulsion is typically your best bet.

While a minority member does not enjoy the same protections as a minority shareholder, an operating agreement, like any contract, contains an implied covenant of good faith and fair dealing. This becomes especially important when the timing of any changes to your operating agreement make it clear that you are targeting a specific member for expulsion. Your reasons for expelling the member should be sound ones, making it clear you are not simply denying them the benefit of the original bargain.

Forced Dissolution

When neither side of an intractable dispute has the authority under the operating agreement to force the other out, judicial dissolution may be necessary. Essentially a divorce without a pre-nuptial agreement for LLCs, a court will, upon request, oversee the dissolution of the LLC and send the members on their separate ways with their share of the proceeds. Where appropriate, courts in most jurisdictions will permit a buyout of a member’s interest and allow the remaining members to keep the company going. Having a judge decide the fate of your company, as well as the price to buy out your problem member is, to put it mildly, not an optimal outcome.

Buying Out an Expelled Member

Expelling a member and redeeming their membership interest (buying them out) are two distinct acts. Typically, expelled members are no longer permitted to vote, access company books and records, or otherwise influence the operations of the company. They are, however, still equity holders in the company. A well-written operating agreement will provide a clear and straightforward way for the company, or its other members, to purchase the expelled member’s interest.

At what price? Like other provisions in an operating agreement courts will defer to the parties’ agreement, but the level of deference, and the risk the expelled member can raise other claims, varies by state. Courts are likely to be skeptical of a mandatory buyout price that does not represent fair market value, or that imposes substantial discounts on minority interests.

An Ounce of Prevention

Every operating agreement should have clear and detailed provisions for expelling members and redeeming their membership interest. However, most “off the shelf” operating agreements fail to address this issue, inviting uncertainty. While changing an operating agreement to expel a member is possible, it’s a problem you should avoid. Start with a clear agreement among your members regarding the processes for expulsion of members and redemption of their equity interests when you can.

A Legal Professional Can Help

To ensure your operating agreement is working for you, a legal professional can help. As always, our first consultation is free. Do not hesitate to contact me at (303) 534-1958 or contact our team online.

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