As a business grows, its ownership structure may change and an owner may need to be removed. Removing an owner of a limited liability company (also known as a member) may become necessary if a member retires, dies, changes career, commits a breach of conduct, or has a dispute with other LLC members. When members decide that somebody within their ranks must leave the company, the removal can be voluntary or involuntary.
Involuntary removal tends to be more complicated and contentious. However, there are several legal procedures that can be followed to make the removal as smooth as possible. The LLC’s governing documents, as well as state LLC laws, affect the options available for involuntary removal of a member.
LLC Membership Structure and Governance
An LLC is a business entity that combines aspects of a traditional corporation and a partnership. However, unlike a partnership, LLCs can have one member. There is no upper limit on the number of members allowed in an LLC, unless it is taxed as an S corporation.
LLC ownership is typically expressed as a percentage of interest in the company. Depending on the provisions of the LLC’s operating agreement, the ownership percentage may affect members’ voting rights and rights to profits generated by the LLC.
Upon formation, an LLC must submit documentation to the state where it is organized. States do not require an LLC operating agreement, but having one is highly recommended for internal purposes because it describes how the LLC is to be run and often provides a mechanism for removing a member.
Removing a Member according to Governing Documents
An LLC member voluntarily withdrawing from the company is the best scenario. If the member is not willing to withdraw voluntarily, the next best scenario is having an operating agreement that provides a procedure for involuntary withdrawal (i.e., expulsion).
An LLC’s operating agreement may explain the grounds for, and means of, ousting a member. The usual method of involuntary removal is a vote by the other members followed by a buyout based on the departing member’s interest or share in the company. Member buyouts may be addressed in a buy-sell agreement or another internal governing document.
Absent a documented, formal procedure for removing a member, the LLC could negotiate a buyout deal on a voluntary basis, which would keep the matter out of court, saving time, money, and headaches.
Removing a Member according to State Law
If the LLC lacks an operating agreement that specifies a method for involuntarily removing a member, and if a voluntary departure cannot be negotiated, the removal will need to be resolved judicially in accordance with state law.
While state LLC laws vary, many are based on the Revised Uniform Limited Liability Company Act (RULLCA). Twenty-one states and the District of Columbia have adopted the RULLCA, which provides three situations in which the court, when petitioned by the LLC, may order the expulsion of a member:
The member engages in “wrongful conduct” that “adversely and materially” affects the company’s activities.
The member has “willfully or persistently” committed a “material breach of the operating agreement” or materially breached their duties to the company.
The member engages in conduct that “makes it not reasonably practicable to carry on the activities and affairs with the person a member.”
Importantly, in cases where the court acts to expel a member from an LLC (known in the RULLCA as “dissociation”), the member does not necessarily lose all of their rights and interests. Although they lose the right to participate in the LLC’s activities and no longer have fiduciary obligations, they are still entitled to receive distributions. In some states, including New York, however, the court may order the sale of a dissociated member’s economic interest in the LLC.
Dissolving the LLC
Rather than petitioning the court to remove a member from an LLC, members can petition the court to dissolve the LLC. An LLC must be dissolved in order for it to be terminated, i.e., for it to legally cease to exist. The LLC cannot enter into new contracts, although it may be required to satisfy existing agreements. Its creditors must also be paid and its assets must be distributed among members. Members of the LLC who wish to continue working together are free to begin a new LLC and operate under the terms they establish.
Once an LLC member has left the company, whether voluntarily or involuntarily, the company’s records should be updated to reflect the change. This may involve filing documents with the state where the company operates, as well as notifying financial institutions, insurance companies, investors, the Internal Revenue Service, and other stakeholders. If the existing operating agreement does not adequately address involuntary removal of a member, it should be updated to address this issue.
If you are in the process of removing a member from your LLC, schedule a consultation with Summa Business Law. Utah Business Attorney, Paul Sparks can guide you in crafting a removal plan that helps you effect this change as smoothly as possible.