It’s a sad fact of the business world that partnerships don’t always last. In an LLC, member disputes may arise, or a member may simply decide to leave. In such cases, removing an LLC member can be difficult, particularly if they are opposed to removal. But it is crucial to the future of your company to follow correct procedures if the need to remove a member arises.
The Uniform Limited Liability Company Act (ULLCA) does not permit members to simply vote out another member in cases when the operating agreement fails to specify the relevant procedure. This law applies to all 50 states and the District of Columbia.
Why a Member Might Be Removed
The removal of a member may be voluntary or involuntary. If it’s voluntary, the process is simple. When it’s involuntary, things can get messy.
The most common reasons for voluntary removal are retirement, personal reasons, or conflicts with other members. The main reasons for involuntary removal include:
- Member has breached operating agreement, maybe more than once
- Member has engaged in misconduct that could hurt the company
- Member has had repeated disputes with other members, leading to an impasse
Involuntary Removal Process
In the best-case scenario, the operating agreement has specific procedures in place to remove a member. An operating agreement is a binding contract among members, so those procedures must be followed.
If no operating agreement exists, or procedures for removal are not specified, state laws for removal will apply. All states are different, so you will need to check with your state for guidance. In some states, removal requires a court order, which means other members must convince a judge of just cause for removal. In other states, rules outline the removal process, while in still others the LLC must be dissolved to remove a member.
In either case, the member being removed is generally entitled to a buyout agreement and a payout of LLC proceeds in alignment with their ownership stake.
Voluntary Removal Process
Start by checking the operating agreement to stay if it specifies a removal procedure. It may require a simple resignation letter or a “notice of the person’s express will”. Some operating agreements, however, do not allow the voluntary withdrawal, in which case the LLC must be dissolved.
If there is no operating agreement, or if it includes no relevant provision, state laws apply.
What Happens to the Member’s Financial Interests?
The operating agreement should specify what happens to the member’s financial interests. It will usually be a buyout agreement, but there are several possible outcomes:
- Departing member keeps their equity and receives distributions
- Departing member receives no compensation
- Departing member’s financial interests transfer to another member
- Departing member sells their interests & other members may have right of first refusal
- Remaining members retain departed member’s interests in alignment with their equity
If no relevant procedures are outlined in the operating agreement, again, state laws apply.
When a Member Dies
An operating agreement is critical for multi-member LLCs, as it should specify the procedure in the event of each member’s death. Without it, the legal and financial process can be complicated and what happens to the member’s ownership and their heirs will default to the rules of the state.
Provisions may be:
- Surviving members must buy deceased member’s shares from heirs
- Heirs inherit the financial interests of the shares, but not the management interests
- LLC will be dissolved and deceased member’s LLC assets distributed to heirs.
- Deceased’s member’s interests transferred to specified person or people
Essentially, if all members agree, the operating agreement can specify any legal way to transfer the member’s financial and management interests.
In all cases of member removal, the operating agreement will need to be amended and approved by all members. In some states, new Articles of Organization may need to be filed.
While you hope that all of your business endeavors will be successful and long-lasting, circumstances do arise that necessitate a partner’s removal. Whether that removal is voluntary or not, having your attorney involved is a good idea. In the case of involuntary removal, legal action could result, so having an attorney involved from the start can help avoid worst-case scenarios. Any member removal situation highlights the importance of having a comprehensive operating agreement in place, which should be handled by your attorney and designed to protect all members, as well as the LLC.