No one likes to plan for the potential demise of a relationship when things are going great. This is equally true when the relationship in question is the foundation of your business, as is often the case in a Limited Liability Company, or LLC.
Perhaps we fear a self-fulfilling prophecy—by acknowledging that there could be a situation in which a member may need to be removed from the LLC, we fear that situation will inevitably arise. Entrepreneurs can also be reluctant to discuss the potential for one or more members to engage in behavior that would merit their removal; they don’t wish to imply a lack of trust.
But, as more and more business ventures choose the LLC format, the need to have a clear plan of action for what to do in the event a member needs to be removed from the LLC is becoming ever more apparent, as several recent court cases have shown.
WHY YOU SHOULDN’T LEAVE LLC MEMBER EXPULSION UP TO THE LAW
The LLC format is favored by many small business owners as it guards individual members against personal financial and legal liability akin to a corporation while offering considerable flexibility as to how the business operates. However, with this flexibility comes the potential for vulnerability should it ever become clear that for the business to survive, one or more LLC members needs to go.
At best, state LLC statutes express a right to remove an LLC member through “judicial expulsion.” You’ll have to go to court to complete what almost always amounts to a slow, costly process that usually ends with no party happy with the outcome. It’s best to avoid this route.
The good news is that you can avoid a legal quagmire by stating how to remove an LLC member in your operating agreement.
WHAT NEEDS TO BE INCLUDED IN A MEMBER EXPULSION PLAN?
You want to form a clear, detailed plan that allows your LLC to remove a member as smoothly as possible without getting the courts involved, should the case arise. While everyone’s plan looks different, yours should include four key elements:
WHY WOULD THE COMPANY REMOVE A MEMBER?
In other words, what type of behavior, activity, or circumstances constitute grounds to take an LLC member out of play? Common examples include a loss of professional licensure, burdensome lawsuits against other members, or other actions that place the viability of the company in jeopardy.
HOW IS A MEMBER EXPELLED FROM YOUR LLC?
Spell out the process for removal. This could be an in-person vote among all LLC members, or a written document signed by remaining members. You may wish to include the right for the individual(s) whose membership is in question to defend his or her position in an official meeting, or you may not.
WHEN IS IT OFFICIAL THAT A MEMBER HAS BEEN EXPELLED?
Establish who may vote for the removal of a member and how many votes in favor of removal are needed to make the expulsion official. This can be particularly tricky when an LLC is comprised of family members (i.e. a parent and a child); this makes it all the more important to define clear parameters ahead of time.
WHAT (IF ANY) RELATIONSHIP DOES AN EXPELLED MEMBER HOLD WITH THE LLC AFTER REMOVAL?
This helps define the business’s relationship status in the aftermath of member expulsion. What relationship do the remaining members have with the former member? Does the expelled member have any remaining interest or participation in the company?
While forming your plan may require some difficult conversations among your colleagues, the payoff of having everyone in agreement about the “whys” and “hows” of member expulsion is twofold: all members are clear about what types of actions could result in their removal, and should the situation arise, you are prepared to execute your plan without an expensive legal battle.
Plus, you don’t have to do it alone. Experienced legal counsel can ensure your operating agreement includes all the necessary elements to provide for a clear, actionable plan. If you have questions, we invite you to contact our firm today. Asheville small business attorney Chris Craig has many years of experience helping new and established LLC’s with documentation, transactions, and other legal needs. He and our experienced small business legal team at Craig Associates will be happy to offer guidance.