Someone recently asked me to write a blog article answering the question, “How can I get rid of a difficult member in my LLC?” This article will answer that question, but will also address the broader issue of how a member might be removed from an LLC, whatever the reason.
The Short Answer:
First, though, I’m going to cut straight to the chase, and give the answer in its most basic terms: if you want to be able to kick a member out of your LLC, you’d better plan for it in your written LLC operating agreement. I don’t think it is possible to overstate how important a well-drafted LLC operating agreement is to the proper functioning of an LLC with multiple members.
The Long Answer:
Before getting to the details, a little bit of background is in order. Any time questions come up about LLC membership, keep in mind that there are two separate aspects to owning an interest in an LLC. In the terms used by the Washington Limited Liability Company Act, RCW Chapter 25.15, these two aspects are “membership” and the “transferable interest.” “Membership” is the right to participate in management of the LLC. While an LLC may be directly managed by its members, or it may have a manager, in the end all LLCs put some amount of management control in the hands of the members. Additionally, members have rights to information about the LLC, such as access to its financial records. The “transferable interest” is simply the right to receive distributions of the LLC’s assets. A person who owns a transferable interest, but who is not a member, is called a “transferee” under the LLC Act; in LLC operating agreements, they are frequently referred to as “economic interest owners” or something similar. A member always owns a transferable interest, but a transferee is not a member, has no say in the management of the LLC’s operations, and has limited rights to inspect the LLC’s records only if the transferee is a former member.
Now, How About Removing That Member?
First, we will cover the removal of a member’s membership rights (known as “dissociation”), as opposed to divesting the member of her transferable interest.
Under the LLC Act, there are only a few circumstances that result in dissociation: death of a member who is an individual; dissolution of a member that is a corporation, LLC or other legal entity; transfer of all of the member’s transferable interest; bankruptcy or appointment of a receiver or liquidator of all or a substantial part of the member’s property; a court order declaring an individual member to be incapacitated. If your LLC doesn’t have an operating agreement with terms providing for removal of a member, you are out of luck–there is no right under the LLC Act to dissociate a member at the choice of the other members.
Hopefully, your LLC has a written operating agreement. If it does, that agreement may address ways that a member might be dissociated. The most common LLC operating agreement terms for dissociation include: breach of the operating agreement by that member, failure to make a required capital contribution, or an attempted transfer of the member’s membership interest or transferable interest where that transfer is prohibited by the LLC operating agreement. A minority of LLC operating agreements dissociate a member in the case of a prohibited transfer, but more often, the prohibited transfer is simply void, and the member attempting the transfer remains a member.
As you can see, the typical LLC operating agreement, like the LLC Act, provides for dissociation in certain circumstances caused by the dissociated member, but most LLC operating agreements don’t have provisions allowing dissociation of a member at the option of the other members. However, it is possible for an LLC operating agreement to provide for such a provision. For example, there’s no reason an LLC operating agreement couldn’t allow dissociation of a member by the unanimous vote of the other members. Of course, that wouldn’t work very well if there were just two members–as soon as there was an argument, one member might vote out the other. Even with more than two members, a provision allowing a member to be voted “off the island” seems likely to be abused.
It seems unfair to allow the other members to strip a member of his membership interest while not also paying that member for his transferable interest–dissociation without a simultaneous purchase of the dissociated member’s transferable interest simply silences the dissociated member as to the management of the LLC. Even a provision that carried a purchase requirement would be easily abused–a member could be voted out just before some event that would significantly increase the value of the member’s transferable interest, like signing a big contract with a new customer.
A better way to allow the members of an LLC to force themselves apart is through a buy/sell provision. While there can be many varieties of buy/sell provision, the type I have in mind is a “put/call option.” This provision allows one member to make a mandatory buy or sell demand on some or all of the other members of the LLC: buy my interest or allow me to buy your interest. The purchase price is same, regardless of who is doing the buying: for example, if the member exercising the put/call option owns 25%, she might offer to buy the other 75% for $75,000, and the other member or members of the LLC would have the option to accept the $75,000 or buy the offering member’s interest for $25,000. In that example, each 1% of the LLC would be bought for $1,000, regardless of which member ends up as the buyer. This arrangement requires the offering member to offer a sum that he is willing to accept for his own interest in the LLC, which has the effect of encouraging fair pricing: a high price means the offering member may be required to overpay for the other members’ shares, while a low price makes it likely the offering member may be forced to sell for less than his interest is worth.
Note that the buy/sell method of removing a member from an LLC also causes the transferable interest of the departing member to change hands. It would be truly unusual for an LLC operating agreement to contain a provision allowing a member to be forced to part with her transferable interest in the LLC without compensation, except in situations where the member has failed to make required capital contributions; in those circumstances, it is common for the LLC operating agreement to punish the non-contributing member by reducing that member’s interest in the LLC by an amount determined based on the amount other members contribute in place of the non-contributing member.
The subject of dispute resolution may not seem related to the topic of methods for removing a member from an LLC, but I think it bears mention. The primary reason a member would want to kick another member out of an LLC is that they have encountered some dispute that they can’t get past. A well-drafted LLC operating agreement will contain some provisions addressing deadlocks and alternative dispute resolution; i.e., arbitration or mediation, instead of lawsuit. A deadlock provision could simply appoint a mutually trusted third party to be the tie-breaker, or it could set out a more complex process for arriving at a decision, the possible permutations of which are nearly endless. A deadlock provision is most commonly needed where there are only two members in the LLC and they have equal voting rights, although it can be useful in any LLC where it is possible for voting to end up evenly split. An alternative dispute resolution clause can help the parties work out their truly intractable disputes in a way that is quicker and far less expensive than litigation, using mediation and/or arbitration.
In sum, if you want to be able to force a parting of the ways with your fellow LLC member(s), be sure to get it in the written LLC operating agreement at the outset. The LLC act does not contain a right to force out a member or to force other members to buy you out. Just as importantly, be very careful about who join in an LLC–it can be very difficult to part company after the fact. Finally, be sure to include deadlock and alternative dispute resolution provisions in your LLC operating agreement, to help avoid the situations that might lead to you wishing you could kick that member out of your LLC.