Some years ago I had the good fortune to join the ABA Business Law Section’s Committee on LLCs, Partnerships and Unincorporated Entities which, among its other scholarly pursuits in the field of alternative entities, organizes the incomparable LLC Institute held annually. The law professors, practicing attorneys, and other professionals who comprise the Committee’s membership, and who reconvene each year at the LLC Institute to keep abreast of developments in the law, renew acquaintances, and celebrate each year’s winner of the prestigious Martin I. Lubaroff Award, share a deep and abiding interest in analyzing and shaping the positive and common law governing alternative entities.
Yet another membership perk is access to the Committee’s Listserv on ABA Business Law Connect (for ABA members only) where Committee members from across the country regularly raise questions and exchange ideas on a host of topics mostly concerning LLCs and partnerships. Last week, California attorney Gerald Niesar kicked off an interesting discussion that generated dozens of thoughtful responses with a message entitled, “Does an LLC Member Have an Absolute Power to Extricate Him/Herself from the LLC?”
It’s a topic that resonates strongly with business divorce practitioners who frequently are asked (a) to advise clients looking to exit an LLC or partnership or who have co-owners looking to do so, and/or (b) to initiate or defend litigation stemming from a member’s lawful or unlawful exit.
There is much wisdom shared in the exchange of messages that took place. For practitioners and others unable to access ABA Connect, what follows is a condensed account, with attribution, highlighting some of the 30+ messages on the topic of LLC member exit rights.
- The set-up in Mr. Niesar’s kick-off message is a member of a California LLC who feels “trapped” in the LLC with a co-member who is jeopardizing the licensed LLC’s regulatory compliance. The solution offered is to quit (“dissociate” from) the LLC even though it might violate the operating agreement. Mr. Niesar went on to observe that, while certain provisions in California’s LLC Act provide a member with the right to dissociate “rightfully or wrongfully . . . by express will,” others arguably render the right to dissociate not “absolute” if restricted by the operating agreement. On the other hand, he continued, if the operating agreement waives the right to dissociate, wouldn’t that simply be the “wrongful” dissociation expressly authorized by the statute or, he rhetorically asked, “does the 13th amendment not apply to LLCs?”
- Early responses from Tennessee attorney Alexander Davie and New York attorney Jaipat Jain underscore that a member’s right to dissociate from an LLC varies state-by-state, depending on the governing statutes. Mr. Davie commented that Tennessee’s Revised LLC Act “allows an operating agreement to provide that someone lacks both the right and the power to withdraw” and “it is not entirely unheard of to have a provision of an LLC act that denies members the power to dissociate.” Mr. Jain echoed that remark, pointing out that Section 606 of New York’s LLC Law prohibits a member’s withdrawal from an LLC prior to its dissolution except as authorized in the operating agreement. In a subsequent comment Mr. Jain also referenced the Delaware LLC Act’s default rule in § 18-603 stating that a member may not “resign” from the LLC prior to its dissolution.
- Denver attorney Robert Keatinge, who publishes the leading treatise on LLCs co-authored by the late Larry Ribstein, nicely summed up the state-specific nature of the problem with his comment,
The answer will depend on the state in which the LLC is formed. The default rules with respect to dissociation vary from state to state. Some do not provide for dissociation unless provided in the operating agreement and even those that do vary as to the consequences.
- Missouri attorney Jim Borchers commented that the “only question” under the “wrongful” dissociation concept derived from RULLCA and incorporated in the California (and other states) LLC Act is “what damages have been caused by that dissociation.” He suggested exploring the right to dissolve the LLC as an alternative to the problem posed in Mr. Niesar’s kick-off message and (bless his soul) included a link to a blog post by yours truly on the subject.
- Massachusetts attorney John Koenig, after stating that he’d “love to see a discussion about what it means, in a practical sense, to withdraw from an LLC or partnership,” raised the issue of voting/management rights versus economic rights upon withdrawal, writing,
I’ve read that withdrawal is similar to being an assignee who has not been substituted as a member, meaning no voting rights, but maintaining economic rights; but does not give a right to be bought out. Does it mean only that the member is no longer actively working in the LLC, and thus that the member was, in fact, actively working full time, such as an employee would be actively working?
- In his response to Jim’s query, Missouri attorney Steve Gorin observed that withdrawal also may be an option for a non-working member who “wants to be relieved of personal liability” for an LLC manager acting “irresponsibly,” such as failing to pay withholding taxes for which members can be personally liable, or for “failure to object to unjustified risks that the person knows about that lead to a tort.” The idea, he added, “is not to relinquish ownership but otherwise to wash one’s hands of actions taken in running the business that can generate personal liability.”
- Attorney, author and Forbes columnist Jay Adkisson, responding to Steve’s comment, wrote,
Offhand, a membership interest is fundamentally a contractual right which a member may terminate at any time by repudiating the agreement. This may give rise to consequences for breach, but my guess is that it ends the member’s relationship to the LLC as of the instance of repudiation.
- Enter the scary-smart law professor and winner of the Lubaroff Award at last year’s LLC Institute, Professor Dan Kleinberger, pointing out that, departing from the “aggregate” theory under the original Uniform Partnership Act (which New York still hangs onto!), RULLCA’s default rule provides “that a person who dissociates as a member becomes the transferee of the person’s own economic rights (transferable interest)” and that in jurisdictions that have adopted the uniform act, “to the best of my knowledge no jurisdiction has changed this default rule.” He then shared further thoughts on Jay Adkisson’s contract approach, writing,
I wonder – your interpretation, though consistent with contract cases, would render the statute’s reference to “power” nugatory. I agree that any obligation to provide services would not be specifically enforceable. So, you’re likely thinking to the effect of “what difference does it make in event?” I thought of this example – line of credit to LLC, members to guarantee [they each sign], guarantee poorly drafted – omits to state that guarantee continues by each person who is a member regardless of whether the person dissociates. Member claims to dissociate and argues (at minimum) no guarantee for any subsequent draws on the line of credit. BTW, in the uniform drafting process, the committee rejected the suggestion that the default rule deny the power as well as the right. Rationale (to the best of my recollection) – an LLC (other than a SMLLC) is a voluntary association.
- Enter another heavyweight commentator and recent guest on my podcast, Professor Don Weidner, who wrote,
Great discussion that reflects the deep expertise on this list. All I have to add is that, especially in the case of member-managed LLCs, there can still be questions of lingering authority that needs to be wound down and, in some cases, lingering liability. In short, you can’t always simply say “I quit, I’m out” with respect to third parties. Yes, you can immediately end your right to manage and certain fiduciary duties with respect to other members.
- As if Messrs. Kleinberger and Weidner didn’t provide enough professorial firepower, enter Professor of Law, multiple-treatise author, and all around business law guru Carter Bishop who wrote that “if a contract or agreement provision can’t be specifically enforced, it may be breached with damages.” Seemingly agreeing with Jim Borchers’ comment, he added that “the ambiguity surrounding a discharging material breach usually suggests safety in exploring judicial dissolution that the alleged [wrongful acts by the other member] are either unlawful or prevent reasonable continuation (even if not a discharging material breach).”
- Seattle attorney Mel Simburg weighed in next, commenting that “dissociation of a member typically leaves the member as an economic interest holder instead. So, there is no economic effect until the unit representing the economic interest is sold, redeemed, or abandoned rather than the membership status being ended.”
- Maryland attorney Ed Wender agreed with Mel’s point, adding that voluntary dissociation also may make sense to avoid future capital calls if such calls are permitted under the operating agreement and that, if permitted, generally “there is a built in mechanism that tells what happens if a member fails to make a capital call.”
- New Jersey attorney Barry Gartenberg followed up on Ed’s point about capital calls, as did the previously mentioned Jim Borchers and Professor (and past Committee Chair) Jim Wheaton. Barry made the point that under RULLCA, a dissociated member may remain liable for a pre-dissociation capital call. Jim B. agreed with Barry and queried whether an operating agreement can impose a capital call on someone who is an economic interest holder as a result of having withdrawn as a member. Jim W. pointed out that a withdrawn member “remains in privity of and bound by the contract.” Jim B. replied that he wasn’t “convinced that the privity concept applies here with respect to withdrawal/dissociation” which “terminates membership and all the benefits and liabilities that attach to membership … this is statutory.”
- The dialog circled back to its initiator, Mr. Niesar, who made the point that the obligation of, and any remedy against, a member or dissociated member to comply with a capital call “is really going to be governed by each OA [operating agreement], unless someone was asleep at the switch when the OA was drafted.”
- Hawaii attorney Peter Horovitz approached the contractual issue more broadly, writing that
I generally make withdrawal prior to the expiration of the term a breach of the operating agreement allowing (1) claim for damages, and (2) non-withdrawing members the ability to control timing of any windup/distribution. Prevents one disgruntled member from causing unnecessary pain or forcing an untimely dissolution. Particularly helpful when dealing with LLCs or members without liquidity.
My recap doesn’t capture all the back-and-forth or all the worthwhile points made by all the contributors. For those ABA members with access, I encourage you to visit ABA Connect and read the entire dialog. That being said, I’ll leave the last word to Jay Adkisson who summed it up thusly:
FWIW, this is so so so much easier if you quit trying to think of LLCs and partnerships as corporations that have built-in and status-based duties and obligations, and instead focus on the contract relationships, rights, and remedies between the parties, and further recalling that there are relatively few things that the operating agreement cannot “toggle off” by agreement of the members.