You’ve probably heard this analogy before: Going into business with a partner is very much like getting married. In a best case scenario, partners build a thriving business that brings them personal satisfaction and financial success. However, just as in marriage, irreconcilable differences can arise that lead to a business “divorce.” Avoiding a nasty business breakup requires careful forethought and planning.
In Michigan, and elsewhere, limited liability companies (“LLC”) are one of the most common corporate structures for small businesses. “Partners” in an LLC are called members, who typically own and manage the business as part of a member-managed LLC.
Running a business is a stressful endeavor, so it’s no surprise that disputes between members happen—some minor, others significant. Typical disputes involve disagreements over finances, allocation of resources and responsibilities, and conduct that is perceived as not in the best interest of the business.
Consider the following scenario, which is not uncommon in the uncertain world of business:
Two friends hatch an idea for a new business and form an LLC to formalize it. They are enthusiastic and energized about their new venture. They are both all-in from the start.
Then things get hard. They lose an important customer. A key employee quits. Revenue dips and the business requires more sweat and cash from the members. The problem is that one is committed to rising to the challenge and the other starts pulling back. Their contributions become unequal, but their rights to distribution and their membership interests remain the same. Resentment grows. Their differences become irreconcilable.
They never envisioned they would be in this difficult place during the heady, hopeful days of their business’ founding. And therein lies the problem.
It’s in situations like this, and many others, where it’s critical that business owners have a predetermined process in place that helps them resolve disputes. Such a process should be documented in an operating agreement that accounts for scenarios no one hopes for but should not be overlooked.
Without clear guidelines in place, the owners are left to the default remedies provided by state law. For them, and the business, that’s not a great outcome. It’s far better to discuss and document the parties’ intentions up front, much the way a couple might in a prenuptial agreement where significant assets are at stake, to avoid the acrimony and expense of bitter litigation.
While in some instances an irreconcilable dispute between members may result in the demise of the business, that need not always be the case. A well-crafted operating agreement can and should spell out the reasons and process for removing a member so that the only options are not going to court or dissolving the business.
Removing a Member Pursuant to an Operating Agreement in Michigan
An Operating Agreement is a written agreement between the members of an LLC which sets forth the ground rules by which the LLC will operate. The types of provisions that are typically part of an operating include:
? The division of membership interests between members
? How and when profits will be distributed
? What capital contributions, if any, are required to be made
? Roles and responsibilities of each member
? Voting rights that determine how decisions get made
An operating agreement should also address the reasons and process for removing a member. Pursuant to Section 450.4509(2) of the Michigan Limited Liability Company Act (the “Act”) provides that “[a]n operating agreement may provide for the expulsion of a member or for other events the occurrence of which will result in a person ceasing to be a member of the limited liability company.”
In an operating agreement, because it’s being drafted before issues arise, the members can, with clear heads, think through the process they want to establish for removing a member.
In situations where a member agrees to voluntarily withdraw, all that may be required is the submission of a letter by the withdrawing member. In other cases, where a withdrawal is not voluntary, an operating agreement may include a voting procedure allowing the other members to vote for the removal of the member.
Regardless of whether removal is voluntary or involuntary, the departing member is entitled to be compensated for the value of their membership interests. Accordingly, many operating agreements include a buy-sell provision, which authorizes the company, its members, or a combination thereof to buy out the membership interest of another member via an agreed upon methodology for valuing the business.
As a member of an LLC in Michigan, having such mechanisms in place are critically important to the extent it becomes necessary to remove another member. They’re also essential if you, as a member, decide to withdraw from the LLC, as Section 450.4509(1) of the Act provides that “[a] member may withdraw from a limited liability company only as provided in an operating agreement.”
In short, members need to put time and effort into thinking through what may not go as planned with their business from the start—and not merely assume that all will go right. By working with an attorney to craft a thoughtful operating agreement, an LLC and its members can avoid being subject to the default LLC rules in Michigan, and establish procedures that better reflect their unique circumstances.