Limited Liability Company Buyouts

A client and his wife came in a few weeks ago with some questions. He, his wife, and another couple had formed an LLC for a new business venture. Each member owned 25 percent. The venture was still fairly new, though experiencing some apparent success already, when one of the two couples decided it wanted out. My clients, who wanted to keep the business going, came to me for some counsel about what to do.

Fortunately for all parties, we reached a very easy and amicable solution by which my clients will, next week, buy out the other couple for a sum representing their initial investment. It's a good thing that everyone was reasonable, however, because the Operating Agreemeent did not provide a good "dissolution" mechanism, in the event that the discussions had become acrimonius, and it made me realize the importance of a good buyout provision in these operating agreements.

The operating agreement, like most in our state, was written so that the departing couple could not have sold its interest in the company without my clients' approval. And without my clients' approval, they'd have been out of look. Worse yet, my clients owned the physical location of the LLC's business, and, if they'd wanted, could have evicted the LLC from the location and simply set up a new LLC to run practically the same business.

Of course, the departing husband and wife were decent people, and my clients were decent people, and they quickly and fairly negotiated a fair resolution that was mutually beneficial.

The majority of limited liability companies I set up seem to be two parties (usually two men, but sometimes two couples), and in these LLCs, when you're setting them up, think about the exit provisions:

1. Consider putting in a provision that would allow you to sell your interest to a third party if the remaining owners are not willing to buy you out; and/or

2. Consider a provision that will value your interest and set up a payment plan so that while you can force the remaining parties to buy you out, conversely a mechanism is in place so that they can do it without ruining their cashflow.

Of course, picture yourself in the reverse provision: what if you want to stay in but your co-owners do not? A good operating agreement will provide provisions that will provide you a comfort level so that if you start going different ways, you'll already ahead of time know that Agreement has provided a way for all of you to easily separate your interests.

Limited Liability Companies

In a spring post (http://thebusinesslawblog.blogspot.com/2007/04/limited-liability-companies-new-case.html) I wrote about a new case further strengthening the protection offered to limited liability companies. During that time, I was litigating a case in which a home purchaser had paid a large amount of money down to a home builder llc to build a home, only to have it fold. She sued not only the limited liability company, but also the three individual members, one of whom I represented. My client, the only financial strong member of the three, was of course an attractive target for the plaintiff. However, my client was also the least culpable. He'd never met the plaintiff, and actually was nothing more than the cliche' "silent partner"--somebody who put up his money and creditworthiness to allow the two primary members to get loans to build homes.

I'd felt comfortable going in to the case that the law seemed to be in our favor, and during its pendency, two new cases came down from the Court of Appeals further buttressing our arguments. I scheduled a motion for summary judgment (which, for those not in the legal field, is basically a motion to dismiss the Plaintiff's complaint) for mid-November. I wrote a letter to the Plaintiff's attorney giving them one more chance to dismiss their case against my client voluntarily. Normally, in such a case the Plaintiff's attorney, even if they think their case is week, will at least try to fight. However, the Plaintiff had her own risks--we'd filed a counterclaim for attorney's fees, and one North Carolina case had ruled that when a plaintiff improperly named an LLC's member in a lawsuit, the plaintiff may be liable for attorney's fees. The attorney, who was diligent for his client, nonetheless decided the right thing was to dismiss his case against my client. Therefore, though I never got a judge's ruling to reinforce my belief about LLCs, I believe the Plaintiff's dismissal bears out my theory.

Limited Liability Companies, new case

I've written before on this blog that, in my opinion, LLCs are not only as protective as a regular corporation, but that recent caselaw suggests they may be stronger than corporations. A new case from the North Carolina Court of Appeals appears to support this.

In Babb v. Bynum & Murphrey, PLLC, the Plaintiff sues a professional LLC, and one of the members of the LLC (Mr. Murphrey), for alleged wrongful acts committed by the LLC's other member, Mr. Bynum (basically, misappropriation and/or theft of trust account monies held for the Plaintiff).

Plaintiffs stated that they were not following a theory of vicarious liability (i.e., they did not allege that Mr. Murphrey was liable just by virtue of being a member), and the Court appears to tacitly acknowledge that this theory would have gotten the plaintiffs nowhere. Instead, the Plaintiffs proceeded on the theory that the Defendant failed to act to stop the misdeeds of his fellow member. The Court of Appeals held that the "innocent" member had no affirmative duty, absent actual knowledge of wrongdoing, to investigate his fellow member.

This case appears to further buttress the theory that LLCs are strong. Had the defendant law firm been a corporation of some sort, the case most likely would have included additional allegations that corporate formalities weren't followed, or would otherwise argue that the corporate veil should be pierced.

To read the text of the case, go to:

http://www.aoc.state.nc.us/www/public/coa/opinions/2007/060876-1.htm