What Happens When LLC Members Disagree?

What Happens When LLC Members Disagree?

Every business should have a proper legal structure and set of bylaws or an operating agreement upon which it will operate.  While some businesses are more suitable for a partnership or corporation, for the last few decades, Limited Liability Companies or LLCs have become one of the most popular structures.  The LLC allows for limited legal protection against lawsuits and less paperwork and formality than a corporation.  Unlike a corporation, where the directors are tasked with making the decisions, in an LLC the members (or managers) are decision makers.

When forming an LLC, there are two basic structures: (1) manager-managed and (2) member- managed.  Creating a manager- managed LLC is similar to creating a corporation where the Manager(s) act like a Board of Directors in a corporation (and the owners of the LLC are like the shareholders of a corporation.  In a manager- managed LLC, the managers take on the day-to-day decisions of the business and only involve the members in big decisions, such as adding or removing a member, changing the nature of the business or amending the LLC’s charter or operating agreement. In a manager-managed LLC, if a member disagrees with the decision of the manager, the member or members must file a law suit (similar to a lawsuit filed by shareholders of a corporation) to remove the manager.

In contrast, in a member-managed LLC, the members are in charge of every decision, from the mundane, daily operations, to the major decisions, such as adding or removing a member or unwinding the business.  In this case, the members have the power and ability to make all the decisions for the company.  Without an operating agreement specifying to the contrary, the assumption is that each member has an equal share and voting right.  With an even number of owners, this can obviously lead to an impasse in making a decision, which may delay business operations or even harm the business. 

 Whether the LLC is member managed or manager-managed, when LLCs are founded by more than one member, disputes are likely to arise between the members and/or managers.  While sometimes these disputes can be quite healthy for the business, and in turn, help the business grow, some disputes might be more serious and irreconcilable, leading to a member leaving or even terminating the business. One of the best ways to resolve a business dispute is to have the members negotiate based on their mutual business goals and long term business objectives. 

The most common disputes in an LLC involve money, responsibilities and unethical conduct.  LLC owners may disagree about how often and how much profit should be distributed.  These disputes may also involve whether certain members are receiving appropriate compensation. Other times members may be upset over how much work they are doing compared to other members or that one member’s performance is subpar.  The biggest dispute, and perhaps most threatening to the business involves a complaint that one member acted unethically.  A few of the biggest ethical challenges to a business include: misusing or failing to document use of LLC funds, stealing from the LLC (either financially or confidential information) and entering into an agreement that competes with or otherwise harms the LLC.

Once a dispute occurs, there are a few common ways owners work to resolve them.  First, the owners try to negotiate with one another.  Through this negotiation between them, they must try to separate their emotions and not take the disagreement personally.  If negotiation does not work, LLC members can hire a neutral third party skilled in dispute resolution to help mediate the dispute.  In addition to professional mediation services, many law firms have lawyers skilled in serving as nuetrial mediators to help with resolution.  If none of these work, then the last resort is to seek arbitration or help through the Court process.

When possible, it is best to try and avoid the disputes described above.  Some of the measures you can take are listed below:

  • Create a business operating agreement: Hire a lawyer to create an operating agreement. In addition to specifying the way the business should be managed on a daily basis, the operating agreement should also include the following provisions:
    • Each member has the authority to act on behalf of the Company (or if it is Manager-Managed, that the Manager has the authority to act on the Company’s behalf).
    • How and when profits will be distributed.
    • How much each member must contribute to the business as an owner.
    • Duties and expectations of each member.
    • Voting rights and relative share for each member.
    • Which decisions require unanimous vs majority approval.
    • Dispute resolution provisions between members (or managers).
    • How the business will handle adding or removing a member (or a manager).
    • The process for dissolving the business (including purchase price, valuation and overall procedures).

After an operating agreement is in place, it should be reviewed regularly, perhaps annually to update and modify provisions and procedures as the business grows and evolves.

  • Discuss and responsibilities of each member (or manager): It is important to make sure every member has a voice and that the expected workload and duties of each member is discussed.  Put everything in writing and revisit this discussion regularly, perhaps have semi-annual meetings with all the owners to discuss the health of the business and workload.
  • Create a buyout or buy sell agreement: Discuss the process for buying out the shares of an exiting member (due to retirement, death or incapacity) and put it in writing.  Think of this as a business will.
  • Discuss big decisions with the members: Before committing the business to a large financial or contractual obligation, discuss the decision with the rest of the members.  Something you think is a great opportunity might be considered a great risk to the other members. 

One of the best ways to minimize disputes is to put everything in writing.  If you are a member of an LLC with a current or anticipated dispute, you are welcome to contact us.  We have a team of lawyers that can help your business resolve the dispute either informally or by involving the Court.