In today's Freedom Friday blog and email newsletter, I want to talk about an issue that I get a lot from my clients and prospective clients, and that's how they should handle the situation of a business partner leaving. Either my client wants out of the LLC or business partnership, or the other person needs to leave the business, or desires to, these types of situations involve a lot of legal questions I get asked all the time. So, in today's Freedom Friday blog and email newsletter, I'm answering the question, “What should your small business doe when a business partner leaves?”
The first part of the answer is before you start a business with another person, you need to have a partnership agreement, and this is especially true for a 50-50 general partnership, but also for a limited partnership. If you're forming an LLC, you need an operating agreement to cover these issues, too. At a minimum, your partnership agreement needs to address the transfer or discontinuation of the business, in the event one of the partners decides to leave (or is removed involuntarily), include a statement that departing partners are no longer financially responsible to the remaining partner(s), and provide guidelines or directions on how remaining partner(s) would assume assets and liabilities based on their ownership interest.
In addition, when a partner leaves a partnership, you need a bona fide separation agreement, documenting all the issues, including the fact that the departing partner must have his or her name removed from the operating agreement or bylaws, the articles of formation be updated (if they exist), and that the IRS must be updated if the departing partner was the responsible party for the EIN. If the departing partner was the personal guarantor on a loan for the partnership, he or she must be removed from that, and possibly a new contract must be negotiated with the lender.
It's also important to understand that there are two major types of partnership separations: separations which are contested, and those that are not. Uncontested departures include retirement from the business, death of a partner, and a partner's disability or incapacitation. In such cases, the partners generally remain cordial, and the partners can work together on the transition, plan ahead, and come to a mutual agreement. However, partnership disputes can arise for several reasons, including differences of opinion between the partners or management styles, loss of faith between partners, disagreement as to the terms of departure, outstanding assets or liabilities, and issues with the operating agreement, bylaws, or partnership agreement regarding whether the departure is even permitted (or not). Believe it or not, many operating agreements for LLCs, or partnership agreements, seek to bind LLC members or partners in a partnership, and prohibit members or partners from leaving a company. In such cases, attorneys usually get involve to attempt to remedy the situation without court intervention, and if that does not resolve the matter, to file for judicial dissolution of the partnership, and even civil damages resulting from the partnership dispute.
Regardless of whether a partnership departure is contested or not, your business needs to follow the business structure document, i.e., the operating agreement for an LLC, the bylaws for a corporation, the partnership agreement for the partnership. If any of the remaining partners wish to remain in business, there needs to be a buy-sell agreement for them to buy out the ownership rights and equity interest of the departing partner.
Thinking about starting a small business? Or maybe your small business is having issues with contracts, leases, business partners, collection issues, or experiencing other barriers to growth? Please contact me at [email protected] to schedule a FREE strategy session.
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