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Why Can Your Multi-Member LLC Hold You Hostage?

Posted by Jonathan Krems | Sep 08, 2022 | 0 Comments

In this week's Freedom Friday blog and email newsletter, I'm going to talk about what may sound like an odd topic, but what is actually a VERY common topic.  I have been getting a lot of new clients in the past several months, and many of them have come to me and asked questions like, “How can I get out of my LLC?” or “How can I restructure the LLC because someone else is leaving?”  Or similar questions.  I have actually had several new clients which have resulted in LLC restructures or LLC exits.  In fact, a few weeks ago when I was on “The Conservative Continuum,” I brought this very issue up.  It is SO IMPORTANT of an issue that it has also come up with at least one client who asked me to review a contract for him to join an LLC --- and I literally told him that if he joined the way the operating agreement was drafted, the LLC could hold him hostage?  Isn't that crazy?  You can join a multi-member LLC of your own free will and volition, but then you can't leave necessarily if you want to?  Really?  Yes, its real.  So, in this week's Freedom Friday blog and email newsletter, I am answering the question, “Why can your multi-member LLC hold you hostage?”

Now, I don't mean literally hold you hostage, I am using this phrase as a metaphor.  What this means is that I have reviewed many operating agreements in the last three (3) months, and by the way, many of these operating agreements are being produced by DIY services like LegalZoom and others, and they all have a provision that goes something along the lines of if you wish to leave voluntarily, you either need the consent of the every other member of the LLC, or at least the majority of the members of the LLC.  You simply cannot withdraw or leave from the LLC voluntarily given these provisions of certain operating agreements.  As I told one of my clients recently, this scenario is a huge red flag.

So, you might be asking, "What's wrong with someone leaving a business voluntarily?”   First of all, it depends on why they are leaving.  Perhaps there is a good reason for them to leave, for instance, they became incapacitated, filed for bankruptcy, or even died.  Most operating agreements do not consider those kinds of departures to be “voluntary.”   What I mean by leaving voluntarily is leaving solely because you want to, or you do not believe the LLC is a good fit for your business interests.  Its kind of like divorces… people divorce each other for “irreconcilable incompatibility” or those kinds of differences.  Unfortunately, many operating agreements do not allow for a amicable “business divorce” because they hold the LLC owners hostage from leaving.

What many small business owners don't know is that there are actually solutions to this problem which can be avoided.  Yes, these solutions usually do involve hiring a lawyer to help with your operating agreement at the beginning of your small business journey.  However, DIY services like Legal Zoom simply do not provide operating agreements that include these solutions.  A solid buy-sell provision where if you are a member of an LLC, and you wish to leave, that the LLC as a whole, and your fellow members have the “first right of refusal” to buy your membership interest from you is a solid solution to the unanimous consent alternative.  Depending on how many members are in your LLC (how many owners), and other factors, there may be other creative solutions to this problem, but always consult with an attorney to help you devise these solutions as part of your operating agreement.

Unfortunately, there is one other option on the table if you have an LLC operating agreement that is holding its members hostage, and you have uncooperative members who will not give unanimous consent or help in the “voluntary” departure of a member, and that is litigation.  You can always sue to leave an LLC if you have to, and request that the Court dissolve the LLC involuntarily according to the law.  While this is a solution, it always means that everyone including the department member loses in the end, and it's always better to find a win-win solution rather than a lose-lose solution.

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.

For more information about Liberty Legal Solutions, LLC, please visit our website at http://www.libertylegalok.com/

About the Author

Jonathan Krems

Jonathan is the Founder and Managing Attorney of Liberty Legal Solutions, LLC, a law firm dedicated to building, protecting, and defending the business and personal interests of our clients in Oklahoma.  Jonathan's primary practice areas are business law, contracts and agreements, business liti...

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