I often deal with very small New York limited liability companies, where the members did not enter into an operating agreement. That is a very bad situation to be in, but that is the reality I often encounter. As explained elsewhere, when an LLC does not have an operating agreement, you have to look to the default rules of the New York LLC law. One often misunderstood area among members of an LLC is issues surrounding members leaving a New York LLC. So let me explain three important things to know:
1. Absence Does not constitute Withdrawal of an LLC Member under the Law
A typical situation is when the members of an LLC are fighting and one member stops being involved in the business of the LLC, either voluntarily, “I’m out of here, can’t take this any longer”, or was locked out “wait, my keys and passwords are no longer working, what is happening?”. The member still involved in the day-to-day management of the LLC business then claims that the leaving member has withdrawn, is out of the business, bye-bye, you are no longer a member of the LLC. Or, as I have seen more than once, some lawyer for the bully member demands that the absent member sign a document that assigns all of his or her membership interests back to the LLC or the bully member. Well, not so fast.
When a member loses his membership status, gives it back, and no longer is a member, it is called member withdrawal. See New York Limited Liability Law Section 606. But here is where the confusion often comes in: A member just leaving his post and moving to Spain, leaving the other members behind to manage the business, is not considered withdrawing, that lazy member is still a member. A member getting kicked to the curb by the other members is also not withdrawing. The member is still a member, nobody withdrew. There is no obligation to transfer the membership interest to anyone.
You don’t lose membership by absence alone. That membership interest is your property and you cannot be deprived of it by just saying it is so. Section 606 of the NY LLC law provides:
Notwithstanding anything to the contrary under applicable law, unless an operating agreement provides otherwise, a member may not withdraw from a limited liability company prior to the dissolution and winding up of the limited liability company.
2. You cannot vote an LLC Member “off the Island” unless the Operating Agreement says so
Another variation is that the remaining member claims that they voted by a majority that the leaving member is now out, expelled, bye-bye, you are no longer a member. Again, not so fast. Unless the operating agreement of your LLC specifically provides for the expulsion of a member, you cannot, by majority vote or otherwise, throw out that member and take his membership interest in the LLC away.
There is one possibility for members to get rid of another (minority) member and that is by a so-called freeze-out merger, but it requires a lot more than just voting the member out and it entitles the frozen-out member to the value of the membership interest.
3. There is no clear path to a Buyout for LLC Members who want to withdraw
Let’s say you want to retire and let go of your membership interest. Can you force the other members to give you your investment back or whatever your membership interest is worth? No, sorry, there is not, unless your operating agreement has some provisions providing for a buyout or another possible transfer of your interest. You also have to be careful that walking away from the LLC cannot be construed as a breach of your obligations towards the LLC with the result that you may be personally liable. If you’ve been heavily involved in day-to-day business, you cannot just walk away. A way out of this situation would be to negotiate some sort of exit strategy. Maybe bring someone else in who takes over your obligations, and maybe have the LLC pay you for your membership interest over a long period of time. In any event, the other members have to agree to any such solution.
Three things you learned about members leaving a New York LLC:
- Absence from the day-to-day operations of an LLC does not deprive you of your membership interest.
- Members cannot be expelled from an LLC unless the operating agreement allows it.
- You cannot force a buyout of your membership interest if you want to leave the LLC behind.
And all of this can be dealt with in a properly drafted operating agreement. You can agree to the outcome you want prior to starting the LLC. No LLC should go without a carefully drafted LLC operating agreement. There are a million variations and a form from legal zoom or other incorporation service is simply not sufficient.