Let’s say you have a member in your LLC who creates nothing but problems. You wish that member would just leave. If your operating agreement does not have any specific provisions dealing with the expulsion of a member or buyout of a member, or if you do not have an operating agreement in the first place, what can you do? There is a totally legal way to get rid of a minority LLC member, it is called a cash-out merger or freeze-out merger.
First, What Not to Do
Many ill-advised majority members resort to shady tactics, such as just changing the locks to the business and every password needed to participate in management. Or they pass a resolution that just announces “Member, you are now expelled, please leave the premises”. All such maneuvers are likely against the law and result in litigation. New York does not allow you to expel a member unless the operating agreement says so. You can always negotiate with the annoying member, but if he or she does not want to agree, what do you do? It is called a cash-out or freeze-out merger. Here is how that goes:
What you can do: Cash-Out Merger
A freeze-out merger is a procedure that allows you to expel a member by buying him or her out for the fair value of their membership interest in the LLC.
First, one would form a new LLC. Then the existing LLC, the one with the problem member, would be merged into the new LLC by the written consent of the majority members. The merger, to be effective under the law, must have an agreement of merger, which will set forth that the majority members will receive all equity in the new LLC and the problem minority member will receive only cash in the amount of the fair value of his prior interest, but no membership interest in the new LLC.
Within ten days after the merger becomes effective, inform the problem member of the merger and offer the fair value of the member’s interest in the LLC. If the former member does not accept the offer, the only remedy is Section 623 business corporation law., a court procedure that challenges the determination of the fair value of the membership interest. The ousted member cannot claim that the merger was arbitrary, because done solely to get rid of the member and for no other valid business purpose. The proceeding can be started by the LLC or the ousted member. If both the LLC and the ousted member do nothing, the ousted member forfeits any rights.
Don’t do this without Legal Advice – You may end up being responsible for Legal Fees
To orchestrate a cash-out merger and observe all necessary procedural steps and notices is quite involved and I would not recommend doing this without legal advice. There is the possibility that the LLC will be made liable for the legal fees of the dissenting member in the appraisal court proceeding if the court determines that the cash-out offer you made was ridiculously low compared to the real fair value of the membership interest, if you failed to make such offer in the first place, if you didn’t start the appraisal proceeding after the offer was rejected or if you didn’t act in good faith in general.
How can a Minority Member prevent this from happening?
Future Minority Member, If you’re reading this you may be wondering if there is any way to prevent this from happening in the first place. Yes, there is. Before you invest your time and/or money in a limited liability company, insist on an operating agreement that provides that all mergers require your consent. If that cannot be negotiated, insist on clear rules for evaluating the value of your membership interest in the case of a forced buyout, which is essentially what a cash-out merger is.