How can you deal with disagreements between LLC members? Short Answer: you prepare for this scenario in the operating agreement and provide sensible solutions for any disagreement.
The long answer:
Pick the rights business partners
Just like in marriage, it usually does not work out for the long run if you act hastily and pick someone not suited for you. You have to have known your potential business partner for more than a year; it should be not someone you have only known for weeks or a couple of months. It should be someone who has the same values and goals. You should have worked through issues successfully before, so you know the partner has the capacity to fight constructively. You could try out a potential business partner by working on a smaller project to test out if you are a good fit.
But most importantly, once you are ready to partner in a business, plan ahead by contracting around LLC member disagreements, which are sure to happen even with the best business partner and in a perfect world. If you do business as an LLC, you will plan for disagreements in the operating agreement. Read on for how that works.
Management in an LLC and possibilities for deadlock
New York Limited Liability companies are governed by the New York Limited Liability Company Law and by a so-called operating agreement entered into between the members of the LLC. The members have great flexibility to shape their rights in the operating agreement any way they desire. Despite this opportunity, many people do not adopt an operating agreement and are left with the default rules under the New York LLC law.
Under the law and most operating agreements, an LLC can be managed directly by the members or by managers. If the LLC is managed by members, each member can bind the LLC in most day-to-day transactions, such as buying supplies or entering into new relationships with vendors. If the LLC is managed by managers, only the managers, who are similar to a board of directors in a corporation, have authority to act for the LLC.
Many operating agreements provide that certain bigger transactions require a majority or super-majority consent of the members or the managers. If there is no operating agreement, the New York LLC law also requires majority consent for certain major decisions. Now, if you have an even number of members or managers, disagreements will happen at some point in time. Thus, it is good to plan for this scenario in the operating agreement. There are a number of ways to address this problem:
Give room to think and mediate (and meditate) over the LLC member disagreement.
Often, or I would say always, disputes and disagreements happen due to poor communication. If you force the disagreeing parties to come to the table and sit with the issue over a period of time, they may be able to come to a resolution. If you cannot do it on your own, you may engage the services of a trained mediator. These people are trained to bring the disagreeing LLC members together and have them come to a resolution. Also, time sometimes does magic. How often have you been angry about something and determined to do this or the other thing, but then, after a while, the anger dissipated, and you were able to see the whole picture and the other party’s side.
So whenever a disagreement occurs, an operating agreement may provide:
Member Deadlock. In the event the Members fail to agree on any of the matters set forth above (“Deadlock”), the Members shall meet on at least three (3) separate occasions held at least three (3) and not more than ten (20) business days apart and try to resolve such Deadlock in good faith. If, after the above prescribed meetings, the Members are still unable to resolve the issue, then the Members shall select, by mutual agreement, an independent mediator to resolve the dispute and such independent mediator shall resolve the dispute in the best interest of the Company. The determination by the independent mediator shall [not] be binding on the Members.
Provide for a buy-out in case of LLC member disagreements
When you can really not agree after going through several rounds of negotiation with or without a mediator, you could decide to divorce one another. This would be through a buyout by one partner of the other. If the disagreement is already deep, you probably won’t agree on a fair buyout price or on who buys out whom, so this should also be in the operating agreement before a dispute arises. There are several options on how to structure this.
One option is to try to make the parties subconsciously arrive at a fair price. The agreement would provide that a member can notify the other member that he or she wants to sell his or her membership interest. The notice has to include the price that the member is offering. Upon receipt of the offer, the other member can either accept the purchase price and surrender his or her membership interest, or he or she can turn it around and decide to purchase the membership interest. But one option has to be chosen. By using this mechanism, the offering member will most likely pick a realistic price. However, the member with more available funds is clearly in a better position to exercise the buy-out option.
What if you have nothing dealing with LLC member disagreements in the operating agreement?
You could still suggest using the service of a mediator or keep negotiating and talking. If the LLC is harmed by the disagreement to the extent that it cannot go on normally, there is the possibility to force a dissolution in court. But this is difficult to achieve and requires (under current case law) that “the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved, or continuing the entity is financially unfeasible.” Courts have often found that the business is just doing fine, even though the members cannot agree on a matter.