February 2015: Business Law

Review LLC operating agreements

Columnist, Larry Covell

Columnist, Larry Covell

As a result of changes in the Limited Liability Company law and a recent court decision, members of LLCs should review their operating agreement to determine if revisions are necessary.

There are two situations that north country LLC owners should consider. The first is the ability of a member to withdraw from ownership of the LLC. Prior to the revision, any member of a LLC had the right to withdraw from the business and be paid a “fair value” for their interest. The LLC’s operating agreement could limit the right or establish procedures for withdrawal.

In the absence of an operating agreement limitation, the right of withdrawal was unrestricted. This statutory right was useful if a member wanted out of the business for personal reasons, and it was particularly advantageous when there was a “falling out” between the members. The LLC statute was changed in 1999 because of estate and gift tax implications. The present law provides that a member may withdraw only if the operating agreement provides for it. North country LLC owners should check the status of their operating agreement to determine if it complies with the statutory revision.

Members of a LLC in the case of “In the Matter of 1545 Ocean Avenue LLC” did not revise their operating agreement to conform to the revised law and when there was a  falling out between the two members, the only option was judicial dissolution of the LLC. According to LLC law, a court can judicially dissolve a LLC whenever “it is not reasonably practicable to carry on the business” in conformity with the articles of organization or operating agreement. The legal question becomes what does “not reasonably practicable to carry on business” mean?

The plaintiff tried to convince a court to use the same standard that shareholders of corporations use when they seek dissolution of a corporate business. The Business Corporation Law provides two instances where a shareholder can ask for judicial dissolution. The first instance, which is most frequently used, occurs when a shareholder or shareholders who are owners of 20 percent or more of stock petition a court for dissolution if the directors are guilty of illegal, fraudulent or oppressive actions or if they loot or waste corporate assets for non-corporate purposes. In the second instance, shareholders of 50 percent or more of shares can petition a court if the directors or shareholders are so divided that they cannot carry on their appropriate duties or there is so much dissension that dissolution would be beneficial to the shareholders.

The court rejected the plaintiff’s contention that Business Corporation Law standards should be used for dissolution. Instead, the court defined “not reasonably practicable to carry on business” to mean that the petitioner “… must establish in the context of the terms of the operating agreement or articles of organization, that 1) management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to realized or achieved, or 2) continuing the entity is financially unfeasible.” The court rejected the notation that a dispute between the members is sufficient to justify a judicial dissolution.

A member of a LLC should review two important matters with their attorney. First, does the LLC operating agreement permit a member to exit the business and if so under what circumstances? A “falling out” of members is not the sole reason to review the language. There are other reasons why a member may wish to leave the business, such as retirement, a change in personal circumstances or health reasons. Second, does the operating agreement define what events must take place in order for a court to order judicial dissolution of the business?

The court in this case held that the LLC operating agreement or articles of organization is the key language that is examined when a member wishes to seek judicial dissolution.

Larry Covell is a professor of business at Jefferson Community College and an attorney. Contact him at lcovell@sunyjefferson.edu. His column appears every other month in NNY Business.