Though Florida was one of the first states to enact legislation permitting the organization of a limited liability company (“LLC”), usage of LLCs as a corporate form is still a relatively new thing. With the Florida Limited Liability Company Act of 1999 and the passage of certain taxation legislation, LLCs are a very favorable business organization form for small and mid-sized businesses. Nearly every LLC maintains a separate written or oral operating agreement, which is generally defined as the agreement governing the LLCs business, and member’s financial and managerial rights and duties. LLCs operating without an operating agreement are governed by the state’s default rules contained in the relevant statute and developed through court decisions interpreting those laws. In Florida, the LLC statute is Fla. Stat. Chapter 608.
Often in a small, member-managed LLC, managerial and financial disputes arise among the members regarding business affairs of the company or distribution of company assets. Clients often come to our firm to analyze and litigate issues regarding one or more fellow members who have committed breaches of the operating agreement, common law or statutory duties or in some cases have gone as far as violating criminal laws. In analyzing the aggrieved member’s rights against these rogue members practitioners must first turn to the LLC operating agreement before utilizing Fla. Stat. §608 and case law to fill in the gaps. As a case study for expulsion, we will analyze a scenario where a member is diverting company assets.
Grounds and process for expulsion under common scenarios in a standard form operating agreement
Though every operating agreement is different, there are several common clauses and issues set forth in a standard form operating agreement. These common clauses are in place because there are reporter volumes of cases litigated on the underlying topics they seek to contractually address. For instance, a common dispute amongst members of LLCs revolves around unauthorized company expenditures for personal use. In most operating agreements, title to assets are held exclusively in the name of the company, with no member possessing any right to the assets of the company or any ownership interest in those assets except as indirectly as a result of the member’s ownership interest in the company. Further, most operating agreements provide that no member has any right to partition any assets of the company or any right to receive any specific assets on liquidation of the company or on any distribution from the company.
As such, the rogue member who starts racking up company debt or stroking checks to cover personal debts is doing so without proper authorization or title. Finances of LLCs clearly fall within the purview of assets of the company that are not subject to dispersion or handling on personal whims. Subject to the restrictions governing the Limited Liability Company Act of the State of Florida, proper distributions are typically only those certain distributions that are made from time to time and in such amounts as the members determine to be authorized.
To the extent that transfers or any other unauthorized transactions by a rogue member exist or existed, most operating agreements provide that the company is under no obligation to indemnify that member if the obligations were born out of any breach of the Member’s duty of loyalty to the company, acts of intentional misconduct or a knowing violation of law, unlawful distributions, or transactions in which the member derives improper personal benefit.
In addition to violating clauses regarding transfers without title, the rogue member has likely violated several standard clauses relative to administration of company business. Specifically, members are only allowed to bind the company and engage in business to the extent that the company has provided authorization. If the member is conducting personal business or settling personal debts with company assets, these are not likely to be authorized business affairs. Authorization in most LLC’s requires majority consent in conducting company affairs after a meeting called to garner said authorization. To the extent that a member is transferring or disposing of assets, most operating agreements require prior written consent to pledge or otherwise transfer or dispose of substantial assets of the company, or incur indebtedness by the company other than in the ordinary course of business. Ultimately, the rogue member may have breached their contractual and statutory obligations prohibiting self-dealing and improper accounting as well.
In all operating agreements, stealing company money constitutes grounds for expulsion. Most often the member is expelled from the company by an affirmative vote of the members holding a majority of the ownership interests held by members other than the expelled member if the expelled member has been guilty of wrongful conduct that adversely or materially affects the business or affairs of the company, or the expelled Member has willfully or persistently committed a material breach of the articles of organization of the company or the operating agreement. Other traditional grounds for expulsion included breaching specifically articulated duties owed to the company or to the other members such that such breaches render it reasonably impracticable to carry on the business or affairs of the company with the expelled Member.
If such wrongful conduct that adversely and materially affects the business or affairs of the Company exists, the remaining members typically have a set period of time (60-180 days) from the date of the rogue member’s expulsion to purchase the interest of the expelled member on mutually agreeable terms if the remaining members opt to continue the company by themselves or with others. As a prerequisite to perfecting rights to continue the company in accordance with the operating agreement, typically the remaining members are required to provide written notice of election to the expelled member. If they do not elect to continue the company, it will be dissolved and must be wound down and liquidated in accordance with the operating agreement and Florida law.
If an agreement on the purchase price of the expelled member’s interests is not reached within a certain number of days (usually 30-60 days) following the company’s election to purchase the expelled member’s interest, the interest typically is required to be valued by a third party appraiser. Valuation requires an assessment of the membership interests at their fair market value as of the date of the event of expulsion. If the appraisal is not completed within stipulated time (again, usually 60-180 days) following the election to purchase the expelled member’s interest, the company and the members are then typically free to apply to a court of competent jurisdiction for the appointment of another appraiser to judicially determine the purchase price for the member’s interests. The purchase price is typically payable with a 60 month promissory note from the company to the expelled member. Judicial expulsion does not limit or adversely affect any right or power the company or other members have to recover damages from the expelled member or pursue other civil, equitable or criminal remedies.
If the misprision of assets rises to a level of theft, in addition to corporate expulsion, the company and the remaining members likely possess vested claims against the rogue member of threefold the actual damages sustained and reasonable attorney’s fees and court costs incurred in prosecution of the claims in accordance with Florida Statute §772.11 governing Civil Theft and Fraud. In the event these claims are pursued, it is advisable to turn the case over to the local State Attorney’s office for investigation and prosecution of felony crimes of theft, access device fraud crimes, dealing in proceeds of unlawful activities and related offenses.
Considering the legal and financial ramifications of expelling a member through judicially compelled means, it is often advisable that all members first seek to sit down and work through the issues to reach a mutually agreeable resolution to remedy past transgressions and smoothly transition the interests of the company. In the event that agreement cannot be consummated, judicial expulsion and theft prosecution are available remedies with or without an operating agreement in place. The final section below describes how the Florida Limited Liability Company act handles the expulsion process when the operating agreement is silent on the issue.
Expulsion under the Florida Limited Liability Company Act
Statutory expulsion or dissociation in Florida LLC’s is mostly accomplished on grounds of breach of duty of loyalty or duty of care and only through agreement or judicial process. Accomplishing expulsion, however, is a tall task with many complicated statutory and factual obstacles.
Generally, each manager and managing member owes a duty of loyalty and a duty of care to the limited liability company and the other members of the limited liability company as set forth in Fla. Stat. § 608.4225(1). The duty of loyalty includes, without limitation, accounting to the limited liability company and holding as trustee for the limited liability company any property, profit, or benefit derived by such manager or managing member in the conduct or winding up of the limited liability company business or derived from a use by such manager or managing member of limited liability company property, including the appropriation of a limited liability company opportunity. See Id.
Typical claims of statutory breach of the duty of loyalty center around managing members who fail to: account for the operation of the LLC; fail to make payments or give credit for the repair and improvements of LLC property; properly distribute or account for assets; provide members with information and access to LLC records; refrain from competing with the LLC or taking a materially adverse business position; or provide adequate documentary support with regard to capital contributions or business expenditures.
The duty of care is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law. Id. Each manager and managing member must discharge the duties to the limited liability company and other members under statute or under the articles of organization or operating agreement and exercise any rights consistent with the obligation of good faith and fair dealing. Id. Violations of duty of loyalty and duty of care through siphoning assets would constitute offenses meriting expulsion.
Further proof that it is foolish to not have a written, thorough operating agreement, the Florida Limited Liability Company act is very restrictive on upon the process of expulsion or withdrawal of a member without dissolution of the company. Under the 1999 LLC Act amendments, unlike the prior statute, a member’s termination of membership through withdrawal or expulsion does not trigger automatic dissolution of the LLC. It does, however, require a judicial process with specific findings of fact as to wrongful conduct in order to force the member out. Ergo, absent an operating agreement with a clause on point or an agreeable exit strategy, there are no express non-judicial provisions within Fla. Stat. Chapter 608 pertaining to continuation of the business once a member has committed an act worthy of expulsion or dissociation. If the members of the company wish to continue the business and they have not codified expulsion in the operating agreement, it is best that they diplomatically find a way to compensate the expelled member and obtain requisite releases in order to continue the company under the same nomenclature and avoid costly litigation expenses.
Upon withdrawal, a withdrawing member is entitled to receive any distribution to which the member is entitled under the articles of organization or operating agreement, and if not otherwise provided in the articles of organization or operating agreement, the withdrawing member is entitled to receive, within a reasonable time after withdrawal, the fair value of the withdrawing member’s interest in the limited liability company as of the date of resignation based upon the withdrawing member’s right to share in distributions from the company. Fla. Stat. § 608.426. In the absence of a statement in the articles of organization or the operating agreement to the contrary or the consent of all members of the limited liability company, a member, irrespective of the nature of the member’s contribution, has only the right to demand and receive cash in return for the member’s contribution to capital. Id.
In sum, if you discover that one of the members of your company has been violating their duties and obligations under your operating agreement or Florida Statute, it is best that you consult a Florida business lawyer to examine your rights in law and equity. Do not let that rogue member destroy all of your hard work in building your business and brand. Find a way to inexpensively and efficiently effectuate an ouster through consulting with an experienced lawyer.