Member Disputes in an LLC

What happens if the members or managers of a limited liability company (“LLC”) can’t agree on the operations of the business? What happens if a member fails to comply with terms of the operating agreement or engages in fraudulent conduct? Understanding the processes and procedures for resolving member or manager disputes will be critical to determining the correct path towards resolving disputes on your terms.  

1. Does the Operating Agreement resolve he dispute? 

When disputes or problems arise between members or managers of an LLC, the operating agreement will be the place to look to determine the available remedies. Operating agreements frequently include provisions to resolve issues such as voting deadlock, member expulsion, company dissolution or forced buyouts. For example, an operating agreement can provide that any voting deadlocks that may arise between the members or managers are to be settled by a coinflip or a 3rd party previously appointed by the members to decide the issue. Operating agreements can also include provisions that automatically expel a member or manager by a majority vote upon a finding of fraudulent or harmful conduct. 

The power of the operating agreement in settling member disputes cannot be understated, as the operating agreement will prove the processes and procedures that members must follow to resolve the dispute, but only if the operating agreement has included provisions governing the issue. Operating should be drafted to provide the processes and procedures triggered upon the occurrence of a predefined event described in the operating agreement. Operating agreements that plan for contingencies and provide clear resolutions can efficiently and indisputably resolve LLC disputes without court action.

2. If the Operating Agreement does not resolve the dispute, can members resolve the dispute without judicial action?    

If an operating agreement fails to include processes and procedures that resolve member disputes, then Florida statutes will provide the default rules. Judicial action may or may not be necessary, depending on the relationship between the members. According to Section 605.0701, Florida Statutes, Members may vote to dissolve an LLC without judicial action only if all the members consent to the dissolution. According to Section 605.0602, Florida Statutes, members may be expelled as a member of the LLC only when it is unlawful for the LLC to carry on the company’s activities and affairs with the person as a member and upon a unanimous vote of the members. Resolving a member dispute between members who cannot agree can be extremely difficult without an operating agreement or judicial action under the default statutory rules. 

3. If the Operating Agreement does not resolve the dispute, can members resolve the dispute without judicial action?    

If an operating agreement fails to include processes and procedures to resolve member disputes and members cannot achieve the requisite vote required by default statutory rules, members will be forced into litigation. Members should proceed cautiously before commencing judicial action because of the costs and risks associated with such litigation. There are effectively two methods of judicial resolution available to members of an LLC that cannot agree or have a member who renders agreement impossible: (A) Judicial Dissolution or (B) Judicial Expulsion.

• Judicial Dissolution 

According to Section 605.0701, Florida Statutes, to obtain a judicial dissolution, a member will need to petition a court to determine whether grounds for dissolution exist. A court can judicially dissolve an LLC if: 

(1) The conduct of all or substantially all of the company’s activities and affairs is unlawful; 

(2) It is not reasonably practicable to carry on the company’s activities and affairs in conformity with the articles of organization and the operating agreement;

 (3) The managers or members in control of the company have acted, are acting, or are reasonably expected to act in a manner that is illegal or fraudulent; 

(4) The limited liability company’s assets are being misappropriated or wasted, causing injury to the limited liability company, or in a proceeding by a member, causing injury to one or more of its members; or

(5) The managers or the members of the limited liability company are deadlocked in the management of the limited liability company’s activities and affairs, the members are unable to break the deadlock, and irreparable injury to the limited liability company is threatened or being suffered.

However, even if grounds for judicial dissolution exists, Section 605.0706, Florida Statutes, provides a potentially harsh penalty for the member petitioning for judicial dissolution. According to Section 605.0706, Florida Statutes, in a proceeding initiated by a member of a LLC for judicial dissolution, the company may elect, or, if it fails to elect, one or more other members may elect, to purchase the entire interest of the petitioner in the company at the fair value of the interest. Thus, members who petition a court for judicial dissolution following a member deadlock are potentially subject to a mandatory buyout of their interests should the LLC or other members elect to purchase the interest of the petitioning member. 

• Judicial Expulsion 

The alternative to judicial dissolution is member expulsion. Section 605.0602, Florida Statutes, provides that a member may be expelled from the Company by judicial order because the member (a) Has engaged or is engaging in wrongful conduct that has affected adversely and materially, or will affect adversely and materially, the company’s activities and affairs; (b) Has committed willfully or persistently, or is committing willfully or persistently, a material breach of the operating agreement or a duty or obligation; or (c) has engaged or is engaging in conduct relating to the company’s activities and affairs which makes it not reasonably practicable to carry on the activities and affairs with the person as a member. An expelled member loses their status following a judicial dissolution and will have no right to participate as a member in the management and conduct of the LLC’s activities, including the right to vote. However, an expelled member will retain the economic rights provided by their membership interests. Still, expelling a member can allow the remaining members to operate the LLC without the expelled member having any voting rights or involvement in operational decisions. 

Conclusion 

There is no easy way to resolve LLC disputes that occur between members. However, an LLC and its members will benefit from having a well-drafted operating agreement that considers potential member or manager disputes and provides clear and definitive processes to achieve a resolution. LLCs that fail to include sufficient dispute resolution mechanisms in the operating agreement will require members to follow the statutory rules, where litigation looms should the members fail to agree unanimously on dissolution or expulsion.