How to Remove a Member from an LLC

Like most entities, businesses evolve and change over time. Changes in ownership can be part of that evolution, as an LLC member could decide to move on to another venture, pass away, or reach a point where they are no longer a good fit for the company.

A member who desires to leave an LLC normally can do so without much trouble, especially if terms for voluntary withdrawal are sufficiently covered in the LLC’s Articles of Organization and/or Operating Agreement and all other members agree to the terms. When other owners want to remove a member who doesn’t want to leave, however, the situation can become complicated, normally requiring legal assistance.

Regardless of whether the removal of an LLC member is voluntary or involuntary, the process of doing so must be conducted lawfully and in accordance with the terms of the LLC’s Operating Agreement, which is a document that explains how the LLC will operate, based on the needs and wishes of its members. If there is no Operating Agreement or the one in place doesn’t include terms for removing a member, the LLC will have to follow the default procedures of the state.

Let’s start by looking at some scenarios in which removing a member from an LLC might be necessary.

Reasons for Removing a Member from an LLC

Changes in ownership occur for all sorts of reasons, some more palatable than others. It’s not all that unusual for a member of an LLC to want to leave the business and do something different with their life. In other cases, LLC members may be forced to remove a member involuntarily due to something that’s occurred.

Voluntary Member Removal

An LLC member could decide to resign for a number of reasons, including:

• Retirement
• To take advantage of an opportunity with another business
• Pursuit of personal interests
• To attend to a personal issue, such as health or family
• To avoid conflict with other members

Involuntary Member Removal

Or members might want to remove an owner for behavior that is not consistent with the rules and/or values of their organization. These could include:

• Engaging in criminal activity or wrongful conduct
• Failing on numerous occasions to adhere to the terms of the LLC’s Operating Agreement
• Failing to fulfill their responsibilities within the organization
• Engaging in conflicts of interest
• Exhibiting an inability to work effectively with other members of the LLC
• Facing litigation that could threaten the finances and/or reputation of the LLC

Regardless of the reason for removing a member from an LLC, the process must be carried out in accordance with the company’s Operating Agreement, which is a legal document, or by following the laws of your state. Not doing so can set up other members for legal challenges.

Circumstances in Which a Member May Be Removed

Ideally, an LLC’s Operating Agreement contains detailed information regarding grounds for removing a member and lays out various procedures, depending on circumstances, for how the removal should be conducted. Terms for removal may also be addressed in the company’s Articles of Organization, which are papers filed with the state when the LLC was formed.

Because an LLC is considered a separate entity from its owners, in most cases the company can remain intact after a member leaves voluntarily, is removed by other members, or dies.  In some cases, however, either because of what’s stated in the Operating Agreement or required by the state, an LLC may have to dissolve and then reform, if applicable.

Let’s consider three circumstances under which a member may be removed from an LLC, and how the removal might occur.

1. A Member Chooses to Withdraw

In many cases, an LLC’s Operating Agreement would call for a member who chooses to withdraw from the company to submit a written notice of resignation, sometimes called a notice of the person’s express will. The agreement also may stipulate how much notice the exiting member must give.

If there is no Operating Agreement or terms for removal are not covered in the Articles of Organization, consult your state’s laws. Some states allow an LLC to continue operations when a member leaves and no formal succession plan was documented, while others require the LLC to dissolve and reform with new Articles of Organization and a new Operating Agreement.

2. Other Members Choose to Expel an Owner

Again, members must consult their Operating Agreement and adhere to its terms for removing a member. If you’re fortunate, your agreement will include an expulsion clause or other provision that allows owners to vote out a member under specific circumstances.

Implementing procedures outlined in the agreement may include a formal vote on whether a member can be removed under the terms of the expulsion clause. The vote might have to be unanimous, according to the terms of the agreement. Once a vote has been taken to remove a member, the remaining members should draw up an amendment to the LLC’s Operating Agreement, stating why the member was removed and how their interest in the company will be handled.

If the expulsion of a member is not covered in the LLC Operating Agreement or Articles of Organization, other members must consult state law. Laws regarding removal of a member from an LLC vary from state to state, so be sure you do some research and understand what is required.

Some states have rules based on the Revised Uniform Limited Liability Company Act (RULLCA), which normally do not permit members of an LLC to remove another member. Often, however, the LLC can ask the court to approve the expulsion of a member under certain circumstances, such as wrongful conduct, breach of contract, failing to fulfill responsibilities, or exhibiting an inability to work effectively with other members of the LLC.

In some states, as when a member voluntary withdraws from the LLC, a company may be forced to dissolve when a member is expelled.

3. When a Member Dies

An LLC’s Operating Agreement should spell out how the death of a member is handled. Again, if it does not, you’ll have to consult the laws of the state in which your LLC is registered.

An Operating Agreement could stipulate provisions concerning the death of a member including these:

• Surviving members must buy the deceased member’s ownership shares from heirs.
• Heirs of the deceased may inherit financial interests of the LLC but not management rights in the business.
• The LLC must dissolve and the deceased member’s shares be distributed to heirs.

How the death of a member is handled can significantly affect a company, its remaining members, and the beneficiaries of the deceased, and terms of the Operating Agreement should be strictly adhered to.

If remaining members must defer to state law due to the absence of an Operating Agreement or lack of provisions regarding the death of a member, they may be forced to dissolve and reform the company.

Some states require an LLC to distribute the deceased member’s financial interests – and in some cases, management interests – to beneficiaries in accordance with the will of the decedent, while other states have different rules for handling assets.

Dealing with Economic Interests of Members

Depending on the terms of an LLC’s Operating Agreement, the economic interests of the member leaving and those remaining can be handled in several ways. Many people assume that when a member is removed from an LLC their economic interest in the company no longer exists, but that is not necessarily the case.

Unless a court orders otherwise, a departing LLC member can continue to receive distributions from an LLC in states that have adopted RULLCA provisions. The member who’s been removed would not retain management rights but would maintain financial interest under RULLCA rules.

On the flip side, a departing member could continue to be responsible for debt the LLC has incurred and other liabilities, depending on the terms of the Operating Agreement. Unless a formal release agreement is allowed and executed, the exiting member could be obligated to continue to pay tax obligations, outstanding loans, or personal guarantees.

Some ways in which the economic interests of the departing member and those remaining might be handled are:

• The member who’s been removed continues to hold their equity and receive contributions.
• The remaining members buy out the departing member’s interests after calculating those interests using a method such as fair market value, book value, or a pre-agreed formula that’s spelled out in the Operating Agreement.
• A member who leaves voluntarily agrees to receive no compensation once their time with the company is over.
• The interests of the member who is removed transfer to someone else.
• The member who is removed sells their interests in the company with the stipulation that remaining members are given right of first refusal, if called for in the Operating Agreement.
• Remaining members distribute the removed member’s interest, either equally or according to a pre-agreed formula that’s set out in the Operating Agreement.

Just a warning: the likelihood of disputes over the handling of economic interests of both the member being removed and those remaining generally is very good. In addition to the initial investment of the exiting member, factors such as professional expertise, ownership of property or equipment, time spent with the company, and others may come into play while attempting to determine the monetary worth of a member’s ownership.

It can be extremely difficult to place monetary value on some factors and members often disagree what that value should be. When that occurs, it can result in drawn out legal action and costly bills. Hopefully, that underscores the need for a thorough and thoughtful Operating Agreement, which can take out the guess work and help everyone avoid a difficult and costly situation. If no Operating Agreement is in place or it doesn’t cover how economic interests will be handled, you’ll need to rely on statutory rules unless a court decides otherwise.

Compliance and Other Issues to Consider

An LLC must notify the state regarding any changes to its ownership and update any other business records that contain information about members, such as their names, ownership interests, roles, and responsibilities.

You’ll need to update your formation documents, which include your Operating Agreement and Articles of Organization. How and when that must be done varies depending on your state, so be sure to find out what’s required.

Tax considerations also must be addressed, particularly in LLCs that are taxed as pass-through entities. The departing member may owe capital gains tax on appreciation of their ownership shares and the federal tax obligations of the LLC could be affected. Also, the LLC will need to update Schedule K-1 filings to reflect changes in ownership.

Remaining members of the LLC also should notify third-party entities such as banks, credit unions, suppliers, and others who may be affected by the ownership change. Remaining owners also might want to consider changing passwords or taking other steps to ensure the member who’s been removed can no longer impact the business.

A Word of Advice

As you can see, removing a member from an LLC can be a complicated process that should be undertaken carefully while following all legal requirements and obligations.

I hope this article reinforces the importance to an LLC of a good Operating Agreement and prompts you to examine your agreement to see if it needs improving or updating, as there is a lot at stake when you’re running a company.

If you’re faced with the task of removing a member from an LLC, consider seeking legal advice, as failing to proceed properly could have financial consequences and lead to legal issues in the future.