Some limited liability companies undergo ownership changes as their businesses evolve. Members may come or go — either voluntarily or involuntarily — for a variety of reasons. So how do you remove a member of an LLC? Well, that depends! Different circumstances can affect the process and the outcomes for what happens to a member’s ownership interests in the company.
Whether an LLC’s members want one of their members gone, a member wants to withdraw voluntarily, or a member passes away, the company must carry out the process lawfully. Ideally, an LLC’s organizational documents or LLC operating agreement will detail the procedures for removing a member and what happens with the ownership interests. If not, the state’s laws establish if and how members can be removed.
It’s helpful for business owners to consult an attorney when creating their operating agreement. It is the governing contract adopted by an LLC’s members to regulate how to manage the company, share profits, and handle other aspects of the business’s affairs. Likewise, it’s wise to seek professional legal guidance when removing an LLC member to ensure no steps are missed and help reduce the chances of a stalemate between members (potentially resulting in the court dissolving the LLC).
Common Reasons for Member Removal
Involuntary Member Removal
Legal action by a Limited Liability Company to expel a member from the entity is known as “involuntary dissociation.” Several valid reasons for pursuing involuntary dissociation include:
- The member has breached the LLC operating agreement repeatedly
- The member has engaged in wrongful conduct that will or has harmed the company, or
- The other members have deemed it not reasonably practical for the LLC to continue with the member (e.g., if a member is constantly at odds with other members and the friction affects company operations)
Voluntary Member Removal
An LLC owner might decide to withdraw of their own accord (voluntary dissociation). For example:
- They may wish to retire,
- They may resign because of conflicts with other members
- They may leave the LLC for personal reasons (for example, health or family issues)
What Happens to the Member’s Economic Interest in the Company?
If dissociated, whether voluntarily or involuntarily, a member’s equity interest in the LLC might not automatically terminate. For example, in states that have adopted the Revised Uniform Limited Liability Company Act provisions, unless a court orders otherwise, a dissociated member does not retain management rights in the LLC but maintains a financial interest in the company and receives distributions. That’s why it’s critical for an LLC’s operating agreement to lay out what happens when an owner is expelled or withdraws from the company.
Below I’ve listed some of the possible ways a member’s ownership interests might be handled. Which must occur depends on the circumstances, whether the LLC has an operating agreement (or articles of organization) that addresses those situations, and the state’s laws. If an LLC operating agreement does not detail what should happen, statutory rules will prevail unless a court decides otherwise.
- The member will continue to hold their equity and receives distributions.
- The remaining members will buy out the member’s interests.
- A resigning member will receive no compensation upon withdrawal.
- The member’s interests will transfer to someone else.
- The member can sell their interests in the company (typically giving remaining members first right of refusal before offering them to someone outside of the LLC).
- The remaining members equally distribute the removed member’s interests among them.
A word of caution: In a buyout situation where the remaining members purchase the dissociated member’s ownership interest in the LLC, things can get tricky. When determining the monetary worth of a member’s ownership, more than just the member’s initial investment in the company may come into play (e.g., time spent working in the company, property or equipment invested in the company, the professional expertise the member brought to the organization, etc.). For example, LLC members might have agreed that a member who only invested 25 percent in the company is entitled to 40 percent of the profits because of their specialized industry knowledge that helped grow the business. Upon a member’s withdrawal or expulsion, the LLC may benefit by bringing in a third party to do a valuation – i.e., evaluate the situation and assess the value that the member (or heirs) is entitled to.
Three Scenarios for Removing a Member
Because a limited liability company is considered a legal entity separate from its owners, usually it can remain intact after a member of a multi-member LLC leaves, dies, becomes incapacitated, or is involuntarily dissociated.
First and foremost, LLC members must check their company’s operating agreement and articles of organization. If those documents do not include provisions for handling the situation at hand, then the LLC must follow the state’s default procedures.
Scenario 1: When the LLC Wants to Expel a Member
An LLC’s articles of organization, filed with the state when forming the LLC, might include provisions for a member’s involuntary withdrawal (usually, via an attachment to the state’s form). Or the LLC’s operating agreement might detail those provisions. When either of these documents contains procedures for voting out a member or forcing a member to withdraw, the LLC must follow those steps.
If an LLC’s governance documents do not contain express language about removing members, the company must follow the state’s procedures. Those rules vary from state to state. Some state statutes do not have provisions for expelling members, and the entity may have to be dissolved (closed). Twenty-one states and the District of Columbia have LLC laws based on the Revised Uniform Limited Liability Company Act (RULLCA), which typically does not allow members to vote out other members. However, in those jurisdictions, the LLC may ask the court to order the expulsion of an LLC member if the circumstances involve wrongful conduct, breach of contract, or a situation in which it’s not reasonably practical to have the individual as a member.
Regardless of the procedure that the LLC must follow, members must pay attention to every detail!
Scenario 2: When a Member Withdraws
An LLC’s operating agreement or articles of organization should set forth specific provisions for handling matters if a member withdraws or resigns from the company. An operating agreement might state that if a member wishes to withdraw, they must submit “notice of the person’s express will,” which is usually a written notice of resignation. Or the required notice might take another form, such as members’ approval of amending the LLC’s articles of organization (or certificate of organization). Some LLC operating agreements do not allow members to withdraw and require dissolution if a member leaves. If no operating agreement is in place or doesn’t include provisions for when a member leaves, then an LLC must follow its state’s laws. Some states require the LLC’s dissolution when a member leaves and no formal succession plan was documented.
Scenario 3: When a Member Dies
Ideally, an LLC operating agreement will explain what must happen when a member passes away.
Several possible provisions an operating agreement might include are:
- Surviving LLC members must buy the deceased member’s ownership share from the departed heirs.
- The deceased’s heirs may inherit only the financial interests (i.e., profits, losses, assets) but not management rights in the business.
- The LLC must dissolve if a member dies, and that deceased member’s share of the LLC’s assets must be distributed to the departed’s heirs.
Because different alternatives can have significantly diverse effects on the company, remaining members, and the beneficiaries of the deceased member, it’s essential for operating agreements to include detailed procedures.
If an LLC’s operating agreement doesn’t include what should happen when a member dies, remaining members must follow their state’s law. Some states require that an LLC dissolve and start a new LLC if a member dies (although that’s more so with single LLCs rather than multi-member LLCs). Other states require that a deceased member’s financial interests (and sometimes management interests) go to the beneficiaries in the individual’s will. Some states may have other rules in place for handling the death of an LLC member.
Business Entity Compliance After Removal of an LLC Member
An LLC must notify the state about any changes to its ownership and update any other business records that identify the LLC members, their ownership interests, roles, and responsibilities.
As you can see, many factors affect how to remove an LLC member and what happens to that member’s ownership interests upon removal or withdrawal. An attorney can serve as a valuable resource in navigating the procedures and ensuring the process gets appropriately handled.
CorpNet is here to help you complete all your required compliance filings accurately and on time. Whether you’re starting a new LLC, need to file articles of amendment, or must file articles of dissolution, we have the expertise and experience (in all 50 states!) to help you as you work through the process. Contact us today to get started!