It is common for ownership structures in LLCs to change. Members retire, disputes arise, partners move on, or circumstances force a departure. Exactly how member removal works depends on the operating agreement. With an operating agreement, the process is relatively straightforward. Without one, serious complications can arise.
Learn more about voluntary and involuntary member removal and the role of the operating agreement. Much depends on the laws of the state in which the LLC was formed. After a member leaves, the LLC must make further changes.
Can a member of an LLC be removed?
The simple answer about whether a member of an LLC can be removed is yes. However, how that happens depends on the LLC operating agreement and state law. Based on the operating agreement, the removal can be smooth or rocky.
Keep in mind there is a critical distinction between removing the members’ right to participate in managing the LLC and their economic interests in receiving distributions. These are separate issues. Removing membership rights does not necessarily affect their financial interest in the business.
There are two types of member removal:
Voluntary: The member agrees to leave. This is the simplest scenario, typically handled through a buyout and amendment to the operating agreement.
Involuntary: The member does not agree to leave. This quickly becomes complicated and often requires legal processes.
An LLC should never attempt an involuntary removal without consulting a business attorney. A DIY approach can have serious consequences.
Why the operating agreement is everything
An LLC operating agreement defines exactly how the business operates. Along with protecting LLC members, the operating agreement clarifies members’ rights and responsibilities. A well-drafted operating agreement should also cover membership removal. The operating agreement should address:
- Grounds for removal
- Vote required
- Valuation of departing members’ interest
- Buyout structure
Here are common operating agreement provisions that address removal:
- Breach of the operating agreement
- Failure to make required capital contributions
- Prohibited transfer of membership interest
- Vote by remaining members within a specific threshold
If your operating agreement currently does not address removal, remedy that by updating the agreement before a dispute occurs. Always have your attorney draft or review removal provisions.
When an LLC does not have an operating agreement or removal provisions, it is likely governed by your state’s default regulations. Such rules seldom include a straightforward removal mechanism.
Voluntary removal: when a member agrees to leave
If a member is willing to depart, the process is much easier. The most common mechanism is a buyout in which remaining members purchase the departing member’s interest at an agreed-upon price. It is worth obtaining a professional business valuation to establish a fair price. This helps avoid later disputes.
Again, it is wise to hire a business attorney to handle the documentation for any membership transfer. The attorney can handle the following:
- Reviewing the operating agreement: The document may specify the use of certain procedures or valuation methods.
- Buyout price agreement: The operating agreement may specify a valuation method, or the parties can negotiate one. It is worth obtaining a professional business valuation to establish a fair price. This helps avoid later disputes.
- Documenting the agreement in writing: This requires a formal purchase agreement or membership interest transfer agreement.
- Amending the operating agreement: An amendment is necessary to reflect the change in ownership.
- Filing any required state or federal amendments: In most states, this means filing Articles of Amendment with the Secretary of State. You must also notify the IRS of the ownership change.
Involuntary removal: when a member won’t leave
There is no sugarcoating the fact that involuntary removal of an LLC member is contentious and complicated. Here are the mechanisms to deal with a member who will not leave of their own volition and must be removed involuntarily.
Vote by remaining members
Depending on the operating agreement, remaining members may vote to remove a member. This usually requires a specified majority or unanimous consent.
Most operating agreements do not include outright removal by vote. Such a provision is easily abused. Instead, well-drafted agreements tie removal to specific grounds. It also requires a simultaneous buyout.
Buy-sell provision (put/call)
A common mechanism is a buy-sell provision, also known as a put/call option. One member offers a price per ownership percentage, and the other must either buy at that price or sell at that price. This encourages fair pricing because the member making the offer does not know which side of the deal they will end up on.
For fairness and practicality, a buy-sell provision is the best way to force a parting of ways without litigation.
Judicial removal
Judicial removal is expensive and time-consuming. It should only be considered when the operating agreement has no removal mechanism and negotiations for a voluntary departure have proven ineffective. Always try mediation or arbitration first before petitioning a court. Hiring a business attorney is essential.
Depending on your state, courts may order member expulsion under specific circumstances. That is generally when the member has:
- Engaged in wrongful conduct that materially harms the LLC
- Persistently breached the operating agreement
- Made it “impractical” to continue operating with them as a member
Even if the state allows courts to expel a member, that does not necessarily affect the former member’s economic interest. In some states, the removed member may still be entitled to distributions. Some states permit courts to order the sale of the departing member’s financial interest.
Dissolving the LLC as an alternative
When it is clear that removing the member is not going to happen without spending large sums on legal fees, dissolving the LLC is sometimes the last resort. Since dissolution has significant legal and financial implications, a business attorney should always advise you before proceeding.
A dissolution terminates the LLC. Assets are distributed, creditors are paid, and members who want to continue can form a new LLC under agreed-upon terms.
How to remove a member from an LLC: step by step
Below are the steps in order to remove an LLC member:
Step 1: Review the operating agreement
Identify any removal provisions in the agreement. Note required vote thresholds, acceptable valuation methods, and buyout procedures.
If there is no operating agreement or removal provisions, consult a business attorney before proceeding.
Step 2: Document the decision
For voluntary removal, get the departure agreement in writing and have all parties sign it.
When it comes to involuntary removal, document the vote and grounds for removal per the operating agreement’s requirements.
Step 3: Agree on a buyout
Determine the value of the departing member’s interest. You must use the method specified in the operating agreement. If there is no specification in the operating agreement, negotiate a method before proceeding.
Draft a membership interest purchase agreement.
Step 4: Amend the operating agreement
Update the operating agreement to reflect the new ownership structure. Remove the departing member and adjust the remaining members’ percentages accordingly.
Tailor Brands supports LLC formation and compliance. We know that getting the operating agreement right from the start is the foundation for handling membership changes cleanly when they arise.
Step 5: File state amendments
File an amendment with the Secretary of State to update the LLC’s official records. Requirements vary by state, as do filing fees.
Step 6: Notify the IRS and other parties
Notify the IRS of the ownership change. The specific form depends on how the LLC is taxed.
Update banks, insurance providers, vendors, and any other parties with whom the LLC has agreements that reference membership.
A new EIN generally isn’t needed just because a member leaves. You just need to update the IRS on who’s responsible, using Form 8822-B. You’d only need a new EIN if the LLC itself ends and reforms as a different type of entity.
What to do if your operating agreement doesn’t address removal
The bad news is that the operating agreements of many LLCs do not address member removal. If this is your situation, there are options. The first is to negotiate a voluntary buyout. It avoids taking the matter to court and saves time and money.
The best time to plan for member removal is before it is needed. Head off potential membership removal disputes by amending the operating agreement now. Always have an attorney review and amend the document. An operating agreement with clear removal provisions is far easier and cheaper than resolving disputes after the fact.
If the dispute is already brewing, pursue mediation or arbitration. Both are faster and less expensive than litigation.
If that does not work, consult a business attorney about judicial removal options under state law.
Conclusion
Removing a member from an LLC is manageable when the operating agreement addresses it. When it does not address member removal, expect difficulties. While voluntary removal is always preferable to involuntary, a business attorney should be involved in any removal process.
Be proactive and create or add removal provisions in the operating agreement so that the process is as straightforward as possible should the need occur.
FAQ
Yes, but how it happens depends on the operating agreement and state law, and the process can be smooth or complicated depending on documentation.
Voluntary removal happens when a member agrees to leave, typically through a buyout, while involuntary removal happens without their consent and often requires legal processes.
It’s a put/call option where one member offers a price per ownership percentage, and the other must either buy or sell at that price.
Not necessarily, since management rights and economic interest in distributions are separate issues that can be treated differently.
Options include negotiating a voluntary buyout, pursuing mediation or arbitration, or in difficult cases, seeking judicial removal through the courts.