Overview of LLC Member Withdrawal Agreements
Any member has the right to voluntarily withdraw from a limited liability company. Many LLCs are set up with automatic buyout clauses that come into play upon a member’s voluntary withdrawal or frequently will require that there be a written withdrawal agreement. The member’s buyout price or formula may be set forth in the operating agreement itself or determined as provided for in the withdrawal agreement itself.
An LLC member’s voluntary withdrawal does not make it impossible for the LLC to continue doing business. In fact, the withdrawal of a member may be initiated by either the member or the remaining members. However, when a member withdraws from an LLC, that member will have certain rights, and those rights may need to be protected in an operating agreement.
The following illustrates when an LLC member withdrawal might occur: Managers and officers of the LLC might be members. When a manager or officer withdraws, there are issues about how the business entity will continue and who will take over the managing or officer role. For example, consider the following scenarios: A manager or officer who withdraws might continue to serve as a manager or officer and even be compensated despite his or her withdrawal provided the operating agreement so provides. However, it is generally preferable to have a manager or chief executive officer who has some stake in the company.
An LLC member who is also an employee might withdraw from both roles . Alternatively, that member might remain as an employee and just give up that person’s membership in the LLC. The withdrawal agreement could resolve the terms of that member’s employment continuing. That might include the employee/member receiving payment for unused vacation and sick leave. The agreement could also extend certain benefits into a separation agreement, including severance pay or continuing health insurance coverage. There might also be issues about the timing of when the member-employee is paid for the value of their interest in the LLC.
Situations involving the withdrawal of one or more minority members may need to be handled delicately. If the remaining members do not have the funds needed to buy out the withdrawing member, it may be best for the members to engage the services of a business valuation expert. Having the value of the withdrawing member’s interest assessed may help everyone to agree to terms or help to provide a basis for a settlement agreement.
It is critical that you consult an attorney to draft or review any withdrawal agreement before it is signed. The rights of a withdrawing member should be clearly set forth and protected through the operating agreement or a stand-alone agreement. Without such an agreement there might be unrecoverable losses for the withdrawing member.
If your LLC has a member withdrawal agreement and at least one member is withdrawing, that agreement may contain some or all of the following elements: Many circumstances can create the need for a withdrawal agreement.
Essential Elements of a Withdrawal Agreement
While every LLC is different, your withdrawal agreement template should have a number of fundamental components. These components may vary in length and detail depending on the precise nature of the member relationship, but some general standards exist for each component. First and foremost, the clauses of the withdrawal agreement template should usually be sequenced in the order they appear in the process of withdrawal. For example, a few iterations of parts may not make sense until followed by another iteration. Therefore, this section will instruct the reader to seek to understand the order of components. Broadly, below is a list of some of the components that are often seen in withdrawal agreements: 1. Notice requirements – if the agreement requires certain notice to be given to the LLC prior to withdrawal, this clause should specify the notice requirements. 2. Parties – this clause relating to parties basically states the member(s) entitled to withdraw must be specified in the withdrawal agreement template. 3. Payment terms – the agreement often specifies the conditions of payment to the withdrawing member. 4. Releases – the withdrawing member often must indemnify the LLC from any liabilities or losses related to the member’s actions with the company. 5. Survival – the agreement usually states that certain obligations (such as confidentiality obligations and indemnification obligations) survive after the agreement is terminated. This clause protects the LLC in the future. 6. Confidentiality obligations – most often, the agreement contains provisions requiring the withdrawing party to keep company information confidential after withdrawal. This clause can help prevent an ex-member from "spilling the beans," so to speak, about sensitive company affairs.
Legal and Compliance Issues
When preparing LLC member withdrawal agreements into templates, there are some legal considerations. While we do not dispense legal advice or substitutes for the law here, it is important to put out some guidelines and the legal compliance questions that might arise when crafting these. Any issues should be fully discussed with your attorney.
Many states have specific statutory regulations governing the members of limited liability companies. The LLC must comply with all such provisions of state law, and the member agreement should complement, not contradict them. For statutory provisions concerning LLCs, see the LLC state laws table in the Nolo Press Limited Liability Company: Formation and Papers book from 2003.
In addition to the terms of the operating agreement and any governing document, for LLC member withdrawal agreements, the law will impose certain terms on the withdrawal. For instance, if the member agreements are silent on the matter of withdrawal, many state RULPA versions will allow LLCs to expel partners and members over time. State specific laws will also govern what is left behind upon withdrawal. In some cases, like when withdrawal is in the midst of an LLC dissolution, the rules regarding distribution when withdrawing are governed by rules for winding up in bankruptcy (under 11 USC 771, et seq. – the US Bankruptcy Code). This means that the LLC has to pay creditors first, and then distribute among members.
In some cases, Member agreements will have to comply with the securities laws of the states involved. For example, if an investor wants to buy more of the LLC, she might have to comply with federal securities laws under the Securities Act of 1933, and state laws concerning securities (for example, the Texas Securities Act under the Texas Uniform Securities Act). Member withdrawal agreements may contain sales of interests or units of the interest in the LLC, which may or may not involve securities.
In short, members withdrawal agreements have to be made with an eye to compliance with state regulations governing the LLC and the parties to the withdrawal agreement.
How to Create The Draft
When it comes down to writing an effective LLC withdrawal agreement template, several steps should be followed:
The Step by Step Process to Draft a Comprehensive LLC Member Withdrawal Agreement
1. Consult an attorney – It never hurts to have an expert by your side. An attorney for an LLC can go through the document and supply the primary participant with important information in regard to the document’s proposed legal framework.
2. Amend to reflect the situation – By adding any details that already exist, you can better help the legal professional by outlining the outcome of the agreement, the timeframe of the exit, reasonable expectations, and any pertinent details.
3 . Look beyond the exit – Are there any events pending in the future? If the LLC has elections coming up for one of its officers, for instance, mention them so that they can be planned for (this is an issue, of course, for members who only hold minor positions in the LLC).
4. Customize to your LLC – Every LLC is different, and therefore, so too must be its LLC member withdrawal agreement template. Make the changes as necessary. You can even add a signature line for the other members if your LLC consists of more than two members.
5. File correctly – Once the LLC member withdrawal agreement has been signed by both parties, be sure that it is taken to the correct office; usually, this would be the office of the Secretary of State.
Resolving Common Issues
Despite the fact that we have been negotiating between LLCs, their members, and their managers for quite a long time now, we have seen some conflicts between owners that are of interest for today’s purposes. Accordingly, below we outline three common issues in these negotiations:
Issue 1: New Ownership Perspective vs. Unwillingness to Buy-Out Member
In the negotiation of the LLC withdrawal agreement template, the company (or the purchasers) may want a discount to the exit price of the withdrawing member. These negotiations are often partly based on the relative position of the withdrawing member. If he or she has other members to broker the deal, they may be able to hold firm to the price. In larger companies, shareholders may seek out to third parties as this can drive the price up by causing competition. However, we have also seen times where the withdrawing member is desperate for cash and will accept almost any offer. In these cases, the ownership group must balance getting the best deal for the bottom line against the goodwill of the withdrawing member.
Issue 2: Dealing with Unpaid Contributions
Another issue which comes into play during these negotiations is the lack of contribution from certain members. This could be due to an unpaid loan, a capital call that was not paid, or non-distributions through the years. These factors should not be used to argue to the withdrawing member that they deserve to be paid less in a buy-sell transaction. First of all, these forces should be collectively discussed among the members with a goal of coming to a global solution. This is to say that if the withdrawing member was not receiving distributions all along, it is only fair to consider increasing their earnings from this point going forward. This should help work out the problematic deal. Also, if the withdrawing member did not take part in certain capital calls, they will have no real complaint about their share of the capital call. For example, Company A has two members, Member 1 and Member 2. Member 1 has a 75% owner, and member 2 has a 55% ownership. Member 1 has refused to make any capital calls, and therefore Member 2 has not taken any distributions. If Member 2 leaves the company now, they would be getting 100% of the assets which is unfair since Member 1 put up all the capital. The right choice in this situation is to calculate the proportional contribution of both members and give each member their contribution amount at time each member received their ownership stakes.
Issue 3: The Slowdown and Buyout
Frequently, we have seen deals and deals on paper negotiated for limited liability companies. Still, because essentially, these companies are run on relationships, sometimes the value of some members decreases based on a personality clash. We had a process earlier this year where the negotiating members had had very good luck. The company had growth and its revenue was fair. Then, one of the crucial members decided that they did not want to work at the company any longer. This resulted in the remaining partners selling the company to the departing member at a low price. The damage from a split company can often be repaired in time, but it can take a long time to get to a level again where the returned value would be substantial. This is an example of where relationships matter. We can easily construct a contract that would address economic concerns, but at the end of the day, the partners still have to get along.
Although in business it is common to talk about the bottom line, these items are much like the success in a relationship. There are great couples who they too have their times where one may feel wronged by the other. The trick with business, as it is on television, is to work out the disagreement. In cash transactions, we often justify the person who makes more money as having more control and vice versa. Unfortunately, the law does not recognize personal feelings and therefore, if you and another are similarly situated in an LLC agreement, the law will force you to solve the problem as the document states rather than on how the situation is developing.
The owner’s agreement template provides a roadmap. Sometimes, it is simple; other times, it is complicated. However, this map can take the four corners of the agreement and apply it to the situation at hand.
Using Templates in the Drafting Process
An LLC member withdrawal agreement template can make it easier to ensure compliance and reduce stress levels. Not only will a template allow for flexibility in how compensation is structured, but it also provides a uniformity and standardised approach to refer to regardless of how big or small your LLC is. A member withdrawal agreement from an LLC template can be downloaded easily and regulations are often mapped out in accordance with state law , so you won’t have much interpretation to do on your part. This helps to standardise not only how you respond to a member who wants to withdraw, but also what you can expect in terms of your LLC partners’ responses. You can understand the process and what to expect, making the whole process easier once you have a template to refer to.
