Law in the Marketplace: Avoiding LLC divorces - Concord Monitor

There are presently about 65,000 New Hampshire LLCs in good standing. These LLCs constitute the vast majority of New Hampshire business entities except for New Hampshire state-law sole proprietorships. At least 75% of them have only a single member; about 20% have two members; and the remaining 5% have three or more members.

Obviously, business divorces are not a problem for single-member LLCs. However, they are potentially major problems for multi-member LLCs, and above all for two-member LLCs. Indeed, federal statistics suggest that, like marriages between individuals, as many as half of all two-member LLCs end in business divorces because of disputes between the members that they cannot voluntarily resolve.

If you are forming a two-member LLC or if you’re a member of an existing two-member LLC, what should you do about the problem of business divorce? The short answer is that you should address the problem with brutal honesty and absolute practicality in a written LLC operating agreement. Specifically, your operating agreement should address concretely and in significant detail every legal and tax issue that could possibly result in an unreconcilable disagreement between you and your co-member. By my count, there are at least 28 such issues.

But even if your operating agreement addresses all 28 of these issues, and even if it does so clearly and in adequate detail, it’s still quite possible that, perhaps years down the road but perhaps as early as tomorrow, such a disagreement will arise. How should your operating agreement address this possibility?

First of all, I suggest that it should provide that neither of you will seek to resolve the dispute in a lawsuit under the dissolution provisions of the New Hampshire LLC act. I’m not saying these provisions aren’t any good; actually, they’re excellent. But any dissolution suit between you and your co-member is likely to be time-consuming and expensive; it will probably intensify any bad feelings between you and your co-member; and the judge that resolves it might do so in a manner that leaves both of you deeply dissatisfied.

Instead, I suggest that your operating agreement provide that if an irreconcilable dispute arises between you and your co-member, the dispute must be resolved in one of the following three ways:

■ First, it may provide that it must be resolved by a “Texas shoot-out” provision. This provision will provide that in such a situation, either of you may propose to buy out the other on any price- and non-price terms you choose; but the other party (the “offeree”) may either accept those terms or may buy out the offeror on the same terms.

As will be obvious to you, the purpose of a Texas shoot-out provision is to maximize the likelihood that the offeror will offer fair terms to the offeree, since the offeror rather than the offeree may have to sell his or her LLC membership in compliance with these terms. I should note however, that a Texas shoot-out may not work if one of the members has significantly more cash for a buy-out than the other. This may give a substantial advantage to the wealthier party in any buy-out.

■Second, your operating agreement may provide that the dispute must be resolved by a third-party arbitrator in his or her absolute discretion. This provision should, of course, provide that the arbitrator will have no liability to either party if that party feels that the arbitration decision is unfair to him or her. Otherwise, you may have a hard time finding an arbitrator. In addition, however, your arbitration provision should provide that if you and your co-member can’t agree on the identity of the arbitrator, the site of the arbitration and the governing procedural rules within, say, 15 working days after one of you makes a buy-out offer, each of you must propose your own interim arbitrator and the two arbitrators thus chosen must agree on the actual arbitrator.

■ Third, your agreement may provide that if an irreconcilable dispute arises between you and your co-member, the two of you must cooperate in selling your LLC to one or more third parties. Since both of you will know that this “mandatory-sale” provision may result in a sale for significantly less than the long-term value of your LLC, the provision may well force both of you to find a voluntary resolution of your dispute that you wouldn’t otherwise have found. But your mandatory-sale provision should also provide that if either of you fails to cooperate in seeking a buyer, one of you may sue the other for failure to cooperate, with the loser owing attorneys’ fees to the winner.

However, while the above three types of provisions are, in my experience, the provisions that are the most likely to be best for a majority of two-member LLCs, they may not work for you and your co-member because of unique circumstances. Thus, when you’re drafting your operating agreement or revising it to address irreconcilable disputes, you should consult with a good LLC lawyer to ensure that the provision you choose will work for both of you. There are plenty of good New Hampshire LLC lawyers who can help you determine such a provision.

John Cunningham is a lawyer licensed to practice law in New Hampshire and Massachusetts. He is of counsel to the law firm of McLane Middleton, P.A. His practice is focused on LLC law and tax, LLC formations and the handling of LLC disputes and lawsuits. His telephone number is (603) 856-7172. His email address is [email protected]. His website is llc199a.com. For access to all of his Law in the Marketplace columns, visit concordmonitor.com.

source: https://www.concordmonitor.com/Law-in-the-Marketplace-Avoiding-LLC-divorces-43487463

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