Law in the Marketplace: Buying out your partners - Concord Monitor
As I’ve written before in this column, it’s critical that the operating agreement of every New Hampshire multi-member LLC identify all of the “events of dissociation” potentially important to its members. These are:
A member’s death;
Her resignation with a promise not to compete;
Her resignation without promise not to compete;
Her transfer to another person of her entire interest in her LLC’s profits;
Her incurring a disability;
Her filing for bankruptcy;
Her expulsion for misconduct; and
Sometimes, yet additional events, such as her divorce or her loss of a professional license
Furthermore, if any members of her LLC are entities — e.g., single-member LLCs or trusts — the provisions for events of dissociation in her LLC’s operating agreement should address possible dissolutions or other terminations of these entities.
Furthermore, in defining the above events of dissociation, operating agreements should do so in adequate detail. For example, they should address in detail the specific circumstances that will justify the expulsion of a member, and they should define when, for dissociation purposes, a member may be viewed as disabled.
However, in additional to comprehensively identifying and explaining the relevant events of dissociation, it should also state in detail their consequences. This will normally require addressing:
Whether, upon a member’s dissociation, a dissociated member will have a “put right” — i.e., a., right to require the LLC or the other members to buy her out; and
Whether the other members will have a “call right” — i.e., a right to require the dissociated member to sell her membership to the LLC or to the other members.
The fundamental issue with regard to member buyout is the issue of buyout price. Many lengthy legal treatises and handbooks address this issue, and the issue deserves detailed discussion in a future column. For starters, however, here are a few basic buyout price guidelines:
The simplest way to set a buyout price is to ask a business appraisal expert to set it at the time of occurrence of the event of dissociation. But obtaining this appraisal can easily cost thousands of dollars — an amount that the members may not want to pay or can ill afford. In addition, in my experience, even highly regarded business appraisers sometimes propose buyout prices that none of the members think are reasonable.
For this and other reasons, many operating agreements provide that the members themselves of the relevant multi-member LLC must agree on the buyout price. This is because, among other considerations, as direct participants in their industry the members may well know what they themselves would pay if they were buying a company similar to theirs.
Indeed, some operating agreements provide that the members must agree on this price on a set date every year before any event of dissociation even occurs. Such a provision may make great sense and may help to guarantee a fair price if an event of dissociation does occur. But it’s also a dangerous provision because of the substantial likelihood that the members, caught up as they will inevitable be in their LLC’s day-to-day business, are all too likely to forget to make this agreement — and may forget to do so year after year.
However, a buyout arrangement that may make sense for the members of many LLCs should often be an arrangement that doesn’t rely on current fair market value. at all. Instead, if an LLC’s earnings are likely to be reasonably regular in future years, the buyout price may appropriately consist of a formula based on the LLC’s earnings over a period of, say, the past three years (with a different formula for the LLC’s first two years).
Furthermore, in a family-owned multi-member LLC, it may make sense for an operating agreement not to provide for buyouts upon the occurrence of events of dissociation. Rather, the members may well decide that upon the occurrence of such an event, the dissociated member must transfer her membership rights to the other members free of charge, whether equally per member or on some other transfer allocation. However, any such transfer should often be based on RSA 563-C, the New Hampshire Transfer on Death Security Registration Act, a New Hampshire statute that will ensure that the transferees will not be subject to New Hampshire probate on the transfer.
But the key point is this: Well-drafted multi-member LLC operating agreements shouldn’t just define the events of dissociation important to the members. Right after they do so, they should also provide in detail for the consequences of these events, both for the dissociated members and for all of the other members.
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. Contact him at 856-7172 or [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-44390827
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