Every business should have a proper legal structure and bylaws or an operating agreement that sets forth the rights and responsibilities of its owners or members. While the partnership or corporation structure is better suited to some businesses, limited liability companies (LLCs) have become one of the most popular business structures over the past few decades. The LLC structure provides its members with legal protection against lawsuits and requires less paperwork and formality than a corporation. Unlike a corporation in which the directors are tasked with making the decisions, in an LLC, the members (or managers) are the decision-makers.
There are two common management structures for LLCs: (1) manager-managed and (2) member-managed. Creating a manager-managed LLC is similar to creating a corporation: The managers—who may or may not be members—act like a board of directors in a corporation (and the owners or members of the manager-managed LLC are like the shareholders of a corporation). In a manager-managed LLC, the managers make the day-to-day decisions for the business and only involve the members in big decisions, such as the addition or removal of a member, a change in the nature of the business, or amendments to the LLC's charter or operating agreement. Depending on a state's law, if members disagree with a decision of the manager in a manager-managed LLC, the members may remove the manager by majority vote unless another procedure is set forth in the operating agreement.
In contrast, in a member-managed LLC, the members have the power and ability to make all of the decisions for the company, from the mundane daily operations to the major decisions, such as adding or removing a member or dissolving the business. Without an operating agreement specifying otherwise, the assumption is that each member has equal shares and voting rights. An even number of owners can lead to an impasse in making decisions, which could delay business operations or even harm the business.
Whether manager-managed or member-managed, when LLCs are founded by more than one member, disputes often arise between the members and managers. While these disputes can be healthy for the business and help the business grow, some disputes might be more serious and irreconcilable and lead to a member leaving or the business terminating. One of the best ways to resolve a business dispute is to have the members negotiate based on their mutual business goals and long-term business objectives.
The most common disputes in an LLC involve money, responsibilities, and unethical conduct. LLC members may disagree about how often and how much profit should be distributed. Disputes may also involve the compensation of certain members. Other times, members may be upset about how much work they are doing compared to other members or a member's subpar performance. The most serious type of dispute, and perhaps the most threatening to the business, involves complaints alleging unethical behavior by a member, including misuse or failure to document the use of LLC funds, stealing from the LLC (either LLC funds or confidential information), or entering into another business relationship that competes with or otherwise harms the LLC.
There are a few common ways that owners can resolve a dispute. First, the owners can try to negotiate with one another. They must try to maintain emotional distance during negotiations and not take the disagreement personally. If negotiations fail, LLC members can hire a neutral third party skilled in dispute resolution to help mediate the dispute. Many law firms have lawyers skilled in serving as neutral mediators to help facilitate a resolution. If none of these methods work, the last resort is to pursue arbitration or file a lawsuit.
Implementing the following measures can help you avoid these types of disputes:
- Create a well-thought-out operating agreement. Hire a lawyer to help you draft an operating agreement. In addition to specifying the way the business should be managed on a daily basis, the operating agreement should also include provisions that address the following concerns:
- Whether each member has the authority to act on behalf of the company (or if it is manager-managed, whether the manager has the authority to act on the company's behalf);
- How and when profits will be distributed;
- How much each member must contribute to the business as an owner;
- Duties and expectations of each member;
- Voting rights and relative shares of each member;
- Which decisions require unanimous versus majority approval;
- Dispute resolution provisions for members (or managers);
- How the business will handle adding or removing a member (or a manager); and
- The process for dissolving the business (including purchase price, valuation, and overall procedures).
After you create an operating agreement, you should review it regularly to update and modify provisions and procedures as the business grows and evolves.
- Discuss the responsibilities of each member (or manager). It is important to ensure that every member has a voice and that the expected workload and duties of each member are discussed. Put everything in writing and revisit this discussion regularly, perhaps during semi-annual meetings with all of the owners to discuss the health of the business and member workloads.
- Create a buyout or buy-sell agreement. Create a “will” for your business: discuss the process for buying out the shares of a member who is exiting due to retirement, death, or incapacity and put it in writing.
- Discuss important decisions with the members. Before committing the business to a large financial or contractual obligation, discuss the decision with the rest of the members. Something you think is a great opportunity might be considered a great risk by the other members.
One of the best ways to minimize disputes is to put everything in writing. If you are a member of an LLC with a current or anticipated dispute, we encourage you to contact us so we can address your LLC's legal needs.