As of January 1, 2018, every Minnesota LLC has been governed by the Revised LLC Act – or at least portions of the Revised Act. The Revised Act changes much about the manner in which LLCs are governed and managed, which you can read about here, here and here.
The Revised Act gives owners significant flexibility in structuring their business, limiting fiduciary duties, and setting governance rules. Owners exercise that flexibility by putting together an operating agreement. But how do business owners resolve internal disputes when they haven’t adopted an operating agreement?
[Note: The Revised LLC Act defines “operating agreement” as any agreement among the owners of an LLC regarding its management, whether written or oral. Under that definition, any two or more people who decide to start a business together have some sort of operating agreement. But an oral operating agreement to run a business together is both hard to prove the terms and woefully inadequate to address the needs of the business.]
The Revised LLC Act contains default rules – many of which are distinct from the prior LLC Act. Generally speaking, an LLC without an operating agreement is member-managed, with each owner having an equal voice in the company’s operations. Decisions in the ordinary course of business are decided by a majority of the members, and decisions out of the normal course – like merging, selling all its assets, dissolving, adding members, or removing members – require a unanimous vote.
The prior LLC Act had different rules. One significant distinguishing characteristic is that there were avenues to force a minority owner to sell its interests or for a minority owner to force the company to buy it out. Under the Revised act, absent an operating agreement addressing these situations, a company now has very few options when significant disagreements arise among the owners, and nearly all require going to court.
First, any member of an LLC has the power to “dissociate.” That means the dissociated member loses all rights to participate as a member and their fiduciary duties terminate going forward. There are downsides, though. The dissociated member still has financial rights. And, although the member has the power to dissociate, doing so by express will is “wrongful” and makes the dissociated member liable to the company for any damages caused by the dissociation.
Second, the company can expel a member if it is “unlawful to carry on the company’s activities with the person as a member.” That is unlikely to come up often. Alternatively, a company can expel a member by judicial order (i.e. going to court) when it is “not reasonably practicable” to continue operating the business with the person as a member. Again, the end result is that the member is dissociated, still retaining rights to distributions.
If a company without an operating agreement wants to separate a minority owner completely, the only option is to dissolve the LLC altogether. Like expelling a member, it requires a judicial order dissolving the company on the grounds that it is not reasonably practicable to continue the business.
To make matters more difficult, starting the process of dissolving the company does not terminate the fiduciary duties of those in control of the company. During the dissolution process, the company is an ongoing entity, so the fiduciary duties of care, loyalty, and good faith and fair dealing still bind all members.
Even after receiving a judicial order dissolving the company, those in control still owe most of the same fiduciary duties. A dissolved company is required to “wind up” its activities. During the wind-up process, those winding up the company still owe the duties of care and loyalty, with one exception. The duty to refrain from competing with the company ends at dissolution and does not continue during the wind-up process.
Establishing a written operating agreement is more important under the Revised LLC Act than before. Contact one of Rubric Legal’s attorneys if you need to put one together for your business.