Dissociation of LLC

GET OUT: DISSOCIATION OF LLC MEMBERS IN ILLINOIS

Paul Simon famously sang that there are 50 ways to leave your lover. While leaving behind your membership interest in a limited liability company (LLC) may not make for as compelling a tune, there are, in fact, several ways for members of an LLC to dissociate themselves – or be dissociated from – the entity.

Most state laws as to LLC members recognize that relationships between LLC members, as with other relationships, can change, evolve, or deteriorate over time. The interests of one member may diverge from other members or colleagues working in the business.  A specified event may trigger a planned or unplanned exit from the company. Or a member may engage in wrongful conduct or violate the company’s operating agreement such that the other members feel more than justified in kicking them out.  As recognized by most state statutes regarding LLCs, action can be taken to expel a member by judicial determination – a process known as involuntary dissociation.

Address Dissociation Issues Before Hand

When forming an LLC and crafting its central governing document – the operating agreement that will define the rights and obligations of members – it is important to understand and delineate the circumstances that could result in the departure or expulsion of a member.  It is equally important to establish what happens to that member’s interests (including distribution, voting, and equity value) once dissociated from the entity.

Statutory Bases For Dissociation From An LLC

Section 35-55 of Illinois Limited Liability Company Act (Act) sets forth 14 different permissible reasons and circumstances that can justify the dissociation of an LLC member. In the vast majority of cases, however, dissociation becomes an issue for one of four reasons:

Voluntary Dissociation

Under Section 35-55(1) of the Act, an LLC member can dissociate themselves by providing the company with notice of their express will to dissociate upon the date of notice or on a later date they specify, unless such a departure violates the terms of the operating agreement.

Event or Occurrence In Operating Agreement Or Under The LLC Act

Many LLC operating agreements set forth particular circumstances which can or will result in a member’s automatic dissociation from the company, such as the entity reaching a specific milestone, the passage of a set period, the completion of certain tasks, or a member’s conviction for a crime. Section 35-55 (2) and (4) of the Act provide that an event agreed to in the operating agreement can be the basis of a member’s dissociation or expulsion.

The LLC Act also identifies other specified events that result in automatic dissociation, such as the member’s death or incapacity, becoming a debtor in bankruptcy, or executing an assignment for the benefit of creditors

Unanimous Vote of Other Members

Section 35-45(5) allows for a member’s expulsion by unanimous vote of the other members if:

  • It is unlawful to carry on the company’s business with the member.
  • There has been a transfer of substantially of all of the member’s distributional interest (the right to receive income or distributions based on equity), other than a transfer for security purposes or pursuant to an unforeclosed charging order (a lien on the distributional interest).
  • Within 90 days after the company notifies a member that it will be expelled because it has filed a certificate of dissolution or the equivalent, its charter has been revoked, or its right to conduct business has been suspended by the jurisdiction of its incorporation.
  • A partnership, corporation, or a limited liability that owns a membership interest of an LLC has been dissolved and its business is being wound up.

Judicial Dissociation

Of course, not every LLC member parts ways with their company voluntarily, amicably, or as agreed. In such cases, the Act, like most LLC statutes, provides a mechanism for the company or other members to ask a judge to oust a recalcitrant member under the judicial dissociation standards. Importantly, judicial disassociation affects the member, whereas dissolution affects the entity in its entirety.

The Act lists three separate bases for granting an entity or another member’s petition for judicial dissociation:

  • The member engaged in wrongful conduct that adversely and materially affected the company’s business.
  • The member willfully or persistently committed a material breach of the operating agreement or a duty owed to the company or the other members.
  • The member engaged in conduct relating to the company’s business that makes it not reasonably practicable to carry on the business with the member.

Given the nature of the allegations that would support judicial dissociation, such proceedings can and often do get contentious, costly, and disruptive. The Act does not define “wrongful conduct,” leaving the parties to argue and a judge to decide whether a member’s actions were, in fact, “wrongful.” Likewise, whether a member breached a duty to an LLC or engaged in conduct that makes it not reasonably practicable to carry on business are matters that are subject to judicial interpretation. Each case is unique.

Like other provisions that can be drafted to avoid disputes amongst members or equity factions, LLCs and their members can avoid such expensive conflicts by, for example, clearly defining the acts and omissions that constitute wrongful conduct justifying dissociation in their operating agreement. They can also adopt dispute resolution provisions to address early resolution of involuntary dissociation (or dissolution) claims.

What Happens to a Dissociated Member’s Interest In The LLC?

When a member dissociates from an LLC, they are typically divested of all rights to participate in the management or operation of the company. Disassociated members can also lose informational rights but retain their distributional interests. While a dissociated member does not necessarily forfeit the value of their ownership interest in the company (i.e., equity), circumstances may play out differently than the member’s expectations before disassociation.

If you have questions or concerns about the dissociation of LLC members in Illinois, other aspects of the law of LLCs or the Act, or general business dispute issues, please contact me at 312-840-7004 or fmendelsohn@burkelaw.com.  

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