Expelling a Member of a San Diego LLC: You Should Revise Your Operating Agreement

When you start your new business, everything seems perfect. But times change and now you have this troublesome member of your LLC. You ask yourself: How do I expel a member of my LLC? As it turns out, expelling a troublesome member of your LLC may be tougher than it sounds unless you have a well-drafted Operating Agreement. As we discussed recently, California LLCs are governed by the Revised Uniform Limited Liability Company Act, Cal. Corp. Code § 17701.01 et seq. (“RULLCA”).

Considering some case law, it might be time to review your Operating Agreement. (You may want to do that anyway to make sure there is a mandatory buy-out since an expelled member is still entitled to profit distributions.)

Here are a few things you should know.

Statute-Based Expulsions are Not Easy

Under the RULLCA, Cal. Corp. Code § 17706.02(e), expulsions must be made by a court — no “self-help” expulsions are allowed. Such expulsions are called “dissociations.” California Corporations Code provides that a member may be dissociated and expelled as a member by judicial order if the member has:

• Engaged, or is engaging, in wrongful conduct that has adversely and materially affected, or will adversely and materially affect, the limited liability company’s activities.
• Willfully or persistently committed, or is willfully and persistently committing, a material breach of the operating agreement or the person’s duties or obligations under Section 17704.09.
• Engaged, or is engaging, in conduct relating to the limited liability company’s activities that makes it not reasonably practicable to carry on the activities with the person as a member.

Depending on your situation, you might be able to argue “wrongful conduct” or “material breach.” If not, you must move to expel under the “not reasonably practicable” provision of subsection (e)(3). However, case law has made it clear that subsection (e)(3) is potentially a “high bar.” Our research has found no California case yet on subsection (e)(3), but cases from Colorado and from New Jersey provide some guidance. See Gagne v. Gagne, 338 P.3d 1152 (Colo. App. 2014) and IE Test, LLC v. Carroll, 140 A. 3d 1268 (NJ Supreme Court 2016).

In both cases, the courts held that the words “reasonable” and “practicable” were important. Thus, a member could not be expelled for convenience or merely because running the company would be easier or less complicated. The mere existence of a conflict among LLC members does not justify expulsion.

The courts then went on to say that expulsion was fact-based and dependent on the circumstances, then suggested seven, non-exclusive, factors to consider:

• Nature of the LLC member’s conduct
• Whether the entity may be managed so as to promote the purposes for which it was formed even with the member remaining
• Whether the dispute among the LLC members precludes them from working with one another to pursue the LLC’s goals
• Is there a deadlock?
• Despite a deadlock, can the members make decisions on the management of the company?
• Is there still a business to operate? and
• Is it “financially feasible” to continue running the LLC with the member remaining?

The New Jersey court called this standard a “high bar” and, indeed, it does seem like a high bar.

Lessons for Drafting or Revising Your Operating Agreement

The standards under the RULLCA are not the only standards that can be used to expel an LLC member. Subsection (3)(e) of the California RULLCA can be modified by the Operating Agreement. Thus, you could add a provision allowing expulsion of a member because “it would be easier and more efficient” to operate the LLC without the member. It is probably wise to define and specify various behavior that might trigger this low-standard expulsion.

The Operating Agreement could also provide an “act-in-good-faith” test for member actions and voting. Likewise, where member consent is needed for various actions, the Operating Agreement could impose a requirement that such consent “not be unreasonably withheld.”

There are many options depending on what goals you want to accomplish with your LLC and your Operating Agreement.

Mandatory Buyout Provision Needed

As noted above, under the RULLCA, even if expelled, a member still has rights to profit distributions. So, your Operating Agreement must provide for a mandatory buy-out.

Contact San Diego Corporate Law

For further information, please contact Michael Leonard, Esq. of San Diego Corporate Law. Mr. Leonard has the experience to set up your LLC, review your existing Operating Agreement and draft revisions, draft your initial Operating Agreement to meet the specific and unique needs of your business and can assist with any other business-related legal matter. Contact Mr. Leonard by email or by calling (858) 483-9200.

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