New Connecticut Law Adds Additional Grounds to Kick Out Member of an LLC

Here’s a common scenario I see as an attorney handling business disputes:  Four members start an LLC to engage in business together.  They all get along as friends, colleagues, or business associates.  Lets call the hypothetical business Harmony LLC. When they start Harmony, each person has an assigned role with ownership of 25% of the company.  Harmony has two members with management experience, another member has the sales experience, and the fourth member has the technical expertise.  They all verbally agree that each member will work full-time to make the business work. They put a budget together to get started.  Someone in the group brings up legal expenses for a partnership or membership agreement.  In Connecticut, this governance document is referred to as an operating agreement.  The four partners are tight on funds and springing for the legal expenses for a comprehensive operating agreement is not high on the list of priorities.  One of the members brings up that in Connecticut, LLCs are not required to have an operating agreement and there are online sources for cheap, inexpensive form agreements.   Plus, they figure they all get along so why do they need a comprehensive agreement?  As a result, Harmony starts operating in business with either no operating agreement or a bad form agreement.

What happens if Harmony struggles at first, or more than anticipated, or circumstances change for some members?  For example, what if the business potential in the long run is very strong, but Harmony is not generating enough income in the early stages for all four members to survive financially.  As a result, some of the members feel financial pressure.   Lets say the sales or technical member pursues another job offer somewhere and one of them leaves Harmony.  All of the sudden Harmony has 25% of its work force leave the company.  Then, maybe the second member leaves for another job.  Now only two members are left working with Harmony.  However, both of the departing members say they will not give up their collective 50% ownership interest.  Even more problematic, the departing members start competing for clients or customers.  What do you do? Do the two remaining members keep working full time only to have to turn over 50% of the profits to the non-working members?

The two remaining members decide to go to an attorney.  They find out that without an operating agreement, Connecticut LLC’s are governed by Connecticut General Statutes.  Similarly, if you have a poorly drafted operating agreement and the agreement does not address specific issues, then Connecticut’s LLC statute will govern.  Many times this has unintended consequences that might favor some members over others.  A comprehensive operating agreement might cover the Harmony scenario.  It might have provisions that address what happens when a member stops working for the LLC or factually withdraws.  In the absence of such an agreement, however, the members of Harmony may have limited options.  You can be faced with a situation where members of an LLC are forced to go to court to judicially dissolve the entire LLC because they are otherwise locked in with non-performing members.

One the many new changes to the LLC law in Connecticut (effective July 1, 2017) relates to what is known as disassociation of a member.  This is legal jargon for when a member leaves or is kicked out of an LLC.   The new changes to the LLC law provide some potential relief to the remaining members of LLC’s in the same situation as the members of Harmony.  Section 34-263a of Connecticut’s General Statutes addresses “Events causing disassociation.”  One of the provisions states, in pertinent part:

On application by the company or a member in a direct action under section 34-271, the person is expelled as a member by judicial order because the person: (A) Has engaged or is engaging in wrongful conduct that has affected adversely and materially, or will affect adversely and materially, the company’s activities and affairs; (B) has committed wilfully or persistently, or is committing wilfully or persistently, a material breach of the operating agreement or a duty or obligation under section 34-255h; or (C) has engaged or is engaging in conduct relating to the company’s activities and affairs which makes it not reasonably practicable to carry on the activities and affairs with the person as a member

There could be many reasons why the remaining members of Harmony do want to ask the court to dissolve the entire LLC.  Instead, the remaining members may prefer to try to “disassociate” or kick out the members who left.  Section 34-263(a)(5) provides some new grounds to potentially get a court order to judicially remove the members.  The statute permits either the LLC itself or a member to proceed with an application to the court to seek disassociation for the grounds listed, including when it is “not reasonably practicable to carry on the activities and affairs with the person as a member.”    This option was not available prior to July 1, 2017 and provides some useful potential relief for feuding members of an LLC.

Although there are now additional options for disassociation of LLC members, business owners are well advised to address the situation in an operating agreement.  This might avoid the time and expense of going to court with or the last option of judicial disassociation of a member or dissolution of the LLC itself.  Moreover, as I will address in future posts, there are other new changes to the LLC laws in Connecticut that will govern in the absence of an operating agreement.