Protecting an LLC From A Wayward Member While Maintaining SBA Eligibility

March 6, 2015



When creating a limited liability company (“LLC”), members are often so concerned with getting the company established–and anticipating problems that may arise with third parties, be it suppliers or customers–that they fail to consider what will happen if issues arise among the members themselves. This is a mistake.  

Usurpation of corporate opportunities, the misuse of company assets and a breach of fiduciary duties are just some of the most common issues that can arise among LLC members. When these types of problems occur, members of the LLC may want to remove the offending member and divest that member of its membership interest. Unfortunately, this may be easier said than done.

The laws regulating LLCs vary by state. The Revised Uniform Limited Liability Company Act contains a provision that enables other members to expel a member in certain cases, but not all states have enacted the Act or its expulsion provisions.

Some states do not have LLC statutes that contain provisions enabling members of an LLC to expel another member in an expeditious manner. Some allow for a member to voluntarily withdraw, but the states’ provisions may not allow for other members to expel or force another member to withdraw unless another judicial process is first concluded, such as if the member was declared bankrupt or held to have committed wrongful acts. Thus, removing a problematic member can be time-consuming and expensive. In the worst case scenario, dissolving the company and creating a new one without the troublemaking member may be the easiest solution.

However, an LLC need not be bound by the aforementioned weaknesses in state law. In many instances, the terms contained in state LLC laws serve as defaults that apply only when an LLC has not created its own agreements to cover these types of events. LLCs can–and should–add provisions to their articles of incorporation or operating agreements that allow members to vote on whether another member should be forced to withdraw from the LLC, specifying the grounds for expulsion and the procedure to be used. If a company finds itself needing to expel a member, but the LLC’s corporate documents do not contain a provision that covers involuntarily withdrawal, the members can attempt to negotiate with the offending member for a voluntary withdrawal.

Before companies rush to amend their corporate documents, there is a caveat. Small businesses that participate in U.S. Small Business Administration (“SBA”) programs must make sure that their involuntary withdrawal or expulsion provisions do not to run afoul of any SBA requirements. Certain programs require a percentage of the company to be owned, controlled, and operated by individuals with certain socioeconomic statuses (i.e., the 8(a) Program, Woman-Owned Small Business Program and Service-Disabled Veteran Owned Small Business Program), and an LLC is ineligible if the member on whom program participation is based is found to be an unconditional owner. Therefore, the LLC’s involuntary withdrawal provisions must be carefully drafted so they do not inadvertently result in a member of whom participation in the SBA program is based to be held to be a conditional owner.

About the Author: Ambi Biggs is an associate with PilieroMazza who practices in the areas of litigation and government contracts.  She may be reached at abiggs@pilieromazza.com.

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