LLC Operating Agreement series: Members’ Rights
What rights do you have as a member of an LLC? As we lawyers love to say, it depends. The short answer to this question is that your rights are controlled by state statute and by your LLC’s operating agreement. The laws governing limited liability companies (LLCs) allow for flexibility, including the ability to draft unique operating agreements with varying rights and obligations. This ability to determine the rights and obligations is one of the greatest advantages of forming an LLC since it allows different businesses to modify ownership, financial and governance structure in the most effective way for that particular LLC. This flexibility also means that members’ rights tend to vary from one LLC to the next.
In this latest installment in our LLC Operating Agreement series, we’ve detailed some of the more common rights for members. In most cases, these rights may be restricted or enhanced by an LLC’s operating agreement (depending on the jurisdiction).
Right to Information and Records
In Washington State, a member is entitled to access specified records upon a reasonable request. As a member of an LLC, you should stay up-to-date on the financial statements, operating status, management structure, and any other significant events within the LLC. To do this, it’s important for members to exercise their rights to inspect the records of the LLC periodically to stay informed about their rights and the LLC itself.
Right to Withdraw
Unless otherwise provided in the operating agreement, the regulations governing LLCs in Washington provide that the only way a member may withdraw prior to dissolution of an LLC is by receiving the written consent of all other members. There are a variety of ways that operating agreements handle member withdrawal. Some allow for voluntary withdrawal without unanimous member consent, and others restrict a member’s right to withdraw similar to the statute. LLC operating agreements may also detail events that trigger a member’s right to withdrawal. It’s important for members to understand their withdrawal rights in order to develop an effective exit strategy.
Right of First Refusal
While not present in every LLC operating agreement, many LLCs offer their members the right to purchase a withdrawing member’s interest in the LLC. This right of first refusal is triggered when a member decides to transfer or sell his interest to another. One of the main advantages in acquiring this right is to maintain control of the LLC. Problems often arise when a new (perhaps unfamiliar) face steps into the shoes of a withdrawing member. Including this right in the LLC operating agreement can be important for minimizing risks or problems associated with transfer of control in an LLC.
Right to Dissent
In Washington State, a member of an LLC is entitled to dissent from a plan of merger between the LLC and another entity. In addition, the member is entitled to be paid the fair market value of his or her interest if such event occurs. If the proposed merger falls through, the member’s right to dissent will be terminated in relation to the particular failed merger. Washington State has a number of regulations designed specifically to protect a dissenting member’s rights.
Right to Distributions
Generally states do not require LLCs to distribute earnings to members. An LLC may not make distributions to its members if, after such distribution, the LLC will be unable to pay its debts when they become due. In other words, if a distribution will result in the LLC becoming insolvent, it is not permitted. In Washington, once a member is entitled to a distribution he or she holds the status of a creditor, and obtains all the rights and remedies afforded to a creditor of the LLC. Generally the method of allocating profits and distributing earnings to members is spelled out in the LLC operating agreement.
Right to Independent Counsel
As is always the case when entering into a contract, every member has right to obtain independent counsel to represent his or her rights related to the creation and operation of a LLC. It’s important to ensure that your rights are protected as a member of an LLC, and the best way to do this is to (at the very least) consult with a business attorney to review the operating agreement and any other founding documents. Even though the LLC operating agreement may have been drafted by an attorney (that likely represents the LLC itself), it is always a good idea to obtain your own independent counsel to ensure your rights are adequately protected.
On the one hand, the flexible nature of the LLC is one of the reasons it has become such a popular choice for business owners and entrepreneurs starting new businesses. On the other hand, it leaves the door wide open for drafting operating agreements with more restrictive or less restrictive rights and obligations for LLC members. Before entering into any agreement, you should make sure you’ve read and understand your rights and obligations relating to the LLC.
If you have any questions about forming a LLC or drafting an operating agreement for your LLC, please don’t hesitate to contact us today.