Nearly every business owner has had their doubts about being in business with a partner, or multiple partners. This is a common concern for virtually every business owner, at some point in time. Sometimes, the business partner asking this question may be overvaluing his or her own self-worth, but more often, one partner is either not working as hard, marketing as hard, or adding as much value as the other partners. At Gatlin Voelker, we help business owners make informed decisions about whether to act removing a business partner and guide them through the legal process if necessary. The most common question asked is whether you even can remove an owner from the business. Yes– It is possible to remove a business partner/shareholder/member. The process to remove a partner/shareholder/member is most likely going to be determined by the corporate documents and by state statute. In all cases, it is always best to work out an agreement with the exiting business associate and to involve an attorney in drafting the needed documents. Each entity, whether it is a Corporation, LLC or Partnership will have different sets of rules and guidelines.
Removing a Member from a Limited Liability Company
A well-drafted Operating Agreement and Articles of Organization will include provisions for removing a member. Removal may be as simple as the member submitting a letter of resignation, depending on the relevant provisions. However, if the member is not willing to voluntarily resign, the provisions might provide, for example, a voting procedure allowing the other members to vote for the removal of the recalcitrant member. Whether the member agrees to resign, or a vote is passed to force the member to withdraw, the member is still entitled to compensation for his or her interest in the LLC. Your operating agreement may contain buyout provisions that will assist you in this process, or there may be a separate buyout agreement governing such situations. If there are no provisions in either your Operating Agreement or Articles of Organization, both Ohio and Kentucky have statutory processes for removal. While neither Kentucky nor Ohio follows directly the Uniform Limited Liability Act or ULLCA, both States have similar provisions. If there are no default voting procedures to fall back on and an LLC member who remains unwilling to withdraw from the company, often the only solution, short of the members being able to sit down and negotiate a settlement of the issue, is to petition the court for judicial dissolution of the LLC. Generally speaking, if matters reach this particular stage it’s often best to retain an attorney to help you with the process. If the petition is granted, the LLC will undergo winding up procedures to terminate the business. It is always best to try and reach a resolution first.
Removing a Shareholder from a Corporation
As with an LLC, shareholders should first look to the Shareholders Agreement for directions on the buyout procedure of the removed shareholder’s ownership interest. In many cases, the Agreement allows the shareholder’s ownership interest to be sold at fair market value and adjust the remaining shareholder capital accounts accordingly. The valuation method used to determine the fair market value of the shareholder’s ownership interest should be specified in the buy/sell provisions of the Shareholders Agreement. Next, the shareholders will need to draft a resolution for a vote of approval before the board of directors or designated shareholders, whichever the shareholder’s agreement determines. The corporate records need to reflect this removal and the corporation needs to adjust the shareholder capital accounts. If there is no provision in the Shareholder Agreement, then like an LLC, the shareholders will have to seek judicial action. In most states, including Kentucky and Ohio, minority shareholder interests are generally protected. Under most close corporate and partnership laws, the majority owners owe a fiduciary duty to the minority owners and as such must deal with minority owners with candor, honesty, good faith, loyalty, and fairness. We have successfully represented both majority and minority interests in ownership disputes. Most of the litigation involves reasonableness in salaries, reasonableness in distributions and reasonableness in decisions. As an example, it would probably be unreasonable for a 51 percent owner to pay themselves a salary that is significantly above market rate and payout of the business a significant amount of personal expenses and then claims there is no money left to distribute to the minority interest. If your partner/shareholder won’t sell their interest, there are often remedies built into the corporate/partnership agreements. If not, there are always provisions in both Kentucky and Ohio law that deal with “forcing” the sale of a reluctant owner. However, in virtually all cases, where there is not an agreement, the owner seeking the sale, will have to involve the court system and create some justifiable reason to have a court intervene. Examples could include an intentionally obtuse partner, financial challenges, or other circumstances that would make it nearly impossible to continue the business with its current ownership structure.
If you are considering removing your fellow business owner
Make sure you first ask the following questions:
- How does this impact business bank accounts?
- Who do I have to notify about the change of a partner/owner?
- How does this affect taxes for the year this happens?
- Security measures (changing passwords, removing access from certain accounts, etc.)
The legal part of the solution may not be the biggest challenge. Realize there are practical issues that arise as well. In many cases, if the business has debt, both owners may hold personal guaranties and the creditors may be reluctant to release one of the owners. There are also possible tax consequences. It is always best to be preemptive in working out these issues and detail exit strategies in the initial partnership/corporate agreements. In many cases, a well-drafted Operating Agreement or Shareholder Agreement acts as a prenuptial agreement for business and works to avoid significant legal costs and time drain in the future.