Turner Padget Insights

The Best-Laid Plans of LLCs…Sometimes Turn into Disputes Between Members

Posted On Oct 30, 2014

The Limited Liability Company structure can be a great option for businesses; it combines the best of partnerships and corporations. Like corporations, members are not personally responsible for company debt. Like partnerships, they avoid corporate double taxation. Because of these advantages, investors and entrepreneurs are increasingly choosing this business form over alternative structures.  

But as in any other business structure (or relationship), disputes can arise among partners (who are called “members” in LLCs). What are some of the common issues that lead to member fallout, what can you do to resolve them and how can you try to avoid such disputes in the future? 

What Causes LLC Member Disputes?

While disputes between members can come about for many reasons, they often begin with a lack of communication between the members when establishing the LLC. Members’ expectations may vary or be misunderstood, causing discord between the members. 

• Members may disagree as to the scope of the managing member’s authority;
• A member may have breached (or been perceived to breach) a contract term, law or fiduciary duty.
• Perhaps a member received additional compensation and it is unclear to the other members why.  

All of these are issues that arise from a lack of communication (and planning) by the members.

How Should Members Address Disputes? 

Drawing additional income or making a major decision without a member vote may or may not be appropriate. It depends on the terms of the LLC’s operating agreement. A well-drafted operating agreement should define members’ rights and responsibilities. If the operating agreement does not address the issue, or if there is no operating agreement (South Carolina does not require an operating agreement to form an LLC), the South Carolina Uniform Limited Liability Company Act will govern the operations of the LLC. 

The next step (should the issue persist) is to pursue dispute resolution. Most operating agreements provide guidelines for dispute resolution. Normally, they require members to take their matter to arbitration or mediation. Resolving the dispute outside of court is generally the preferred means, and members should strongly consider this even if it is not required by agreement: LLC litigation is complex and can require business valuations, forensic accounting and extensive document discovery. Litigation can be disruptive to business and heighten acrimony between members.

How to Avoid Disputes in the Future.

The healthiest business relationships are those that are well defined. Members should:

• Invest the time and effort into ensuring their operating agreement is comprehensive and detailed, including voting and distribution rights, how member meetings are called and conducted and the powers of any managing members.
• All members should be familiar with the terms of the operating agreement.
• Members should ensure clear communications and institute decision-making and operational procedures that are understood by all.

Protocols are particularly important in LLCs that have a managing member.

Where members’ respective roles, rights and responsibilities are clearly laid out and where there are mechanisms to monitor the relationship, the prospects of things going south are greatly reduced.