Documenting partner or member dissociations

March 20, 2014

document reviewBusiness counselors are frequently asked to get involved in documenting the dissociation of a partner or member from a partnership or limited liability company (“LLC”).  Dissociation is the formal legalistic term for a parting of the ways among the ownership group of a partnership or LLC and includes both voluntary and involuntary terminations of the interest of the dissociated partner or member.  Business counselors must carefully advise the parties about the various structures that can be used to complete the dissociation and since termination of the relationship raises thorny issues regarding valuation and post-termination activities it is recommended that everyone involved be given an opportunity to seek their own independent counsel before actually signing the documentation relating to the termination.

Of course, a partner or member may terminate his or her interest in a partnership or LLC by selling the interest to one or more of the other owners and it is recommended that the parties contemplate this possibility at the time the partnership or LLC is formed and organized and include a “buy-sell” or “buyout” provision in the partnership or operating agreement, or in a separate buy-sell agreement, to establish procedures for completing the transaction fairly and efficiently. A full discussion of issues relating to partnership and LLC buy-sell agreements is provided in Business Transactions Solution §§ 28:1 et seq. and §§ 29:1 et seq., respectively, and examples of agreements for the sale and purchase of ownership interests between partners or members are provided in Business Transactions Solution§§ 25:1 et seq..

Dissociation is often accomplished with funds provided out of the assets of the partnership or LLC.  While the partnership or operating agreement might include procedures to be followed in connection with the complete liquidation and redemption of an ownership interest, it is common to prepare a separate ownership interest redemption agreement to ensure that the parties cover all the issues that might arise in connection with the dissociation and resulting termination of the partner’s or member’s interest in the entity.  For examples, see Business Transactions Solutions §§ 26:94, 26:131 (partnership) and 26:132 (limited liability company).  Among the issues to be covered in an ownership interest redemption agreement are the effective date of the withdrawal; the amount, form, and timing of the consideration to be paid to the departing owner; the allocation of responsibility for debts and liabilities of the entity incurred prior to the effective date of the withdrawal; tax treatment of distributions to be made to the departing owner; representations and warranties of each of the parties; indemnification and releases and, of course, miscellaneous matters such as governing law and notice procedures.  Other forms that may be used for the withdrawal of a partner or member and the liquidation of such owner’s interest in the entity can found at Business Transactions Solution §§ 26:133 et seq.

Depending on the situation the parties may need to draft and execute additional agreements to document the terms of the redemption or liquidation.  For example, if a portion of the purchase price is to be paid in installments the drafter will often prepare a promissory note to formalize the terms of the future payments and a security agreement that describes the collateral pledged to secure the obligations of the entity to make the future payments including, in some cases, a pledge of the ownership interests of the remaining partners or members.  See examples of these documents at Business Transactions Solution §§ 26:137 (promissory note) and 26:138 (security agreement).    If appropriate and desired that dissociating partner or member may be required to be execute a noncompetition agreement that set out post-dissociation covenants restricting the right of the dissociated owner to compete in the same business or profession and/or within specified territorial and temporal limitations.  For example, see Business Transaction Solution § 26:139.

Another step that should be taken, particularly when the situation involves the liquidation of a dissociating member’s interest in an LLC, is execution of a formal authorization to liquidate that includes affirmations by the remaining members that they have verified that payments to the dissociating member will not impair the capital of the LLC in a manner that runs afoul of applicable statutory requirements similar to those imposed on corporations when they are paying dividends and/or redeeming shares.  For an example of such an authorization, see Business Transactions Solution § 26:140.

Dissociation may also occur upon a decision by the requisite percentage of the partners or members to expel another owner.  The partnership or operating agreement may provide that the offending owner must first be given written notice that he or she is subject to expulsion.  For examples of such a notice, see Business Transactions Solution §§ 26:126 (partnership) and 26:127 (limited liability company).  The notice generally must be given no less than a specified number of days before a vote is to be taken, must specify the ground for expulsion, and must indicate a time and place at which the owners will meet to discuss the matter of expulsion and vote on it. At that meeting, the owner in question may be provided the opportunity to defend the action giving rise to the expulsion, including the right, within reasonable time limitations, to present reasonable evidence and have owners or other persons speak on his or her behalf. If, after due consideration, the partner or member is expelled, a formal notice of the action should be delivered to him or her (for examples, see Business Transactions Solution §§ 26:128 (partnership) and 26:129 (limited liability company)).  A unanimous decision of the owners to expel one of their members is not necessary if the partnership or operating agreement makes other provisions. For example, the partnership or operating agreement can provide for the expulsion of an owner upon majority vote of the owners or an executive committee or based upon the decision of a single managing owner. Whether or not a majority (or other percentage) of the owners favor expulsion of another must, of course, be determined without counting the vote of the owner whose exclusion is under consideration.

Further details regarding the procedures relating to dissociation of partners and members are available in Business Transactions Solution §§ 26:1 et seq.