Published on November 8, 2023
Because of flexibility and reduced formalities, Limited Liability Companies continue to be a popular form of business organization for Texas entrepreneurs. It offers flexibility and potential tax advantages, but foresight, planning, and consideration of the business and structure of the LLC still need to be sorted out before the new business starts. Interestingly, analysis is even needed when dealing with a two-member LLC. Everyone’s intentions and interests are aligned to begin, but how are disagreements resolved with a two-member, 50-50 LLC? Your LLC Operating Agreement should be tailored to implement fair and quick resolutions of disputes.
Multi Member LLC Disputes- All Dispute Resolution Provisions Should Not Be Created Equal
Oftentimes, the Dispute Resolution Provisions (DR Provisions) used in an LLC Company Agreement or Operating Agreement typically state that if there is a dispute between members of the LLC they agree to go to a mediation first. If that’s not successful, partners go to arbitration. Many provisions even pick the mediation service and/or arbitration service to use. These provisions are useful in certain situations, but sometimes two-member LLCs would be better served by an inexpensive and accelerated preliminary procedure. For example, if the two members simply decide to “go their separate ways,” a preliminary step might be useful. Possibly, the members have a mutual mentor that they trust and respect. If the mentor agrees, a short preliminary meeting with the mentor to resolve issues that arise from a simple division may be the most efficient and successful method.
On the other end of the spectrum, LLC members can be so distrustful of one another that they cannot even agree on a mediator or arbitrator to use. In this situation, a tiebreaker provision would be useful to trigger the selection of a mediator and/or arbitrator. Mediation and arbitration services usually provide a manner to resolve this issue if no agreement can be reached. The third-party “mentor” discussed above could also be used as a tiebreaker in these situations. Disputes with two-member LLCs can be different that disputes from within multi-member LLCs.
Push-Pull Provisions in 2-Member LLCs
A fairly common process to resolve disputes, especially with a two-member, 50-50 LLC, is a buy-sell provision that is incorporated in your LLC’s operating agreement. This provides a procedure for one member to offer to buy the other member out. If the offer is rejected, then the other member must buy the offering member out for that price. Such provisions can be efficient but often lead to future disputes and may not completely resolve all issues.
Who Owns the IP and Trade Secrets in a Limited Liability Company?
In today’s world, every business has a website, a logo, customer lists and potential trade secrets. The members will build the IP and trade secrets together, but what happens when the members decide to go different directions? Some divisions, such as personal assets, are easy to divide because they make sense. Agreements are typically easy when the member has her own set of customers and associated trade secrets for those customers.
The challenge is finding a formula or agreed-upon process to divide up assets commonly owned by and controlled by the business entity — the IP and Trade Secrets. The issue of division should ideally be discussed by the prospective LLC members and incorporated at the beginning of the Limited Liability Company. In addition to setting the LLC business structure, a plan should be made about what to do in the event of a dissolution. The wisdom of Solomon may not be available later, and a plan should be included in the Company Agreement right when the business entity is formed to address the issue.
In any event, the members should consider an up-front agreement to identify all IP and Trade Secrets as assets of the LLC. Non-compete agreements should also be considered and implemented at the beginning. On rare occasions, a renegade member may decide to depart and take all the IP with him to compete against his former LLC. The argument goes that there was no non-compete agreement between the members of the LLC so the existing business partner rationalizes he can just take the IP and trade secrets because he helped create it.
While Texas case law exists that tends to favor the former LLC in such a dispute, an agreement that all IP and Trade Secrets used by a multiple member LLC are owned by the LLC and cannot be used for any other purpose, could help address this potential risk at the beginning of the relationship. If you are thinking of forming an LLC with two or more members, then first reach out to Wade McClure today for sound legal advice and business solutions. Wade McClure also represents LLCs and its members when another member takes IP or Trade Secrets to compete against the LLC
LLC Members – Should She Stay, or Should She Go?
At times, a member’s conduct may require his removal from the LLC. Member removal provisions are common in Company Agreements but typically require a “super” majority vote in a multi member LLC. Such provisions are useless in a two-member LLC or where there are two equal groups of members.
A foreseeable situation exists when one of the two members is primarily in charge of the bookkeeping for the LLC and gets caught with his hand in the cookie jar of the business’s profits. The member has to go, but how can he or she be removed quickly and still have their other membership rights protected? The typical process would be to “lawyer up” and head down to the Courthouse for a TRO to remove the member. Thought should be given to how to handle this process without the time, costs, and risks associated with going to court. One possible solution could be to implement a self-help procedure to block the member’s access to the bank accounts until mediation or arbitration takes place. In such a situation, an accelerated process would be the most advisable.
Consider These Issues Before Forming a 2-Member Limited Liability Company
This article discusses only four types of issues for two-member, 50-50 LLCs. Many more situations could arise for any LLC — whether it has two or 100 members. Some common legal issues may include questions about personal assets, business income, business licenses, income tax, business taxes, personal asset protection, and partnership income.
The best approach is to go into business with people you trust and discuss resolutions to potential issues at the beginning of the relationship. While every company agreement will have flaws that can be manipulated, detailed provisions and the implementation of a “mentor, mediator, arbitrator” dispute process may be the most efficient and cost-effective way to go. Without it, you could face a lot of stress and legal fees if a member in your LLC decides to break up. Multiple owners don’t need to mean multiple headaches! Whether you are considering forming an LLC or other business venture, or whether you need advice in regard to a business breakup dispute, arbitration or litigation, Wade McClure at Mayer LLP can help you find the solution for you. Contact us today for more information.