The Business Divorce Law Report
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Limited liability company statutes often require the unanimous approval of the members before actions may be taken outside the ordinary course of business or for any amendment of the Operating Agreement.
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The requirement for unanimous action creates a minority veto – any member can veto the actions of the majority – often leading to deadlock.
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States that have adopted the Uniform Limited Liability Company Act, including New Jersey, Pennsylvania and Connecticiut, require unanimous actions. Other states, including Delaware and New York, permit major actions to be taken by simple majority vote.
These days we’re seeing a political world in which we have a national politics that is very, very closely divided, and one or two people have tremendous control over the rest of the country. It’s not just the Congress, but over everyone. And they’re basically, even though they only have one vote, they’re able to stop things, able to derail a process. They have a minority veto.
And that’s what I want to talk to you today about. It’s the minority veto that comes up in the small business world and how it affects limited liability companies, partnerships, sometimes corporations — how it affects their ability to stay in business and how it affects their ability to continue ordinary operations.
Let’s begin with the idea of what’s a deadlock. Deadlock is the inability of the owners of a business to make decisions that are, lawyers would say, material. That means really important to the continued operations in the business.
And you can find yourself very quickly in deadlocked circumstances depending on which state you’re in. In any given circumstance where the laws that govern the operations of a partnership, that govern the operations of a limited liability company, they set aside a class of decisions that the legislature has said are so important that everybody has to agree.
It’s important to understand that the the rules for corporations are different because corporations are creatures of statute. The legislature in each state came up with a corporations code and it created this legal fiction, this entity known as a corporation. A corporations is a legal person, but it’s a legal construct as well, and so it’s a creature of statute. And the statutes in most states are very detailed about such things as mergers and approving mergers and all sorts of decisions that are really critical to the continued operation of the business.
The other kinds of business, the unincorporated business association they are called — and that includes limited liability companies, partnerships, general partnerships, limited partnerships, joint ventures, other kinds of businesses that are not corporations. They are different because they’re creatures of contract. So in a partnerships — say four people decide they’re going to be partners together. When people decide they’re going to be partners together, that’s really a contractual relationship.
A limited liability company – again four people decide that they’re going to form an LLC – it’s clear that this is a contractual relationship. What is one of the key aspects of a contract? That you can’t change it without people agreeing. So if you have four people who form a limited liability company and in forming the limited liability company, the four people have an operating agreement. That’s a contract and you can’t, three of them can’t change it over the objection of one or the others unless that’s something that they’ve all agreed to.
So most states require a unanimous vote, a unanimous agreement to change the operating agreement. Likewise to change s partnership agreement requires unanimous agreement. It doesn’t have to be in the best interests of everybody else involved. Most of the time when it comes to ownership issues like this, you’re an owner, and you’ve got a right to vote and pursue your economic self-interest within the confines, the context of that business.
There are exceptions. For example, in New York, the limited liability company law provides for amendment of an operating agreement by majority vote. That’s rare. Certain kinds of decisions can be made in New York by majority vote that require unanimous decisions elsewhere.
One of issues that comes up a lot in limited liability companies and partnerships is who gets to be an owner. And the general rule is that nobody else is admitted, nobody else gets a seat at the table unless everybody in the company says it’s okay. Everybody has to approve. So if you want to make a new partner in a business, all the other partners have to agree. If you want to admit a new member, all of the members of the limited liability company have to agree. And that really comes from this concept in the closely held business that I refer to as the pick your partner rule. When you’re working so closely on a day-to-day business and you own this enterprise with a handful of other people, the idea is that no one should be forced to do business in that close of a relationship with somebody that they don’t want to do business with. So you have this idea of pick your partner, everybody has to agree.
It’s not unusual in a limited liability company to have an operating agreement that’s been drawn with a provision that provides for compelled purchases and sales. There’s a buy sell agreement that are triggered by deadlock. The other thing that happens frequently is that these cases lead to litigation.
We constantly are writing about this, looking at the issue of how courts are going to step in and deal with a company that’s deadlocked. cases. Sometimes they close the doors. In some cases they sell the business. In some cases, the people in the business sell to each other.
If you if you have a circumstance in which a limited liability company or a partnership agreement, and you’re involved in one and you don’t have any kind of provision for that, it is always a good idea to get a lawyer to take a look at the issue, along with all the other issues that are involved in involve running a limited liability company, running a closely held business. Because once people get locked into a position, it is very difficult to change their minds. So if you have ale where somebody has got a minority veto and they decide to exercise it, that is not the time to think about trying to redraw agreements. Because it just it never works.