How to Resolve Deadlocks in Your LLC
Membership in a limited liability company (LLC) may come with voting rights. Member voting rights are addressed in the LLC operating agreement, which typically provides that LLC members must vote on several issues that are material to the continuance of the business. A unanimous or majority vote may be required depending upon the nature of the matter voted on.
A deadlock occurs when the voting interests of LLC members are evenly split regarding an important decision. Deadlocks can bring the company to a standstill, and special action may be required to break a deadlock. Prescribed actions for breaking a deadlock are sometimes found in the operating agreement; however, if deadlock-breaking mechanisms are not included in an operating agreement, the LLC may have to turn to the courts.
LLC VOTING STRUCTURES
Unlike corporations, which are more tightly governed by state corporate laws, the members of LLCs generally have the freedom to decide how LLCs are run. Many of the day-to-day operations of an LLC are addressed in the operating agreement. An operating agreement is the LLC’s foundational contract. It describes, among other things, management structure, member obligations, and voting rules.
PER CAPITA VS. PROPORTIONATE WEIGHT VOTING
LLC members vote on important company issues, but LLCs are not necessarily democracies. The operating agreement could have a “one member, one vote” structure, also known as a per capita voting structure. Voting weight can also be assigned proportionally, commensurate with a member’s ownership share. This voting structure is similar to the majority shareholder concept found in corporations, where a single member can hold a voting majority.
UNANIMOUS VS. MAJORITY VOTING
The LLC operating agreement can further stipulate voting requirements for major decisions about the company. Although LLCs do not require votes for daily business affairs, the operating agreement may provide that certain crucial decisions must be put to a member vote. Major decisions can include things like adding and removing members, amending the operating agreement, and mergers and acquisitions.
In addition, major decisions may require more than a simple majority vote. They may require a unanimous vote, as determined by the operating agreement. Unanimous LLC actions raise the potential for a minority veto that can prevent the proposed action.
If the operating agreement does not specify situations where a majority vote and a unanimous vote are required, the default rule in that state will apply. Different states have different default rules requiring majority and unanimous votes.
DEADLOCK-BREAKING MECHANISMS IN THE OPERATING AGREEMENT
An operating agreement may have been drafted or amended to include deadlock-breaking mechanisms such as the following:
- Buy-sell agreement. A deadlock could be a triggering event in a buy-sell agreement, which is an agreement between LLC members that allows one member or the LLC to buy the interests of another member. In a deadlock, a buy-sell agreement may set in motion the sale of the deadlocked member’s interest to another member or to the LLC. However, the deadlocked member may be permitted to turn the offer around and buy the offering member’s interest for the same price and terms. That is, the member who offers to buy out the deadlocked member could themselves end up getting bought out. The threat of triggering this dramatic buy-sell showdown could facilitate a resolution.
- Tie-breaker. The deadlock could literally be broken by flipping a coin, if the operating agreement calls for such a solution. More likely, a tie-breaker will take the form of a neutral group or individual that casts the deciding vote to break a deadlock. The tie-breaker could be a professional advisor, such as an attorney, a mediator or arbitrator, or another party with an understanding of the LLC and the industry.
- Rotating vote. This mechanism allows LLC members to hold alternating, tie-breaking vote authority when there is a deadlock regarding a major decision. The tie-breaking voting authority passes from one member to the next in a rotating order.
- Partition or forced sale of the LLC or its assets. A deadlock that cannot be resolved could lead to a contractual sale of the company or an equitable divvying up of its assets. As with a buy-sell provision, the pending possibility of selling the LLC or dividing its assets could motivate a resolution of the deadlock.
- Arbitration or mediation. An operating agreement that does not have one of the above deadlock-breaking mechanisms may nonetheless contain provisions about resolving disputes using alternative methods such as mediation and arbitration.
COURT INTERVENTION TO BREAK A DEADLOCK
Absent a provision in the LLC’s operating agreement to resolve a deadlock—or when mediation or arbitration fail to break a deadlock—the remaining option is for the parties to go before a judge.
. A member of the LLC could file a petition with the court seeking judicial dissolution. Judicial dissolution means that the LLC is dissolved, or ended. Creditors are paid off and profits and assets are distributed to members. Judicial dissolution is at the judge’s discretion. It may be granted if the judge feels that there is no other path forward for the business.
However, the court also has the flexibility to take other actions that may allow the LLC to continue, including:
- Appointing a custodian to temporarily oversee business operations until the creation of a more permanent judicial remedy.
- Ordering an injunction, which is a court order that requires or prohibits specific actions. An injunction could create a path forward for the LLC, but dissolution can still be ordered after an injunction is issued.
- Ordering specific performance, which requires a party to a contract to fulfill an obligation.
- Ordering judicial expulsion of a member, or removing that member from the LLC.
Members should try to avoid litigation or judicial dissolution whenever possible. Litigation is costly and contentious, and dissolution results in the end of the company. A thoughtfully drafted operating agreement anticipates deadlock among LLC members and provides several ways to break the deadlock without resorting to court action.
Contact The Browne Firm if you have any questions. You can reach us at 914-430-4348.