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Minority Member Squeeze-outs in Limited Liability Companies
Limited liability companies have become increasingly popular and are now one of the most common forms of closely held businesses. To the average person, a closely held limited liability company looks and operates very much like a closed corporation. One similarity that that minority interest members in an LLC, just like minority owners in a closed corporation, are at risk of being squeezed out or frozen out by the majority or controlling member or members.
In the context of an LLC, a squeeze-out involves reducing or eliminating entirely a minority member's income and involvement in the business[, often with that income being funneled to the controlling member or members]. Whether the controlling members is able to successfully squeeze out a minority member or whether the minority member can fight off an attempted squeeze out often comes down to how well the operating agreement is drafted, how authority is delegated, and what constraints are in place to check the power of a controlling member intent on oppressing minority members. The Illinois Limited Liability Company Act imposes fiduciary duties on controlling members which act to place additional constraints. Any person considering purchasing a minority membership in an LLC or facing an attempted squeeze-out should consult an experienced shareholder oppression and business divorce attorney.
Governance arrangements in LLCs are largely the product of the members’ contract—such as the operating agreement—along with the Illinois LLC Act and judicial opinions. The Illinois LLC Act, like the LLC statutes of most states, statutes draw on both partnership and corporate law statutes and common law antecedents. The modern trend has been to move more toward more corporate law doctrines. Accordingly, Illinois courts regularly rely on closed corporation precedents in interpreting the Illinois LLC Act. In contrast, Delaware courts regularly refer to the state’s limited partnership act when interpreting the state’s LLC statute as its LLC statute was modeled on the limited partnership act.
Initially, most LLC statutes were designed to insure qualification for favored tax treatment from the IRS. However, in the mid-1990s, IRS policy changed making it easier to qualify for pass-through tax treatment through a simple “check the box” election rather than requiring review of the entity’s governance features. As a result, state LLC statutes have morphed. Certain changes have not favored minority members such as a shift away from the “easy exit” approach of partnership toward a more corporate-like approach, making it more difficult for a member to separate particularly where there is not a readily available market for the member’s interest.
This can be remedied by including provisions in the operating agreement that provide clear procedures for valuing and selling a member’s interest. It is best for an individual considering whether to form an LLC as a minority member to consider these exit strategies at the outset of the relationship and negotiate the inclusion of provisions detailing the circumstances in which a member’s interest may be sold and how the parties will go about calculating the value of the member’s interest in the event the minority member’s interest will be purchased by the LLC or another member or members. It is also advisable for the operating agreement to spell out how, in the event the LLC buys out a member, the capital accounts of the remaining members will be adjusted to spread out the departing member’s interest.
A frequent squeeze-out technique, once a falling out among co-owners of a business has occurred, is to eliminate the minority participant as an employee or as a member or manager of the company. Sometimes the controlling members will attempt to eliminate the minority member’s participation in the company without eliminating that individual’s ownership interest in the business. Courts, however, have held that it would be inequitable to allow the controlling members to preclude a minority member from participating in the company's business while at the same time claiming that person remains a viable member.
Our Chicago minority shareholder and LLC member dispute attorneys have litigated member and shareholder oppression, business divorce, stolen corporate opportunity and breach of fiduciary duty lawsuits for more than three decades. We have prosecuted and defended LLC member or shareholder squeeze-out and freeze-out cases in a wide variety of business contexts. We spend considerable time going over all the business and accounting issues to develop a comprehensive strategy for prosecuting and defending the claims that arise in the case.
Serving clients in Chicago and beyond, our business litigation attorneys have acted as lead counsel in accounting actions including a complex dispute involving tens of millions of dollars in damages that was resolved through an extended multi-year trial where we worked closely with the accounting and damages experts to develop winning strategies. We also have a great deal of experience finding accounting irregularities with assistance of forensic accountants and then locating and interviewing witnesses to confirm those irregularities. We then present them to the court in plain and clear manner so that our client will have the best chance of succeeding. Having worked with many different accountants we have developed successful strategies for presenting the complex accounting and capital structure issues in a manner that portrays our client’s position in the best manner to the court. We offer free consultations to let business owners, shareholders or LLC members decide if we are the best attorneys to represent their interests in complex shareholder or LLC freeze out litigation. We take the time to learn about your business and the issues it faces and let you decide if we are the best qualified lawyers to represent you. To set up a consultation with one of our Chicago LLC member dispute attorneys and Chicago business trial lawyers, please call us toll-free at 833-306-4933 or contact us online.