Amendments to the Limited Liability Company Act Provide Members with New Buyout Remedy
December 1, 2018
While members of limited liability companies form their companies with the intention of productively working together, the development of disputes between members is common. When those disputes cannot be resolved, it often makes sense for one or more of the members to exit the company. The exit may be accomplished through the redemption by the company or the purchase by the remaining members of the departing member's interest.
Often a limited liability company's operating agreement will provide a mechanism for members who no longer wish to remain members to exit the company by requiring the company to purchase their interests and will provide an agreed upon method for valuing those interests. However, where the company's operating agreement does not address the situation in which a member wishes to exit the company and where the remaining members will not voluntarily agree to purchase or to have the company redeem the departing member's interest, members of Illinois limited liability companies must look to the Illinois Limited Liability Company Act (the LLC Act), 805 ILCS 180/1 et seq., to determine their right to exit the company through the forced purchase of their interests. Amendments to the LLC Act that became effective on July 1, 2017 have provided a new right to members of Illinois limited liability companies, dissociated members, and transferees of distributional interests, in certain situations, to petition a court for an order requiring that their interests be purchased.
As amended, section 35-1(a)(4) of the LLC Act provides that members or dissociated members of limited liability companies may petition a court for an order requiring the buyout of their interests where: the economic purpose of the company has been or is likely to be unreasonably frustrated, the conduct of all or substantially all of the company's activities is unlawful, or it is not otherwise reasonably practicable to carry on the company's business in conformity with the articles of organization and the operating agreement. Additionally, section 35-1(a)(5) provides that members or transferees of distributional interests may petition a court for an order requiring the buyout of their interest where the managers or controlling members have acted, are acting, or will act in a manner that is illegal or fraudulent or the managers or controlling members have acted or are acting in a manner that is oppressive and was, is, or will be directly harmful to the applicant.
Even prior to the recent amendments, section 35-1 provided members with the right to seek judicial dissolution of the company where situations similar to those that now entitle members to seek a court ordered buyout existed. However, dissolution of the company was the only remedy available to members seeking relief in those situations. The right to seek dissolution of the company is often not an effective remedy as courts are, understandably, reluctant to order the dissolution of a viable business.
However, as amended, section 35-1 now includes subsection (b), which provides that where a petitioning member or dissociated member has established that one of the situations listed in subsection(a)(4) exists or where a member or transferee of a distributional interest has established that one of the situations listed in subsection (a)(5) exists, the court may order alternate remedies including, but not limited to, a buyout of the applicant's membership interest. Thus, the recent amendments have imported into the LLC Act the concept of providing remedies less drastic than dissolution similar to those found in section 12.56 of the Illinois Business Corporation Act (BCA).
Section 12.56 of the BCA contains a list of eleven non-exclusive remedies that a court may order as an alternative to dissolution in certain situations including where the directors or those in control of the corporation have acted in a manner that is oppressive, illegal, or fraudulent with respect to the petitioning shareholder and where the corporation's assets are being misapplied or wasted. One of those alternate remedies and probably the most commonly ordered remedy is the required purchase by the corporation or one or more of the other shareholders of the petitioning shareholder's shares for the fair value of those shares. Section 12.56 further provides that a court may order dissolution of the corporation as a remedy for the conduct that gave rise to the petition only if the court determines that none of the eleven enumerated lesser remedies and no alternative remedy would be sufficient to resolve the matters in dispute.
In Schirmer v. Bear, 174 Ill. 2d 63, 74-75 (1996), the Illinois Supreme Court held that the circumstances necessary to support the remedy of a forced buyout of the petitioning shareholder's shares under the BCA need not be as severe as the circumstances necessary for a court to dissolve a corporation. Assuming that that principle will be applied to petitions for forced buyouts brought under section 35-1 of the LLC Act, the recent amendments to that section have provided a new exit route for members, dissociated members, and transferees of distributional interests that can establish certain economic conditions of the company or certain types of improper conduct on the part of managers or controlling members that do not rise to the level that would warrant dissolution of the company.
While amended section 35-1 does provide members, dissociated members, and transferees of distributional interests who wish to exit limited liability companies with the potential to have a court order that their interests be purchased if certain situations exist, as is often remarked, limited liability companies are creatures of contract. Therefore, members are able to draft additional provisions to reflect their agreement with respect to buyout rights.