Stuck with a “bad” buyout formula.

Can you be bound by a “bad” buyout formula in your LLC operating agreement? Consider the following…

LLC member buyouts…

As in many states, New Jersey’s LLC law does not entitle a member (i.e., “owner”) to be “bought out” when the member “departs” from the LLC. Accordingly, it is critical for LLC members to have an LLC operating agreement (“OA”) that addresses whether a departing member will be entitled to a buyout, how the departing member’s interest will be valued, and when the buyout price will be paid. There are many well-recognized methods of valuing an LLC. The challenge is selecting the appropriate valuation method. Such can be difficult, especially if the nature or financial magnitude of the LLC may change with time.

The case…

In a recent case, members of an LLC entered into an OA that included a very clear and specific method for valuing the interest of a departing member. Many years later, the plaintiff sought to depart from the LLC and argued that the valuation formula in the OA should no longer apply. The plaintiff advanced various arguments—all of which were rejected by the court. The court held:

  • The mere fact that the parties previously used different valuation methods for financial planning, succession planning and negotiated buyouts, does not establish clear and convincing evidence that the parties intended to modify the OA.
  • The application of a clear and unambiguous contractual valuation formula that results in a lesser value than other methods does not constitute “oppression” of a minority member or a breach of the non-departing members’ fiduciary duties.

Conclusion…

While it is critical for LLC members to have an OA, merely having an OA does not foreclose the potential for disputes. Although it may be impossible to predict every eventuality, LLC members should strive to fashion an OA that will stand the test of time. Please feel free to contact me for more information about OAs or the case… Namerow v Pediacare Associates LLC.

PLEASE NOTE: This article is merely for the general interest of the reader. It is not legal advice or opinion and it does not create an attorney-client. Please call me at 973-921-0600 if you’d like to have a free initial telephone consultation or learn more about me or my practice. Thank you.