Minority Investors in LLCs: Preemptive Rights, Expulsion, Freeze-Out Mergers, and Other Key Provisions

Description

Minority owners in an LLC are, in many ways, subject to the whim of the majority, with limited statutory and common law protection. Those considering investment in an LLC, negotiating the operating agreement, in disputes with other members, or contemplating litigation should be aware of the limitation of protection for minority members.

Most state LLC statutes do not provide minority LLC owners with preemptive rights unless their operating agreement provides for them. Likewise, many LLC operating agreements give the majority the right to make capital calls and provide for potentially severe consequences if the minority members fail to meet those capital calls.

Some LLCs have provisions in their operating agreement that allow for the expulsion of members in certain circumstances, such as, for example, upon a majority or supermajority vote of other members. In some states, including those states adopting the Revised Uniform LLC Act, an LLC can request that a court expel a member based on a finding of wrongful conduct, willful and persistent breach of the operating agreement, or that it is not reasonably practicable to continue the LLC with that member.

A freeze-out merger is a combination of transactions in which the majority owners cause the entity, through a written agreement or plan of merger, to merge with and into a new entity, with a minority owner of the original entity receiving no ownership interest in the new entity, and the ownership interest being extinguished and exchanged for cash. While the majority owner must offer the frozen-out minority fair value for their interest, if the minority disagrees with the amount offered, the only remedy is an appraisal proceeding to determine by the court the fair value of the minority owner's interest.

Listen as our panel discusses recent cases involving contractual waivers of fiduciary duties, contractual discretion, and best practices in protecting the interests of minority owners and challenging managers' actions.