Members of a limited liability company are sometimes dismayed to learn, when they are ready to retire, that the law does not require the LLC to buy them out. Under the Uniform Limited Liability Company Act, which has applied in Connecticut since 2017, a person’s withdrawal from an LLC (which is called “dissociation,” the opposite of association) “does not entitle the person to a distribution.” Conn.Gen.Stat. § 34-255c(b).
Rather, the result of dissociation is that the member’s voting and management rights disappear, and the membership interest is converted to what is called a “transferee interest.” Conn.Gen.Stat. § 34-263b. (This is sometimes referred to informally as an “economic interest.”) As a transferee, the former member still has the right to receive distributions to which he or she “would otherwise be entitled.” Conn.Gen.Stat. § 34-259(b). So, the former member retains the right to ordinary-course distributions, but cannot force a liquidating distribution. This is a variation of the metaphor known as “golden handcuffs.”
The obvious way to avoid this situation is at the front end: including a well drafted buyout provision in the company’s operating agreement. (While the law does not guarantee a buyout, businesspeople are free to create this obligation contractually.) Ideally, that would be when the company is first set up, but the members are free to revisit the issue at any time, and if there is consensus that this type of provision makes sense, they should consider amending the operating agreement accordingly.
If there is no such obligation under the operating agreement, and if the members are disinclined to add one by way of amendment, the would-be retiree can still pursue a negotiated buyout with the other members. Most small-business owners see the wisdom of not staying partners with someone who is eager to retire, and so that kind of overture is often received positively. But in this scenario, the member who hopes to move on will often have relatively little leverage to force a deal.
Much of that leverage arises from membership status, which will be lost if the would-be retiree jumps the gun by withdrawing as a member before a buyout deal is in place (thereby morphing from full member to transferee). Unless the operating agreement says otherwise, retiring as a worker does not ordinarily require an LLC member to surrender membership status. So, “not wanting to work anymore” does not necessarily translate to “not wanting to be a member anymore.” The retiring member needs to state his or her intentions clearly.
Members have significant powers that transferees lack. Aside from voting and management rights, only a member – not a transferee – has the power to bring a derivative action on behalf of the company to redress wrongdoing by fellow members or other people. And only a member – not a transferee – has the power to bring an action to dissolve the LLC, on such grounds as pervasive wrongdoing by those in control, impracticality of continuing the business, or oppressive conduct directed to the member.
The oppression doctrine is potentially important for a frustrated member who retires from actively working in the LLC (thus losing the regular paycheck) but is unable to work out a buyout and therefore feels constrained to hang onto his or her interest in the company. A non-working member still retains the rights of an owner, including the member’s share of profit distributions. If the remaining, working, members pay themselves inflated or improper compensation, benefits and expense reimbursements, thereby draining the distribution pool, that may support a claim of oppression on the part of the non-working member. But the retiree will lose that “watchdog” power if he or she withdraws as a member.
Retirement has great implications for almost everyone. For a member of a limited liability company, there are additional dimensions that often call for input from experienced business counsel.