Commencing a business venture brings excitement, yet the journey can swiftly turn stressful if the co-owners encounter disagreements. This scenario is particularly common in closely held entities like LLCs, especially with two equal partners. To navigate such situations effectively, it’s crucial for key agreements such as LLC operating agreements, bylaws, or buy-sell agreements to incorporate deadlock provisions.
Deadlock provisions serve as clauses within agreements, delineating actions to be taken should members encounter an impasse in making critical decisions due to a deadlock.
Deadlocks arise when members reach a standstill on crucial matters, such as the business’s direction or profit allocation. These provisions can entail procedures for resolving deadlocks, such as mediation or arbitration, or protocols for LLC dissolution if resolution proves unattainable. Additionally, they may outline processes for buying out a member’s interests or, in certain cases, removing a member contributing to the deadlock.
Two recent cases, In re: Dissolution of Doehler Dry Ingredient Solutions, LLC and James H.Q. Davis Trust vs. JHD Properties, LLC, demonstrate why it’s so important to have customized, considered and well-drafted deadlock provisions in your operating agreement or bylaws, whenever you have more than one owner, investor, or member of your business.
In the first case, In re: Dissolution of Doehler Dry Ingredient Solutions, LLC, a court denied a request for judicial dissolution because the LLC operating agreement contained a buyout option in the event the members were deadlocked on a material decision. This buyout option allowed any member to deliver written notice to the other members proposing a purchase price for the units, and after receiving the notice, the other members must either buy all of the electing member’s units at the offered price or sell all of their units to the electing member at the offered price.
In the second case, James H.Q. Davis Trust vs. JHD Properties, LLC, a court denied a motion to dismiss a request for judicial dissolution. The two managers of LLCs that owned undeveloped land disagreed on the proper management of the LLCs and the court found that the allegations were sufficient to show that it is not practicable to conduct the LLCs’ business in conformance with the operating agreements. This was due to the deadlock on the use of the land and the lack of a mechanism in the LLCs’ operating agreements to break the deadlock.
These cases demonstrate that having custom, clear, and well-considered deadlock provisions in your LLC agreement is not only important, but can be the difference between a successful business and one that gets tied up in court or unable to move forward in the event of a conflict among the partners. When creating an LLC agreement, it’s important to consider how you’ll handle conflict, and even an exit of the business, not just how you’ll enter the business. Buyout provisions should detail a method for getting to a buyout price, just as with any other buyout event (e.g., death, permanent disability, or retirement). The agreement should also specify the payment provisions, such as payments can be made over x years at y interest rate. And, the terms under which a buyout may occur.
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