New York Business Lawyers

A critical but often overlooked LLC operating agreement provision is the “Member Withdrawal” provision. In New York as well as other states, an LLC member is not allowed to withdraw (in other words, leave the LLC and be compensated despite the departure) from the LLC, unless the actual written operating agreement specifically provides the right for such withdrawal. New York Limited Liability Law Section 606.

To setup the New York LLC to allow for withdrawal of a member, there are several critical factors that should be addressed.  These are 1) the mechanics surrounding the withdrawal (i.e., the when’s, where, and how’s of how the withdrawal actually plays out, including how notice is provided to the LLC); and 2) how does the withdrawing member get compensated for his or her former stake?

And, as always,  compensation is a complicated question. In New York, in the event the LLC operating agreement does not specify a compensation formula for the withdrawing member, the LLC law states the withdrawing member is to receive “fair value” for his or her LLC interest. New York Limited Liability Law Section 509. While this seems like a robust approach in the abstract, this is a recipe for potential disaster.  The “fair value” concept can be construed in a variety of ways, thereby leading to friction.  Without a clear calculation for assets, especially in the closely held company context, the LLC can find itself in a serious bind.   Moreover, third party valuation can be a difficult and costly process that results in a multitude of conflicting figures.    In the alternative, the LLC can craft custom calculations and approaches for certainty.   One such approach is to simply return the withdrawing member’s capital account. Another approach is to take multiples or fractions of that capital account or the member’s ownership interest. Hypothetical Example:  1) take the withdrawing member’s capital account and multiply it by 1.5X; or 2) the LLC profits for the prior three years multiplied by 3, but prorated against the member’s ownership percentage.