Statutory Balancing of Interests of Continuing and Outgoing Owners of Partnerships, Limited Partnerships, LLCs and Corporations Upon Separation
S. Timothy Buynak, Partner
The concept of “disassociation” has now been legislatively inserted in California statutes governing partnerships, limited partnerships, LLCs and corporations, thereby providing an established process and valuation approach when business owners elect to end their association.
Business breakups are always difficult. Owners who have worked together, sometimes for decades, are at odds. Emotions flare and litigation is usually the result, unless there is an existing agreement that determines how breakups are processed and how the departing owner(s) interest is valued and paid. Such agreements are an important part of an entity’s organizational documentation.
California legislature has recently provided statutory guidance for business breakups, including the insertion of a new “disassociation” concept. All agreements governing business separations upon death, withdrawal, or other separation of the owners or the sale of their ownership interests, should be reviewed for compliance with California’s new statutes.
Partnerships – Disassociation Cannot Be Waived. For partnerships, a partner is disassociated upon the occurrence of actions ranging from a partner’s withdrawal to the partnership’s expulsion of a partner. It might occur simply by a partner’s statement to the partnership that “I am out of here; buy me out”. The right of disassociation for the departing partner and remaining partner(s) cannot be waived so partnership agreements should be revised to accommodate this new concept. Upon such disassociation, the departing partners’ interests are valued at their “buy-out price”, a new statutory term, meaning the departing partner’s percentage ownership of the partnership’s market value, without any discounting.
Limited Partnerships – The statutory approach for breakups of limited partnerships is similar to that of partnerships. However, the right of disassociation may be waived. Otherwise, for limited partnerships, the right of disassociation overlays the existing terms of the limited partnership agreement. Each limited partnership should consider whether a departing general or limited partner should be retained or rejected and on what financial terms — and it might be different according to the type of disassociation.
Corporations – Liquidation Value of the Departing Shareholder’s Interest. While there can be a voluntary dissolution of a corporation by owners of 50% or more of the company, an involuntary dissolution occurs upon a showing of certain types of wrongful conduct by those in control of one-third of the company’s ownership or upon election of one-half or more of the corporation’s directors. Upon an involuntary dissolution, the remaining shareholders can continue with the corporation and buy-out the electing shareholder(s) at “fair value”. Again, this is a new statutory terms meaning the departing shareholder’s percentage of the liquidation value of the corporation if it were sold under distress and with discounts. A revised shareholder/buy-sell agreement is appropriate, with the consideration of these new statutory concepts.
Limited Liability Companies (LLC) – Revised Uniform Limited Liability Company Act (RULLCA). The concept of disassociation has been included in the new RULLCA legislation governing all LLCs. The right of disassociation are similar to partnerships, but can be waived. Valuation of the interests of the outgoing LLC members are valued at “fair market value” meaning the highest market value of the interest without discounts or illiquidity considerations. All LLCs operating agreements should be reviewed in light of the new statutory scheme under RULLCA.
Summary. For the breakup of California partnerships, LLCs and corporations, a new statutory scheme has been implemented by the California legislature. Shareholder/Buy-Sell Agreements are of paramount importance to implement the desires of the owners of a business and avoid the harsh elements of the new legislation, if possible, and if desired. We look forward to drafting, reviewing and/or revising your Shareholder/Buy-Sell agreement for each of your business entities, to fairly implement the exit strategies desired by your business and its owners. It is critical that such agreements are in place and are current. These should be accomplished now and not when a partner, member or shareholder is on the verge of leaving.
S. Timothy Buynak, Parntner