Many Tennessee Limited Liability Companies (“LLCs”) are set up, for whatever reason, so that their operating agreements do not provide for the buying out or expulsion of a member, whether pursuant to a mandatory buy-sell clause or pursuant to a clause that sets forth conduct which is grounds for expulsion. In fact, quite a few Tennessee LLC’s have members who have never executed an operating agreement.
If there is no mandatory buy-sell provision in an operating agreement for an LLC pursuant to which a member can be forced to sell his or her interest (or to buy out someone else’s), members looking to get rid of another member must look to the provisions of the Tennessee Revised Limited Liability Company Act (the “Act”). The Act, T.C.A. §48-249-503(6), provides the limited circumstances which permit a court to expel involuntarily an LLC member. They are:
- Where the member has engaged in wrongful conduct that has adversely and materially affected the LLC’s business
- Where the member has willfully and persistently committed a material breach of the LLC documents
- Where the member has willfully and persistently committed a material breach of the duties owed by the member to the LLC or to the other members, as set forth in T.C.A. §48-249-403
- Where the member has engaged in conduct relating to the LLC’s business that makes it not reasonably practicable to carry on business with the member
As of this blog, there is no opinion from any Tennessee appellate court which applies, or further explains, the above statute. Some conduct would obviously warrant expulsion under the above statute, e.g. stealing from other members, a criminal conviction for a felony involving dishonest conduct, or repeated and intentional usurpation of opportunities available to the LLC. There is, however, quite a bit of gray area when it comes to what a Tennessee court could determine amounts to circumstances justifying an expulsion under the above statute. The case law from other states which interprets the above statute (which has been adopted uniformly by many other states) is also rather limited.
If a member is terminated under the above statute, it is also unclear as to whether the member must give up both his financial interest and governance interest, or just his governance interest. While an expelled member may not want to retain his or her financial interest given the loss of his or her governance interest, the wording of T.C.A. §48-249-505(a)(1) leaves room to argue that an expelled member may, nevertheless, retain his or her financial rights in the LLC.
My bet is that, when a Tennessee appellate court is called on to do so, it will interpret the Act as requiring a member expelled under T.C.A. §48-249-503(6) to give up his or her financial and governance interest in the LLC.
T.C.A. §48-249-506 provides what an expelled member must be paid for his or her membership interest (which would include financial and governance rights). That statute requires that the member be paid “fair value” for his or her interest.
It is critical to understand that “fair value” is not the same as “fair market value,” and it can be assumed that, even though the Act does not define “fair value,” its use of “fair value” instead of “fair market value” was intentional. In the context of the valuation of LLC membership interests, “fair value” is, generally speaking, “fair market value” with value then adjusted upwardly to account for the fact that an LLC member’s interest may be a minority interest and for the fact that there may be no real market for an LLC member’s interest like there is for, say, the stock of a publicly traded company.
T.C.A. §48-249-506 lays out several factors and methods a Tennessee court may use to determine the fair value of an expelled LLC member’s interest. One of those methods, and the one I have seen used frequently, is for the court to choose an independent appraiser to value the interest. If the court invokes that method, expect for it to require both the expelled member and the expelling entity to share the costs of the court appointed appraiser.
For Tennessee lawyers who handle LLC disputes, knowing the basics about the above statutes is important as is understanding the broad discretion a Tennessee court will have not only with respect to expelling an LLC member, but also, with respect to valuing his or her LLC membership interest.