A member of a Tennessee Limited Liability Company (“LLC”) may, at some point, lose his or her membership interest, either voluntarily or involuntarily. An Operating Agreement of an LLC may have provisions which address the conditions under which a member’s interest may be terminated. If the LLC does not have an Operating Agreement, or the Operating Agreement which it does have does not contain provisions dealing with the termination of a member’s interest, then, the provisions of Tennessee Revised Limited Liability Company (the “Act”) will apply by default. (The Act’s provisions always apply, by default, where an LLC does not have an Operating Agreement). Frequently, Operating Agreements contain provisions related to the voluntary and involuntary termination of a member’s interest in the LLC.
Under the Act, an LLC member may voluntarily terminate his or her interest in the LLC. (If the member does so in contravention of the terms of the LLC’s Operating Agreement, the member may be held liable for any damages caused by such voluntary termination). As well, under the Act, a member’s interest may be terminated involuntarily by a Tennessee court under certain circumstances set forth in the Act at T.C.A § 48-249-503.
What does a member of an LLC receive under Tennessee law when his or her membership interest has been terminated, whether voluntarily or involuntarily? If the Operating Agreement provides how the valuation and payment is to be made, then its terms will control. If the Operating Agreement does not provide for how a terminated member’s interest is to be valued, then the provisions of the Act, specifically T.C.A §48-249-505, will apply.
Under §505, a member is entitled to be paid “fair value” for his or her membership interest. That term, as explained by the Court of Appeals of Tennessee in a recent decision, is not the same as “market value.” In Raley v. Brinkman (Tenn. Ct. App. 2020), two members, Raley and Brinkman, owned 50% of the membership interests of the LLC at issue. Among several rulings arising from the dispute between the two, the trial court ruled that Raley’s interest should be involuntarily terminated because of his conduct.
After terminating Raley’s interest, the trial court set about to determine the fair value of his interest. Both Raley and Brinkman used CPAs, who were both business valuation experts, to testify as to the fair value of Raley’s interest. The methods they used, and the trial court’s and Court of Appeal’s decision about which was the most appropriate, is the most significant part of the decision.
Brinkman’s expert argued that the value of Raley’s interest should be discounted for lack of marketability and lack of control. The reasoning of this position is that a 50% interest in a closely held company, like Raley’s and Brinkman’s LLC, has a very limited market unlike, for example, publicly traded stock in a large company. Regardless of the profitability and going-concern value of an LLC with two 50% membership interests, very few potential buyers, if any, would not seriously discount that value in light of the position in which they would be if they bought one of the 50% interests. Buying a 50% interest puts one in a position where there is likely to be a deadlock in the management of the LLC, and where the prospects of liquidating one’s interest in the future would be very limited (unlike, again, a publicly traded stock).
The Court of Appeals affirmed the trial court’s decision that, under Tennessee law, the determination of the fair value of an interest in an LLC should not take into account any discount for lack of marketability or lack of control. In response to Brinkman’s argument that applying a discount to Raley’s shares was appropriate because he should be punished for his wrongful conduct, the court pointed out that the statute which provides for the payment of an LLC membership interest at fair value specifically states that a valuation should not consider wrongful conduct.
The Raley v. Brinkman case resolves an issue which has been unresolved for years in Tennessee limited liability company litigation. It is an imminently fair decision and puts Tennessee in accord with most other states on the issue of the valuation of an LLC’s member’s interest.