Understanding Your Membership Rights in an LLC
What Rights Does an LLC Member Have in a NJ LLC?
A membership agreement in a NJ LLC is a contractual relationship between two or more persons as co-owners of an enterprise called a Limited Liability Company. It is a voluntary association that cannot be forced upon a member without the member’s consent. The membership agreement can be verbal or in writing.
A written membership agreement is the foundation document for member rights and obligations, supplemented by those provisions of the revised NJ Limited Liability Company Act and other applicable laws. A membership agreement in the LLC need not be in writing unless it falls within the Statute of Frauds, which mandates that certain agreements be in writing to be enforceable, or if the terms of the agreement are so complicated that it must be reduced to writing for a proper understanding of its terms, in the event of a dispute. For a thorough discussion of what the Statute of Frauds means, visit our related site, NJ Contract Law.
Subject to the terms of the member agreement, the day-to-day business of the company is conducted by the members as agreed. Generally, decisions are made by a majority vote.
It is strongly recommended that all LLC membership agreements be in writing to reduce controversy and contested issues inherent in verbal agreements.
Who Can Become an LLC Member?
There are no legal restrictions on who can become a member of an LLC, except that a minor (a person under 18 years of age) cannot become a member. A person or other legal entity becomes a member in accordance with the terms of either a membership agreement or an operating agreement. Both terms are interchangeable and refer to the same entity and the agreements reached between the members.
Conditions and limitations on membership in the LLC are, if any, governed by the written or verbal operating agreement of the members, or, if none exist, by the terms of the admission of a new member. If the membership or operating agreement is a verbal agreement between the members and no written agreement has been prepared and signed, then when a person becomes a member, they become an “actual member” only upon the approval of all existing members. An interested person can purchase an interest in an LLC by way of cash, services in lieu of cash payment (often called “sweat equity”), a promissory note, or any form of consideration agreed to by the LLC and/or the selling member.
Understanding Membership Rights in an LLC
Who Runs the Affairs of the LLC?
Unless the operating agreement provides to the contrary, the rights and obligations of each LLC member(s) is/are coequal under the law. You can have passive members who assume no active involvement in the company’s operations, except that NJ law permits passive members to vote for a managing member(s) and/or officers. If the members are active members, unless limited in the operating agreement, they have equal rights in the management, access to, and inspection of the LLC’s books and records, and to a formal accounting of the company’s affairs. A member’s interest in the company’s assets and property is not assignable or subject to attachment or execution to satisfy personal obligations, but their membership certificates can be seized by creditors.
An LLC Member is a Fiduciary to His or Her Co-Members
As a member of a New Jersey LLC, it is important to understand a legal term called a “fiduciary relationship”. A fiduciary relationship is one based on trust, confidence, loyalty, and good faith between LLC members. The law imposes this standard unless modified in writing. All members of the LLC owe a reciprocal fiduciary duty to the other members of the LLC.
New Jersey law allows any member who is a victim of a co-member’s breach of fiduciary duty to take legal action. These claims arise if a member, typically a majority member or members, operates the business in a manner that is detrimental to the minority members of the company. For example, the majority of members cannot involve the company in a business venture merely for their own personal gain. All decisions by majority members on behalf of the company must be made in good faith and in the company’s best interests.
It is important that all members understand that the fiduciary duty of good faith and fair dealing requires honesty and transparency. The majority of members must provide proper information regarding business decisions to all minority members. If they give false, misleading, or intentionally inaccurate information, they can be subjected to a claim of breach of their fiduciary duty. When a member brings a breach of fiduciary duty claim questioning a transaction, and where most members gain a significant profit, the burden of proving that the transaction was fair and equitable for all members falls on the majority member(s).
Legal Liability of an LLC and Its Member(s)
An LLC can be legally liable for any wrongful act of its member(s), within the ordinary course of LLC business. The LLC can also be liable for any breach of trust by its member when dealing with a third party if it is within the scope of his or her (apparent) authority as a member. If there is any limitation or restriction on the right(s) of a member to represent the company, enough notice must be given to third parties dealing with him or her, if liability by the company is to be avoided.
Resignation as an LLC Member
New Jersey law allows a member to resign from an LLC if permitted in the operating agreement. Generally, a written operating agreement will discuss resignation and/or withdrawal by a member(s), but if the operating agreement is silent on this subject, a member may resign on at least six months prior notice to the LLC and to the other member(s) but keep in mind, if the operating agreement prohibits the resignation of a member(s) prior to the dissolution date specified in the Certificate of Formation, a member can be “stuck” in the LLC until the date specified in the operating has come and gone, if the other members will not release him or her.
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Individual members of an LLC are not (generally) personally liable for the obligations of the company. Therefore, a member’s personal assets may not be levied upon or attached by creditors. A member of the company, to the extent that he/she is required to satisfy a company obligation personally while acting as a member, is then entitled to proceed against the company to recover, by contribution and reimbursement, his/her economic loss.
The Limited Liability Company, as a business entity, is liable for any contract, obligation, and commitment made by its authorized members. It is also liable for any tort committed by a member within the scope of the member’s authority.
A newly admitted member is liable for the debts of the LLC only to the extent of his/her capital contribution to the company, even for obligations that predate his/her admission.
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—Mike Halsey, Middletown, NJ
What Happens if One of the Members of Your LLC Breaches the Membership Agreement?
Sometimes, members of an LLC may need to discharge a member for breach of the LLC agreement.
All membership agreements should include a clause that allows members to do just that. The power of expulsion is a key component of any agreement. It should set out the circumstances under which a member can be expelled, how the decision to expel the breaching member will be made (usually by a majority vote), and finally state that the LLC will continue to operate without the expelled member. The agreement should also set out the terms of payment (if any) for the discharged member’s interest in the company.
TESTIMONIAL
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A membership agreement can also address what happens when there is a change in the relationship among members, such as the death or retirement of a member.
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On application to a Court, if a member becomes incapable of performing his agreed-upon obligations, or is guilty of conduct which prevents the continuation of the business, a court order dissolving the LLC membership agreement may be entered.
Contact me personally today to meet and discuss your LLC matter. I am easy to talk to, very approachable, and can offer you practical, legal ways to handle your concerns. You can reach me at (732) 863-9900 or e-mail me at fniemann@hnlawfirm.com.
Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a New Jersey LLC Law Attorney