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. It is a voluntary association and cannot be forced on anyone without his or her consent. The agreement can be verbal or in writing.
A written LLC membership agreement is the foundation for members’ rights and obligations, supplemented by those provisions of the revised NJ Limited Liability Company Act and other applicable laws. A membership agreement need not be in writing unless it falls within the Statute of Frauds, 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 the Statute of Fraud. Visit our related site, NJ Contract Law.
Subject to the terms of the written agreement, the day-to-day business of the company is performed by the members as they have agreed upon. Generally, decisions are made by a majority vote.
It is strongly recommended that all LLC membership agreements be in writing to reduce future issues that are inherent to a verbal agreement.
Who Can Become an LLC Member?
There are no legal restrictions on who can become a member of an LLC but there are issues of a minor (a person under 18 years of age) becoming a member. A person 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 to membership in the LLC are, if any, governed by any written or verbal operating agreement regarding the subject or, if none exist, then whenever any new member is approved for admission into the LLC. If the membership or operating agreement is a verbal agreement between the members and no written agreement has been prepared and signed which defines, when a person becomes a member, a member becomes an “actual member” when all the existing members approve his/her acceptance. 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 members are equal under the law. Passive investors assume no active involvement in the operations of the company except for the Voting of managing members and/or officers. If the members are active members, they have equal rights in the management, access and inspection of the books and records, and to a formal accounting of the company’s affairs. Their interest in company assets and property is not assignable, or subject to attachment or execution, to satisfy personal obligations, but their membership certificates are.
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 that you are a fiduciary. A fiduciary relationship means a relationship based upon trust, confidence, loyalty and good faith. The law imposes this standard unless modified in writing. All members of the LLC owe a reciprocal fiduciary duty to the other members within their company.
New Jersey law allows for legal action to be taken by any member who is the victim of a breach of fiduciary duty by a co-member. These claims arise if a member, typically the majority member, operates the business in a manner that is detrimental to the minority members of the company. For example, majority 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 must be made purely in the best interests of the company.
It is important that all members understand that the fiduciary duty of good faith and fair dealing requires honesty and transparency. Majority 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 fall on the majority member.
Legal Liability of an LLC and Its Member(s)
An LLC can be legally liable for any tort, or wrongful act, of a member, within the ordinary course of business. The LLC can also be liable for any breach of trust by a member, in dealing with a third party, in receiving money or property, 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 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, the personal assets of a member 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 pre-date his/her admission.
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What Happens if One of the Members of Your LLC Breaches the Membership Agreement?
Sometimes members of an LLC may find it necessary to discharge a member for breach of the LLC agreement.
All membership agreements should include a clause which allows members to do just that. The power of expulsion is a key component to any agreement. It should set out the circumstances for 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.
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A membership agreement can also address what happens when there is a change in the relationship of the members resulting from the death of a member by the retirement of a member.
On application to a Court, if a member becomes incapable of performing his part, or is guilty of conduct which prevents the continuation of the business, 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 toll free at (855) 376-5291 or e-mail me at firstname.lastname@example.org.
Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a New Jersey LLC Law Attorney