This is a complex issue, but here are the main things you need to know:
1. IRS filing statistics suggest that about 70 percent of all LLCs are single-member LLCs whose members are individuals; only five percent have three or more members; and the remaining 25 percent are two-member LLCs. Thus, LLC practice for multi-member LLCs is almost entirely for two-member LLCs.
2. Sound operating agreements for two member LLCs should address the roughly 25 main legal and tax issues that should be addressed in the operating agreements of all multi-member LLCs. However, in my experience, the members of most two-member LLCs are equal in voting and profit shares. For all of these LLCs, the issue of deadlock is major. Even in the best two-member LLC, it is likely that deadlock issues will eventually arise, and can destroy an otherwise promising LLC.
3. Anna and Bill are equal members of AB, LLC, a member-managed two-member LLC formed under the LLC act of State X. There are four main types of provisions that you should consider including in AB’s operating agreement to address the possibility of deadlock between Anna and Bill. These provisions can interact with one another in myriad ways. As such, analyzing potential interactions remains paramount.
- a. The first is a dispute resolution provision. The best one will often provide for mediation followed by arbitration by a single arbitrator under the Commercial Arbitration Rules of the American Arbitration Association. But in some states, such as New Hampshire, there is an expeditious and expert business court that may be a better option if you meet the court’s amount-at-issue requirement.
- b. The second is a “Texas shoot-out” provision. This provision provides that if Anna and Bill are deadlocked about a key AB issue, either may offer to buy out the other on specified terms. The other must either sell on the basis of those terms or use the same terms to buy out the first. After the sale, only one member will remain; hence the “Texas shootout” appellation.
- c. The third provision provides that if Anna and Bill are deadlocked on a key LLC issue or, in addition, if either of them becomes dissociated from the LLC for any reason (including death, disability, resignation, bankruptcy or even expulsion), they, or the remaining member, must use every reasonable effort to sell the LLC. This enables the members, or the remaining member, to cash out (but the remaining member may be a member of the group purchasing the LLC).
- d. The fourth and fifth are “drag-along” and “tag-along” provisions. These provisions may be important in the event a third party wants to buy AB’s assets or memberships and Anna and Bill disagree about whether the proposed terms are acceptable and the timing is right.
A “drag-along” provision provides that if one member believes that the members should accept the offer and the other either agrees or an arbitrator orders him or her to agree, the first member may require the second—i.e., may “drag along” the second—to sell to the third party on the proposed terms.
A “tag-along” provision provides that the first member may not sell to the third party unless the third party agrees to also purchase the membership of the second member on the same terms as provided to the first party.
(“Drag-along” and “tag-along” provisions are even more useful to two-member LLCs whose members are not equal than to those with equal members.)