Business Law Update for LLCs: The Words You Use In Your Operating Agreement Matter.

Good morning, all! Yesterday was a beautiful day, see the photo I took overlooking downtown Grand Rapids. The leaves are already changing color.

Today I read a Court of Appeals Case that came out yesterday that provides a good example for business owners.

Background – Today LLCs are generally the entity of choice.

Most businesses that were formed in Michigan last year were Lim

ited Liability Companies. This is for several reasons:

Limited liability (Once a limited liability company comes into existence, limited liability applies, and a member or manager is not liable for the acts, debts, or obligations of the company. “Duray Dev., LLC v. Perrin, 288 Mich. App. 143, 151 (2010))

Flexibility (centralized management – generally no distinction between owners/managers) 

No double taxation (like in traditional C-Corporations).

 

Your Operating Agreement is an Important Document

However, just forming the LLC by filing the articles of organization with the State of Michigan is not enough to fully protect your business.

One fundamental document is your operating agreement.  It is that document that spells out how the business affairs of the company are conducted.

It also spells out the “exit” – in what event and on what terms can a member leave the company?

I have often written about why your operating agreement matters.

Today I read an unpublished court of appeals decision that provides another illustration on why not only having the operating agreement matters, but also the exact language in your operating agreement matters.

 

Healthwise Medical Clinic, PLLC, and NP DREAMS,LLC

 

Facts:

The parties:

Plaintiff Rhonda Keller, LNP and Defendant Kasandra Lechel, licensed nurse practitioners.

They were the sole members of two LLCs – HealthWise was the “operating company” and NP Dreams owned the real estate used by HealthWise.

Keller and Lechel had entered into operating agreements governing
HealthWise and NP Dreams.

The HealthWise Agreement had a “personal and professional standard of conduct” section that required a member to withdraw from the company if they violated the provision.

Keller found out that Defendant Lechel had taken actions that she deemed should require Lechel to resign. Lechel did not resign and therefore Keller sued to compel withdrawal from the company.

There were other claims and counter-claims made between the parties; however, the issue relevant for purposes of my article is regarding the buy-out provision in the Operating Agreement.

The Operating Agreement required the Company to buy out a withdrawing member under certain terms.

Plaintiff sued to expel Lechel, claiming she committed bad acts that required her removal. As such, Plaintiff should not be required to compensate her buy out.

 

Trial Court’s Decision

The Trial Court agreed.

“With regard to the HealthWise and NP Dreams Agreements and compensation due to Lechel, the trial court held that “neither the buyout nor the liquidation option provides a logical and just resolution.” The court pointed to uncontroverted proofs that the corporate debts exceeded assets. Further, the trial court explained, because Lechel had breached the contract first, she was not entitled to recover on it. The trial court issued an order stating that Lechel “is not entitled to any compensation for her interests in the two Limited Liability companies.” Id. Page 4.

 

 

The Court of Appeal’s Decision

Court of Appeals reversed on this issue.

Law: Your Operating Agreement is a Contract. Courts will interpret a Contract in accordance with its plain meaning.

The Court of Appeals analyzed this issue as follows:

“Our primary goal in interpreting a contract is to honor the intent of the parties by enforcing the plain and unambiguous language of the agreement. See Klapp v United Ins Group Agency, Inc, 468 Mich 459, 473; 663 NW2d 447 (2003); Defrain, 491 Mich at 367. Clear and unambiguous language will be enforced as written. Farmers Ins Exch v Kurzmann, 257 Mich App 412, 418; 668 NW2d 199 (2003).

 

The Court reviewed the Operating Agreement and held that the language was clear and unambiguous:

“[i]f such Member shall fail to voluntarily withdraw, the Company shall take such
action as may be required to compel resignation under the same terms.” Section 5.2 lists the terms for voluntary withdrawal, including 2 options for compensating the withdrawing member: either (1) payment of 80% of the member’s share of the agreed-upon value of the company, which amounts to $40,000 to defendant.” Id. at Page 7.

 

The Court’s language in its opinion is very telling. It was not going to apply “equity” since the parties were free to contract how they saw fit.

“Despite testimony that HealthWise’s liabilities exceeded its assets, we see no reason to apply an equitable remedy when a contractual remedy is available. See Tkachik v Mandeville, 487 Mich 38, 45; 790 NW2d 260 (2010).

“The parties were free to bargain for protection in the event of a court-ordered withdrawal, and they did so.”

 

 

Lesson:

Take care in drafting your operating agreement. If you desire a penalty in the event of termination of a membership interest – then make sure that language is included in your operating agreement. The courts will enforce clear language in an operating agreement.

 

 

Questions? Comments?

e-mail: Jeshua@dwlawpc.com

http://www.dwlawpc.com

Twitter: @JeshuaTLauka