What Happens if Your Business Partner Goes Rogue?

Litigation

How many times have you said to yourself that your business partner is a close personal friend and, as such, you have absolutely no use for an Operating Agreement? You’ve started the business, it’s gotten off to a great start, so why do you need to waste precious dollars on legal fees in preparing a detailed Operating Agreement that outlines how decisions are to be made?  The mistake, which isn’t always obvious, is that you are trusting years of friendship and believing that the relationship with your co-member(s) in the LLC is of a personal nature, rather than a business one.

Suppose James and Jane are members of a newly formed New York LLC who felt that preparing an Operating Agreement would be extraneous, given their long-lasting friendship.  One day, while James is enjoying an afternoon stroll through the downtown area, he happens upon a vacant storefront that he believes would be perfect for the LLC’s business.  Thinking that he has to act quickly to take advantage of the opportunity, he hastily signs a lease on behalf of the LLC without first consulting Jane.  After learning of what James has done, Jane believes that this particular storefront won’t generate nearly the amount of foot traffic necessary to make this investment viable and strongly disagrees with this action.  As they didn’t have an Operating Agreement in place that could have, among other things, mandated that any material decisions require the unanimous consent of both members, Jane and the LLC are now bound by James’ unilateral decision.

While not every state requires that members of an LLC enter into a written Operating Agreement, New York does, in fact, require members of an LLC to do so.  Section 417(a) of the New York Limited Liability Company Law requires that “members of a limited liability company shall adopt a written operating agreement that contains any provisions not inconsistent with law or its articles of organization relating to (i) the business of the limited liability company, (ii) the conduct of its affairs and (iii) the rights, powers, preferences, limitations or responsibilities of its members, managers, employees or agents, as the case may be.”

Naturally, the consequences for failing to comply with this statute are entirely unclear, but if partners in an LLC don’t address how their business is to be conducted in a written agreement, it’s only a matter of when, not if, they will reach an impasse such as that described in the hypothetical situation above.  In addition to clearly defining the business as being separate from the personal assets of its member(s) from a legal perspective and detailing what happens upon the death or disability of one or more members, the Operating Agreement can help avoid expensive, time-consuming and resource-draining litigation that can drastically impact a company and its owners.

If you have any questions about Operating Agreements, corporate or LLC governance, or any other questions pertaining to the administration of your business, please feel free to contact me at KLawrence@swc-law.com or (516) 228-1300.

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