Minority Investors in LLCs: Preemptive Rights, Expulsion, Freeze-Out Mergers, and Other Key Provisions

Minority owners in an LLC are, in many ways, subject to the whim of the majority with limited statutory and common law protection against what they may view as “oppression.” Those considering investment in an LLC, negotiating the operating agreement, counseling as to disputes among the members, or contemplating litigation should be aware of the limitations of protection for minority members.

Most state LLC statutes do not provide minority LLC owners with preemptive rights unless their operating agreement provides for them. Likewise, many LLC operating agreements give the majority the right to make capital calls and provide for potentially severe consequences if the minority members fail to meet those capital calls.

Some LLCs have provisions in their operating agreement that allow for the expulsion of members in certain circumstances such as upon a majority or supermajority vote of other members. In some states, including those states adopting the Revised Uniform LLC Act, an LLC can request that a court expel a member based on a finding of wrongful conduct, willful and persistent breach of the operating agreement, or that it is not reasonably practicable to continue the LLC with that member.

Some LLC Acts permit the majority members to effect a freeze-out merger with a minority owner of the original entity receiving no ownership interest in the new entity and only the liquidated value of his or her interest. Significant disputes can arise as to the measure of value of the cashed-out minority interest, the terms of payment, etc.

The doctrine of independent legal significance may permit the majority owners to artfully circumvent protections the minority owners believe they have negotiated; whether the implied contractual covenant of good faith and fair dealing will limit that opportunistic conduct remains to be fully determined.

Listen as our panel discusses recent cases involving contractual waivers of fiduciary duties, contractual discretion, and best practices in protecting the interests of minority owners and challenging managers' actions.