Monday, October 21, 2019

Co-Manager and CEO of LLC Properly Removed; The Partial Assignors Retained Voting Rights

Co-Manager and CEO of LLC Properly Removed; The Partial Assignors Retained Voting Rights

In a recent decision from the Federal District Court in Washington state, there was considered the question of whether the co-manager and CEO of an LLC had been removed by the 80% vote required by the operating agreement. That co-manager and CEO asserted that certain members could not participate in the vote because they had partially assigned their interest in the company. Based upon the operating agreement at issue and the Washington LLC Act, that assertion was rejected, and it was held that the co-manager and CEO had been removed. Braddock v. Zaycon Foods, LLC, C-16-1756 TSZ, 2019 WL 3974355 (W.D. Wash. Aug. 22, 2019).

Braddock had been the co-manager and CEO of Zaycon Foods, LLC.

Zaycon’s operating agreement provided for two managers and that a manager could be removed by the members holding at least 80% of the Class A units. Braddock would assert that certain transfers of membership interests that took place prior to the time he became the manager in effect stripped the voting rights in that none had been properly approved in accordance with the operating agreement. On that basis, fewer than 80% of the units had been voted for his removal.

Concluding that none of the transfers had been effective and were therefore improper. As to the effect of those invalid transfers, the court wrote:

Such conclusion does not, however, end the analysis. Although § 8.4 [of the operating agreement] makes clear that, in the event of an invalid transfer, the purported transferee obtains no voting rights and becomes merely an "Assignee" who holds only an "Economic Interests," the provision does not explicitly indicate whether the purported transfer or retains the voting rights associated with the units that were not effectively transfer. Thus, to understand the consequences to the transferor of assigning only an "Economic Interest,", the Court must look to the statutes governing limited liability companies organized under Washington law. 2019 WL 3974355, *5.

Under the Washington LLC Act, where a member transfers less than all of their interest in the LLC, they retain all rights related thereto except with respect to the economic rights that are transferred. RCW § 25.15.251(3). As characterized by the court:

[a]n LLC member may transfer a portion of the right to receive distribution without conferring on the recipient the right to vote or make decisions on behalf of the LLC.  In such circumstance the statute fills in the gap left by the Operating Agreement’s silence, and the transferor continues to have all of the rights of a member, other than the rights to receive the assigned distributions, including the right to vote. Id., *6.

On the basis that the transferor members retain the rights to vote the transferred interests, the 80% threshold had been satisfied and the plaintiff in this action was properly removed as the member and the manager.  The court found as well that the company had otherwise properly complied with the terms of a related employment agreement.

A variety of other claims and counter-claims will survive for trial.

In closing, it should be noted that the court suffered a small foot fault in describing the basis for restricting the ability of an LLC member to transfer governance rights. The court described that basis as it “helps ensure that the LLC is taxed like a partnership by avoiding one of the four characteristics of a corporation, namely ‘free transferability of interests.’” While this statement was certainly at one time true, including at the time of the cited law review article, it became incorrect as of January 1, 1997 and the adoption of the so-called “Check-the-Box” classification regulations.

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