September 29th, 2023
Does Your Operating Agreement Clarify Outcomes When an Employee-Member is Terminated?
Welcome back, dear reader, and thank you for joining us on this informative journey. We have arrived at our 17th piece, and your dedication and feedback have been instrumental in making this series a success. As business owners and managers, your everyday decisions help shape not just your organization but the landscape of business at large. Today, we delve into the nuanced relationship between employment and membership within a limited liability company (LLC). While the operating agreement typically serves as the primary guiding document, the presence of an employment agreement necessitates careful coordination. To ensure harmony, the operating agreement should reference specific employment agreement provisions, allowing both documents to complement each other seamlessly.
Termination by the Company for Cause
Termination for cause refers to the company ending a member’s employment due to a specific reason or “cause,” which is usually defined in the operating agreement or employment contract. This cause often involves substantial misconduct or violation of company policies. It could range from financial impropriety to breach of non-disclosure agreements or failure to meet performance standards. This type of termination is a serious step, and companies usually reserve it for situations where the member’s actions or inactions are gravely detrimental to the company.
In such scenarios, the treatment of the member’s interests varies depending on the specifics outlined in the operating agreement. A common practice involves the company buying back the member’s interests, often at cost. However, the operating agreement could also specify a discounted percentage of fair market value (FMV) given the circumstances leading to the termination. The key is to have clear, comprehensive clauses in your operating agreement that provide fair yet firm protocols for such instances.
Termination by the Company without Cause
On the other hand, termination without cause happens when the company ends a member’s employment without any particular misconduct on their part. It might occur due to company restructuring, downsizing, changes in strategic direction, or simply an organizational decision to terminate the relationship. In these instances, no grave wrongdoing is attributed to the member.
As with termination for cause, the operating agreement typically guides how the member’s interests are managed. In the event of a termination without cause, the operating agreement may provide for the company to buy back the member’s interests, potentially at FMV. However, given the absence of misconduct, the agreement might also stipulate accelerated vesting of unvested interests, to provide a degree of financial assurance to the member. As always, clear and anticipatory provisions in the operating agreement help ensure smooth navigation of such occurrences.
Resignation by the Member for Good Reason
In certain situations, a member may choose to resign from the company for “good reason.” This is typically triggered by unfavorable changes in the member’s employment status, role, responsibilities, or compensation. A good reason might include scenarios such as a significant reduction in salary, a substantial change in job duties or location, or a breach of contract by the company. The definition of “good reason” should ideally be stipulated in the operating agreement to avoid ambiguity.
In terms of the member’s interests, when a resignation occurs for a good reason, the operating agreement usually has provisions to protect the member. This could mean that the company purchases the member’s interest at FMV depending upon the circumstances leading to the resignation. It might also allow the member to retain certain rights, such as profit shares or distributions, for a specified period post-resignation. The operating agreement should ideally set out these terms clearly to ensure fairness and minimize disputes.
Resignation by the Member without Good Reason
There can also be instances when a member decides to resign without a defined “good reason.” This could be due to personal circumstances, a change in career direction, or any number of reasons that do not relate directly to the company’s actions or changes in the member’s employment conditions. Such a situation is a voluntary termination of the employment relationship by the member.
How the member’s interests are handled in this scenario is also a function of the terms in the operating agreement. It might stipulate that the company has the option to buy back the interests, possibly at cost or a discounted percentage of FMV given the unjustified nature of the departure. In any case, the operating agreement should provide clarity and guide the process, ensuring it is conducted in an orderly and fair manner.
We hope this article has been informative and useful for your business. If you have any questions or comments, please contact us at firstname.lastname@example.org. We plan to answer general questions in an upcoming FAQ series. If you need legal advice specific to your situation, please ask to schedule a consultation with an attorney to discuss your company’s goals.
Stay tuned for our next enlightening piece as we dive deep into the relationship between operating agreements and intellectual property rights. Don’t miss out on crucial insights regarding the obligation of members to assign all created intellectual property to the company in the course of business.
This article is for informational purposes only and should not be relied upon as tax or legal advice. Please consult professionals for advice tailored to your specific situation. The author and publisher assume no responsibility for any errors or omissions or for any actions taken based on the information presented.
Categories: What's Missing from Your Operating Agreement?