Michigan LLC Is Not Obligated to Pay Withdrawing Member for Its Interest – Operating Agreement Allowed Member to Sell Its Interest, Subject to LLC’s Right of First Refusal

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Michigan LLC Is Not Obligated to Pay Withdrawing Member for Its Interest – Operating Agreement Allowed Member to Sell Its Interest, Subject to LLC’s Right of First Refusal

Many state LLC statutes limit an LLC member’s ability to withdraw from the LLC, or require payment to the withdrawing member under some circumstances. Michigan’s statute, for example, says that an LLC member can withdraw only as provided by the LLC’s operating agreement, and that if the operating agreement is silent on a withdrawal distribution, the withdrawing member must be paid the fair value of its interest. Mich. Comp. Laws §§ 450.4509(1), 450.4305.

In a recent case before the U.S. Court of Appeals for the Sixth Circuit, an LLC member that withdrew from a Michigan LLC contended that it should be paid the fair value of its interest. Bellwether Cmty. Credit Union v. CUSO Dev. Co., LLC, No. 13-1853, 2014 WL 1887559 (6th Cir. May 12, 2014). The Court of Appeals upheld the district court’s ruling that the LLC had no obligation to make a withdrawal distribution to the withdrawing member, because the operating agreement’s procedures for a withdrawing member complied with the statute.

Background. Bellwether Community Credit Union was a member of CUSO Development Company, LLC, a Michigan LLC that provided administrative services to financial institutions such as Bellwether. In 2011 Bellwether withdrew from CUSO, as was permitted by CUSO’s operating agreement. Shortly thereafter Bellwether filed suit to recover a withdrawal distribution from the LLC for the fair value of Bellwether’s member interest.

The Michigan LLC Act addresses the right of a withdrawing member to receive a distribution:

If a provision in an operating agreement permits withdrawal but is silent on an additional withdrawal distribution, a member withdrawing in accordance with the operating agreement is entitled to receive as a distribution, within a reasonable time after withdrawal, the fair value of the member’s interest in the limited liability company as of the date of withdrawal based upon the member’s share of distributions as determined under section 303.

Mich. Comp. Laws § 450.4305 (emphasis added). Bellwether contended that because CUSO’s operating agreement was “silent on an additional withdrawal distribution,” Bellwether was entitled to the fair value of its member interest.

CUSO argued that its operating agreement was neither silent nor ambiguous on the distribution rights of withdrawing members. The operating agreement provided CUSO with a right of first refusal: The withdrawing member was required to specify a price for its interest. The LLC or, if it declined, the other members then had the right to purchase the interest for the specified price. If neither the LLC nor the other members purchased the withdrawing member’s interest, then the withdrawing member had the right to sell its interest to a third party at the specified price (or a higher price) for 90 days.

Bellwether offered its interest to CUSO and the members for $655,223, but there were no takers. Bellwether did not attempt to find a third party buyer and instead filed suit.

Court’s Analysis. The court characterized the right of first refusal as “a detailed process for a withdrawing member to follow, which clearly contemplated a discretionary withdrawal distribution if [CUSO] exercised its right of first refusal to purchase shares back from a dissociating member.” Bellwether, 2014 WL 1887559, at *4.

The court pointed out that if CUSO had exercised its option to buy back Bellwether’s interest, its payment to Bellwether would have qualified as a withdrawal distribution. “Distribution” is defined by Michigan’s LLC Act as “a direct or indirect transfer of money … by a limited liability company to … its members … in respect of the members’ membership interests.” Mich. Comp. Laws § 450.4102(2)(g).

The court’s conclusion was that although the operating agreement did not give a withdrawing member an absolute right to a distribution, it was not “silent” on the issue. The operating agreement provided a mechanism for Bellwether to receive a withdrawal distribution, if CUSO exercised its right to purchase Bellwether’s member interest. The fact that CUSO did not exercise its purchase right did not make the operating agreement silent on the withdrawal distribution. Bellwether, 2014 WL 1887559, at *4.

Bellwether raised other arguments that relied on parol evidence, but the court found the language of the operating agreement to be clear and unambiguous and therefore rejected extrinsic evidence. Id. at *5. Bellwether also argued that equitable principles should be applied to interpret and modify the operating agreement’s provisions. The court rejected that argument by referring to Michigan law: “The Michigan Supreme Court has explained that principles of equity alone do not serve as a basis for ignoring express contractual provisions under the guise of interpretation.” Id. at *6.

The court accordingly affirmed the district court’s order granting summary judgment for CUSO.

Comment. The result in Bellwether appears consistent with the statute and the CUSO operating agreement. But the case illuminates a strange corner of LLC law.

The origins of “withdrawal” apparently lie in the early concept of a partnership as an aggregation of partners rather than an entity. A partner could remove itself from the group and cause the dissolution of the partnership. But LLCs are different.

An LLC member has no liability for the debts of the LLC and usually will have no obligations under the LLC’s operating agreement. In many manager-managed LLCs the members will have no management authority. Withdrawal therefore does not seem to accomplish much, unless it results in the member being cashed out. And under most LLC operating agreements, a withdrawing member is not entitled to receive any withdrawal distribution.

The answer may lie in the fact that LLCs are taxed as partnerships, and in some cases an LLC member may receive allocations of profit from the LLC that increase the member’s federal income tax bill, with no cash distributions to cover the members’ increased tax liability. Withdrawal could be used to bring an end to that unpleasant scenario, albeit at the cost of forfeiting the value of the member’s interest.

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