An important part of creating a limited liability company, but often overlooked, is preparing for contingencies such as the withdrawal of a member. The state law where the LLC was created will govern the circumstances and conditions of a member’s withdrawal, which can vary greatly from state to state. In order to adequately meet the expectations of the LLC members, a written operating agreement should be prepared when the LLC is organized that specifies how to handle the withdrawal of a member from the LLC.
In the absence of an operating agreement, state law will determine if a member can voluntarily withdraw from an LLC. Arizona LLC law is among the most permissive by allowing a member to withdraw by mailing or delivery a written notice to the other members. Maryland LLC law also allows withdrawal on written notice, however, the withdrawal is not effective for six months. In many states though, if there is no operating agreement that allows a voluntary withdrawal, the law restricts a member's right to withdraw by requiring the unanimous consent of the other members or the dissolution of the LLC, such as in New York and Washington.
Some state LLC laws also have provisions that mandate a member's withdrawal from the LLC upon the occurrence of a certain event. For example, Arizona LLC law specifies several such events that include filing a voluntary bankruptcy petition or making an assignment for the benefit of creditors. Other states that have LLC laws similar to the Arizona law may use differing terminology, such as "cessation of membership" in Maryland and "events of disassociation" in Washington.
Liability for Withdrawal
The primary factor a member should consider about withdrawing from an LLC is to withdraw in the manner specified either in the LLC's operating agreement or, if none exists, according to state law. If a withdrawal is attempted in a manner not allowed by law, the withdrawing member will be liable for any economic damages his actions cause the LLC or the remaining members. Moreover, even in states where a member has the right to voluntarily withdraw, such as in Arizona, the member may still be liable if his actions are in breach of an operating agreement and cause harm to the LLC or its members.
The importance of planning for a member’s withdrawal from the LLC is twofold. First, the state LLC law must be understood regarding the circumstances and conditions for withdrawal, and a comprehensive operating agreement should be prepared that addresses the withdrawal issues (see Resources). The agreement should specify under what conditions and in what manner a member may withdraw. Secondly, the agreement should provide for the handling of the member’s financial interest in the LLC after withdrawal. Presumably, a withdrawing member desires to be bought out or otherwise receive a return of his capital contribution. A properly drafted operating agreement will specify how to value the member’s interest and the terms under which the remaining members must pay for his interest.