A limited liability company (“LLC”) is one of the most common types of business organizations in Louisiana. There are many benefits to operating your business as a LLC including the simplicity of forming a LLC courtesy of the Louisiana Secretary of State’s online GeauxBiz platform. However, because LLC’s are simple to form, their freedom and ease can also cause complex problems.
Owners often rely on the form documents provided by the Louisiana Secretary of State to protect their business. However, those documents are generally not complete. The purpose of this article is to discuss the issue of the “ambiguous owner.” An ambiguous owner is a person or entity claiming ownership in your business, specifically a LLC.
Written Operating Agreements Can Help Avoid Ownership Disputes
When a LLC is formed, the Secretary of State requires a document titled “Articles of Organization” to be completed. While this document seems formal, many businesses utilize the generic language therein but fail to reduce their operations to writing. At the beginning of a new business’ life, the member(s), which are the owners of the company, generally are in harmony and focused on getting to work on their intended purpose. But it is critical to allocate ownership interest and percentage from the outset to avoid confusion. It is also critical to implement a procedure for exiting the business and more importantly for allowing new owners.
A written operating agreement governs the affairs of the business and serves as a contract amongst the owners. Due the relative novelty of Louisiana LLC law and the hybrid corporation-partnership principles that apply, the operating agreement will serve to prevent any unintended consequences.
Operating agreements are critical for any Louisiana business. The following types of businesses should always have operating agreements in place:
• Healthcare Providers
Louisiana Revised Statute 12:1301 provides that an operating agreement is any agreement, written or oral, of the members as to, or in the case of a limited liability company having a single member, any written agreement between the member and the company memorializing the affairs of a LLC and the conduct of its business.
As the purpose of an operating agreement is to govern the affairs of a LLC, it should list all the members and their membership and the protocol for several procedural issues including, but not limited to, the following:
• Principal Office of place of business;
• Appointment of Manager(s);
• Capital contributions;
• Restrictions on Transfer of Membership Interest of Assignability
• Agreement on capital calls or how the business is to raise money
during those financially tough times;
• Profits and Loss Distributions and Responsibilities;
• How to address voting issues;
• Management of the Business;
• Dissolution (when the business decides to close its doors);
• Accounting; and
• Ownership Separation.
More importantly, perhaps the most critical element of a written operating agreement addresses the issue of permitting new owners.
The issue always arises if an owner deceases or becomes permanently disabled. But what about when an owner sells its interest or you have an employee that believes they are an owner.
Ownership Claims: The Ambiguous Owner
A written operating agreement should provide its owners with their ownership allocation.
Louisiana law provides that ownership interest is a thing, not including land, and that it may be assigned in whole or in part. If you do not have an operating agreement or an agreement agreement that controls the transfer of ownership, the Courts will look to Louisiana law. Louisiana Revised Statute 12:1330 clearly states that an assignee of an interest is not yet a member and that an assignee cannot exercise any rights or powers of a member until he is admitted as such.
In order for an assignee to become a member or owner and be granted the powers, rights, and duties of an owner, the other owners(s) must unanimously consent in writing. If you are faced with an ambiguous ownership claim, the courts will look at the facts of each case. Presently, Louisiana Courts are unsettled on what factors to consider when determining who is a member of a LLC.
How have Courts determined whether an “Ambiguous Owner” is actually an Owner?
If your business does not have a written operating agreement controlling how owners can sell and buy interest, the courts will look to Louisiana law. There are basic principles of contract law at issue as well. For instance, in order to become a member, it must be in writing. However, if you email an offer to a potential buyer, which is accepted, there is a possibility the courts may find there was a “meeting of the minds”, thus an enforceable agreement.
In Destiny Services, LLC v. Cost Containment Services, LLC, the 1st Circuit employed a fact-based analysis in finding that the plaintiffs were members of a business. In Destiny, a three member LLC submitted a joint proposal to the two plaintiffs inviting them to participate in the LLC in a maximum 20% “equity position.” The plaintiffs agreed and bought in at 5% equity transferring the equivalent monies which were accepted by the original owners. A dispute arose when the plaintiffs requested to inspect the LLC’s records but were denied claiming they were not members. In support of that contention, the defendants cited the annual report which only included the original three members. The Court considered the following factors, the plaintiffs’ contributions of capital, inclusion on tax returns, notice of meetings, and permission to vote. Finding that the plaintiffs participated in those events, the court concluded that they were owners.
In Destiny, the Court applied a fact-based analysis akin to corporate ownership disputes. It held that the offer and acceptance of membership interest when taken with all of the actions thereafter constituted a consent to the transfer of membership interest set out in Louisiana Revised Statute 12:1332.
In another case, Settles v. Paul, the Louisiana 2nd Circuit held that a LLC’s organizational document listing only Ms. Paul as a member was controlling even though a fact based analysis would conclude that both Mr. Settles and Ms. Paul were members. Ms. Paul and Mr. Settles formed Landmark Construction Company of Coushatta, LLC. While the couple intended for it to be equally owned, the organizational documents listed Ms. Paul as the only member. In addition, the couple split profits and costs and each were responsible for various roles at the LLC. After the two split, Mr. Settles requested access to the financial records as owner. Ms. Paul denied the request claiming that that she was the sole owner.
The Court applied a partnership theory to resolve the issue despite the company’s designation as a LLC. This analysis lead the Court to conclude that the parties had inadvertently formed a partnership which acted as the parent company to Landmark Construction Company of Coushatta, LLC. While, it reached an equitable result, the Court was forced into a bizarre line of reasoning because it had to circumvent the fact that Mr. Settles was not included in the membership list.
What Factors are Used to Determine Ownership?
While ownership interest in a business is generally not a disputed issue, it can happen. Oftentimes, it is the result of informal documentation, failure to keep meeting minutes and misunderstandings. In addition, ownership disputes can be the result of a longtime employee believing they were owed an ownership interest in the business for their valued contribution.
If your business is facing a claim from an ambiguous owner, it is critical that you contact a lawyer to assess your situation. In addition, it is important to understand the factors that will be used by the court to determine ownership.
Should you have any questions or you would like to discuss this issue in further detail, please do not hesitate to contact us to schedule a free consultation.