Share This Post
Your Risks as a Minority Member in an LLC: Oppression and Squeeze-Out
A limited liability company (LLC) is a great thing for many entrepreneurs. Among other things, it provides liability protection while requiring fewer formalities than a corporation. But it’s not risk-free. One of the potential risks is minority oppression of members who own less than 50% of the LLC.
Today we’re going to look at what minority member oppression is, what your rights are as a minority member of an LLC, and what you can do to protect yourself.
Risk of Oppression for Minority Members in an LLC
Minority member oppression occurs when a member or members of an LLC act to reduce a minority member’s involvement in the LLC against their will.
When minority shareholder oppression occurs in a corporation, the shareholder can simply sell their shares (albeit at an unfairly low price in many cases) and walk away. However, in an LLC and close corporations, it’s often not so easy. The minority member may find that their investment is essentially being held hostage, and they don’t have a legal avenue to get it out of the company. Walking away means losing their investment.
The oppression often entails reducing the minority member’s income from the business, keeping them out of the loop regarding company business, and excluding them from important management decisions. Another tactic is for the majority member(s) to create a new, separate business entity and merge that with the existing business without giving the minority member any ownership in the new merged business, instead exchanging their interests for cash or eliminating it altogether.
When the end goal of this oppression is to force the minority member to give up their ownership in the LLC altogether, that’s commonly referred to as a squeeze-out or freeze-out.
LLC Minority Members’ Rights Under South Carolina Law
If your LLC does business without important governance documents (covered in the section below) and a dispute arises and goes to court, then South Carolina laws regarding LLCs apply. These vary somewhat depending on what kind of LLC it is (member-managed or manager-managed), but under SC law, minority members can expect certain rights, including:
- The right to a share of distributed profits
- The right to a share of proceeds of a sale if the LLC is sold or dissolved in proportion to their ownership
- The right to see the company’s books and financial records
- The right to sue another member or members for breach of fiduciary duty if they engage in misconduct
These protections sound great but they may not play out the way you want in real life. For example, majority members may take an income as an employee (rather than a distribution as an owner) or spend the company’s money in another way to avoid making distributions to minority members. Or they could structure a sale of the LLC in such a way as to legally cut out a minority member from the proceeds.
In short, don’t rely on default South Carolina laws to protect your interests as a minority member in an LLC. It’s best to have governance documents including an operating agreement with terms that are favorable to minority members and for you as a minority member to know, understand, and agree to those terms.
How Minority Members Can Protect Themselves: The Operating Agreement
In South Carolina, the Articles of Incorporation is the only document your LLC is legally required to have to be in business. Other governing documents are optional but extremely important for multi-member LLCs, the most important of which is the operating agreement.
An operating agreement details the ways in which the LLC will operate, covering such topics as ownership, members’ and managers’ duties, voting rights, how decisions are made, how profits and losses are handled, and more. Terms regarding buying and selling ownership or the LLC may be included or can be handled in a separate buy-sell agreement. Same with raising capital, which may be included in the operating agreement or detailed in a separate capital call agreement.
It’s important to understand that an operating agreement is not bulletproof. Majority members may still try to squeeze out or freeze out a minority member. However, when drafted in a way that protects a minority member’s interests, an operating agreement can help. If an issue arises and goes to court, then the court will look at the terms of the operating agreement rather than defaulting to SC law, which will be better for you (assuming the agreement is drafted well).
Work with a Business Attorney to Draft Your LLC’s Governing Documents
Each LLC is different and the members within each LLC are different, so no two operating agreements are alike. If you’re planning on joining or starting up an LLC with other people, or if you’re already in one but don’t have governing documents, talk to a business attorney. They can not only draft an operating agreement (and other documents) tailored to you and your business, they can also advise you on potential pitfalls and situations you may not have considered. Because what you don’t know can hurt you.
Gem McDowell is a business attorney in Mount Pleasant, SC, serving clients in the Charleston area and across the state. He and his associates at the Gem McDowell Law Group help people start, grow, and protect their businesses and business interests. Gem is a problem solver who has seen a lot in over 30 years of experience, and he can advise you on your situation and help you protect your interests. To schedule a free consultation, call 843-284-1021 today.