LLC Default Rules Are Hazardous to Member Liquidity
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LLC Default Rules Are Hazardous to Member
Liquidity
By Donald J. Weidner*
Simply by forming LLCs, entrepreneurs now unwittingly lock themselves in to perpetual
entities that offer them no liquidity and present them with costly procedural obstacles to
enforcing both their agreement among themselves and their statutory rights. Even in at-
will LLCs that are member-managed, recent LLC acts deny members both a right to dis-
solve and a right to be bought out. While thus locking members in, these acts deny them
standing to bring many if not most of their claims among themselves or against the firm.
In swinging so dramatically toward a corporate model, recent acts have failed to consider
the presumptive intent of small groups of entrepreneurs who operate informally and
expect to have a direct role in management. At least in the case of member-managed
LLCs, legislatures should reinstate more appropriate default rules and courts should be
receptive to claims that members never intended their relationships to have such harsh
consequences.
INTRODUCTION
In the mid- to late-1990s, there was unprecedented legislative activity to offer
unincorporated business owners liability shields protecting them from personal
liability for the obligations of the firm. In 1994, the Uniform Law Commission
(“ULC”) approved the first major overhaul of partnership law in eighty years.1
Only three years later, the ULC added to it the option to become a limited lia-
bility partnership (“LLP”) with a protective shield. This combined package,
which the ULC refers to as the Uniform Partnership Act (1997)2 but is popularly
known as “RUPA,” is the law in most states. At about the same time the ULC
finalized RUPA, it also finalized the Uniform Limited Liability Company Act
* Dean Emeritus and Alumni Centennial Professor, Florida State University College of Law. Dean
Weidner was the reporter for the Uniform Partnership Act (1994). This article is based on Dean
Weidner’s Keynote Address to the American Bar Association Business Law Section’s November
2019 LLC Institute. He would like to express his appreciation to Shawn J. Bayern, Allan G. Donn,
Robert W. Hillman, and Daniel S. Kleinberger, for their comments, with special thanks to Douglas
K. Moll for his particularly detailed comments.
1. UNIF. P’SHIP ACT (UNIF. LAW COMM’N 1994), https://www.uniformlaws.org/ [hereinafter U.P.A.].
2. UNIF. P’SHIP ACT §§ 306(C), 1001–1003 (UNIF. LAW COMM’N 1997), https://www.uniformlaws.
org/ [hereinafter R.U.P.A.]. The ULC subsequently promulgated a version of the partnership act de-
signed to “harmonize” it with certain provision of the law of other business associations. See
UNIF. P’SHIP ACT (UNIF. LAW COMM’N 2013), https://www.uniformlaws.org/ [hereinafter H.R.U.P.A.].
H.R.U.P.A. has received relatively few adoptions.
151152 The Business Lawyer; Vol. 76, Winter 2020–2021 (1996) (“1996 Act”),3 with its shield for members of limited liability companies (“LLCs”). The LLP and LLC shields were virtually identical, and the two acts were also extremely similar on the two key issues that are the subject of this article: they provided members with significant liquidity rights and with easy access to judi- cial remedies. In just ten years, the ULC promulgated the 2006 Uniform LLC Act (“RULLCA”),4 which reversed course on both these key issues. It declared LLCs to be perpetual entities, and it denied dissociated members both the right to dis- solve and the right to be bought out. It also took away their easy access to judi- cial remedies by importing the direct versus derivative distinction from corporate law. This rapid and dramatic change between these two uniform acts reflects the national shift that has taken place on these two key issues. The purpose of this article is to explain and critique this shift, which leaves LLPs and LLCs with very different default rules. Part I of this article explains that RUPA’s default rules were primarily designed to reflect the presumed intent of small groups of entrepreneurs who form with- out representation and expect to operate their business informally. These rules included significant liquidity rights and gave partners easy access to judicial rem- edies, although the buyout rules included corporate-style procedural require- ments the target groups probably do not intend. Part II discusses how and why the uniform LLC acts first embraced, then eliminated, the liquidity rights of partners. The default rules were redirected away from small LLCs formed without the benefit of counsel in order to protect family LLCs engaged in sophis- ticated estate planning. This elimination of liquidity rights made LLCs more like corporations. Part III critiques how and why the uniform LLC acts first em- braced, then eliminated, easy access of members to judicial remedies, adopting instead the corporate approach that denies members standing to bring claims RULLCA now classifies as derivative. In addition to noting the usual arguments that the derivative limitation typically serves no policy in the context of closely held firms, Part III argues that the limitations on judicial remedies are costly ob- stacles that are contrary to the presumed intent of most small groups of entrepre- neurs. In particular, the default rules on special litigation committees are both cumbersome and inconsistent with broader national law that disfavors pre- dispute binding arbitration in the absence of clear agreement. Part IV concludes that, by forming LLCs, entrepreneurs across the nation are now unwittingly lock- ing themselves in to perpetual entities that offer them no liquidity and present them with costly procedural obstacles to enforcing both their agreement among themselves and their statutory rights. It further concludes that, at least in the case of member-managed LLCs, the statutory default rules ought to be brought closer to those that apply to LLPs, which more accurately reflect the 3. UNIF. LTD. LIAB. CO. ACT (UNIF. LAW COMM’N 1996), https://www.uniformlaws.org/ [hereinafter U.L.L.C.A.]. 4. REV. UNIF. LTD. LIAB. CO. ACT (UNIF. LAW COMM’N 2006) (last amended 2013), https://www.uni formlaws.org/ [hereinafter R.U.L.L.C.A.].
LLC Default Rules and Member Liquidity 153
presumed intent of small groups of entrepreneurs who form businesses without
the benefit of counsel. If LLC acts are not liberalized to restore greater liquidity
rights or other member remedies, courts should be attentive to claims made by
members that they are protected by oral operating agreements, by the terms of an
overarching partnership, or by historic principles of law and equity.
I. A RUPA PERSPECTIVE ON CHOICE OF DEFAULT RULES
A. CHOOSING THE DEFAULT RULE: NUMBER AND CHARACTER OF
TARGET GROUP, THEIR PRESUMED INTENTION, AND A CONCEPTION
OF THE ENTITY
The RUPA Drafting Committee considered the choice of default rules to be in-
formed by the number and character of the target group, their presumed inten-
tion, and a particular conception of the entity.
1. The Target Group: Small, Informal, and Unrepresented
RUPA’s primary target for default rules is small groups of entrepreneurs who
organize their business without the benefit of counsel. The drafters assumed
that, whatever the mix of services and capital the members contribute, they all
expect to have some role in the management of the business, which they expect
to operate informally. The Committee thought that the members are often
heavily invested in the firm, perhaps with little or no diversification, and so
might be looking to the firm for income, through either distributions or salaries
to themselves or their family members.5 They are also likely to engage in other
third-party transactions, such as selling or leasing property to the partnership or
lending it money.
These small, informal groups of entrepreneurs are in greatest need of appro-
priate statutory default rules because, unlike large firms or syndications of
investment interests, they typically have little or no written partnership agree-
ment.6 They tend to avoid or minimize a written agreement for any one of a
number of reasons. They may rely on the glue of their pre-existing relationships,
either as friends, family members, or business associates. They may underesti-
mate the problems that are likely to arise over the life of the business, or want
to avoid lawyers, either on aesthetic grounds, to save costs, or to avoid facing
difficult issues lawyers might call to their attention. The task of the Drafting
5. To a large extent, our target group had the characteristics normally associated with shareholders
in closely held corporations, in which “a more intimate and intense relationship exists between cap-
ital and labor.” Robert B. Thompson, The Shareholder’s Cause of Action for Oppression, 48 BUS. LAW.
699, 702 (1993). The shareholders “usually expect employment and a meaningful role in manage-
ment, as well as a return on the money paid for [their] shares.” Id.
6. Here again, the similarity to the closely held corporation is significant. See Margaret M. Blair &
Lynn A. Stout, Trust, Trustworthiness, and the Behavioral Foundations of Corporate Law, 149 U. PA. L.
REV. 1735, 1805 (2001) (noting that “participants in closely held corporations often decline to draft
complex contracts to control their future dealings, instead preferring to deal with conflicts informally
as they arise”).154 The Business Lawyer; Vol. 76, Winter 2020–2021
Committee, in a sense, was a very modest one. Throughout the Committee’s de-
liberations on RUPA, the recurring hypothetical involved two or three people
who owned and worked in a business that used a truck.
2. Default Rules Based on the Presumptive Intention of
Target Group
The RUPA default rules were based on the Committee’s determination of the
presumptive intention of the target group. In drafting an “off the rack” partner-
ship agreement for these small groups of entrepreneurs, the Committee asked
two separate questions about their presumptive intent. One, what are the
terms that the parties would probably have in mind but fail to express? Two,
what are the terms that the parties probably would not have in mind, but
would agree to if the matter were brought to their attention? These two questions
of presumptive intent are essentially empirical questions. To the extent the Com-
mittee could not with any confidence determine presumptive intent as an empir-
ical matter, it chose a default rule it thought was most likely to be fair.
It is especially important to avoid inappropriate default rules for a target group
that has little or no written agreement. For this group, the cost of an inappropriate
default rule is not the cost of drafting around it. For this group, there is no prac-
tical difference between a default rule and a mandatory rule. A person who finds
herself on the wrong side of a default rule will be forced either to accept it or to
incur what might be considerable cost to try to establish a contrary agreement,
either through negotiation, mediation, arbitration, or litigation before a court.
The Committee had no empirical studies to answer the two questions of pre-
sumptive intent. The best evidence of presumptive intent was the experience of
the members of the Committee and the statements of numerous other attorneys
involved in the RUPA process. The ULC often appoints drafting committees of
generalists, on the assumption that generalists in the legislatures enact the
ULC products and on the further assumption that the statutes need to be acces-
sible by generalists. Generalists on the Drafting Committee, and more broadly
among the membership of the ULC, often defer to others, especially American
Bar Association (“ABA”) Advisors, who often have considerable additional expe-
rience across a wide range of industries. ABA Advisors are also important
because the ULC is aware that ABA support or opposition can make or break
uniform adoption by the states, which is a primary goal of the ULC.
On occasion, the Committee added default rules that reflected language that
appeared in agreements drafted and negotiated by some of the sophisticated
business counsel involved in the drafting process, precisely the sort of expertise
we assumed our target group would not have at its side. Particularly in the case
of a partner’s right to be bought out, the result was longer and more technical
default rules.7 Unfortunately, the details went beyond what we could have
7. See infra Part II.A for a discussion of the RUPA buyout rules. The recent LLC rules are even
longer and more complex. For example, the latest Uniform LLC Act has four separate provisionsLLC Default Rules and Member Liquidity 155
assumed was the intent of our target group of unrepresented entrepreneurs.8
Instead, the rules reflected what the Committee felt were fair provisions similar
to those that had been included in agreements that had been fully negotiated
with the assistance of counsel.
3. The Conception of the Entity
RUPA was drafted to replace the venerable Uniform Partnership Act of 1914.
Without belaboring here the UPA’s well-documented history, the UPA began
with an emphasis on an entity theory and ended with an emphasis on an aggre-
gate theory. In the end, the UPA represented a blend of both approaches. In
terms of partnership property, for example, an entity-type of result was reached
but stated in aggregate terms. The UPA declared each partner a co-owner of part-
nership property,9 but then removed the normal incidents of co-ownership.10
RUPA declared for the first time that a “partnership is an entity distinct from
its partners.”11 First, declaring partnerships as entities reflected the reality that
third parties treat partnerships as entities. Second, the entity theory was consis-
tent with the intent to give stability to partnerships that had contracted for
it. Third, the entity theory was adopted for the sake of simplicity.12 For example,
the rules reflecting partnership property are much more cleanly and simply
stated in terms of an entity theory. Finally, RUPA partnerships become even
more entity-like if they register as LLPs to qualify for the “shield” against per-
sonal liability for partnership obligations.13 The RUPA rules for limited liability
partners are very different from the new rules for limited liability company mem-
bers. Entrepreneurs seeking the shield of an unincorporated form should care-
fully consider their choice between an LLP and an LLC.
RUPA made no attempt to adopt a theoretically pure entity model. The Com-
mittee adopted an entity theory only to reach and clearly state the substantive
results it wanted, not the reverse. As was the case in the UPA, it adopted a
blended approach. RUPA includes aggregate features, particularly on issues af-
fecting the relationships among the members themselves. It adopted an aggregate
approach to look “inside” the partnership to identify and enforce the partners’
expectations of one another and of the firm. Most importantly, for example, a
defining operating agreements and their effect. R.U.L.L.C.A. §§ 102(13), 105–07. The provisions are
accompanied by extensive Official Comments.
8. ULLCA continued the focus on “small entrepreneurs without benefit of counsel” and contin-
ued default rules “designed to operate without sophisticated agreements and to recognize that mem-
bers may also modify the default rules by oral agreements defined by their own conduct.” U.L.L.C.A.,
Prefatory Note.
9. U.P.A. § 25(1) (“Each partner is co-owner with his partners of specific partnership property
holding as a tenant in partnership.”).
10. See, e.g., U.P.A. § 25(2)(a) (stating that a partner has no right to possess partnership property
for personal purposes).
11. R.U.P.A. § 201(a).
12. See generally Donald J. Weidner, Three Policy Decisions Animate Revision of Uniform Partnership
Act, 46 BUS. LAW. 427 (1991).
13. R.U.P.A. §§ 306(c), 1001(c).156 The Business Lawyer; Vol. 76, Winter 2020–2021
partner has fiduciary duties both to the partnership and to the other partners.14
As noted commentator Bob Keatinge so aptly summarized, the transition from
the UPA to RUPA represents “going from a partnership’s being an aggregate
which is sometimes an entity to an entity that is sometimes an aggregate.”15
RUPA’s blended approach to the entity is similar to the blended approach the
federal income tax law takes to partnerships and LLCs. While overall, the part-
nership is a tax-computing and reporting entity, the partnership rules, now also
the LLC rules, still possess many aggregate features. In some cases, the parties are
free to choose whether to adopt an aggregate approach or an entity approach.
For example, assume a taxpayer purchases an interest in a partnership or LLC
that has highly appreciated depreciable assets. The taxpayer can be treated sim-
ply as purchasing an interest in the entity, which will compute and allocate to
the purchaser its share of the entity’s depreciation deductions. Or, the entity
and the purchaser can elect to look inside the entity,16 and recognize that the
price the purchaser is paying for a membership interest reflects the purchaser’s
share in the entity’s highly appreciated, depreciable assets.17 The result is that
the purchaser can claim more depreciation deductions than if it had simply
been allocated its share of the deductions computed and reported by the entity.
4. No Concern for the Length of the Statute
The RUPA Drafting Committee ultimately dismissed concerns that the statute
could get too long. The prevailing view was that the Committee should include
all the rules it thought appropriate, and not concern itself with the risk that the
statute was getting too long. On occasion, the prevailing view was that the Com-
mittee should answer, in the statute, every significant question that was raised.
The more questions addressed and answered in the statute, the longer it got.
A statute ought to be short enough and clear enough to state a readily acces-
sible philosophy of the business organization. The statute ought to be easily
readable, certainly by lawyers and judges, and ideally by the parties themselves.
The longer statutes get, the more difficult they are to read, especially by gener-
alists. In addition, the longer and more detailed the default rules, the greater the
likelihood of error in determining presumptive intent.
The tax rules for allocations in partnerships and LLCs illustrate the pitfall.18
Those rules, traditionally addressed to small business, were revised in the 1980s
to comprehensively address tax shelter allocations, and in the process became un-
readable by small businesspeople, their accountants, and their attorneys. Unlike
state statutes defining business associations, the federal income tax rules are di-
vided between the statute and the regulations under it. That is, to some extent,
14. Id. § 404(a).
15. Email from Robert Keatinge, Esq., Holland & Hart, Denver, Col., to the author (Sept. 25,
2019, 04:32 MST) (on file with author).
16. I.R.C. § 754 (2018).
17. Id. § 743.
18. Id. § 704(b); Treas. Reg. §§ 1.704-1–4 (2012).LLC Default Rules and Member Liquidity 157
the statute can serve as a shorter conceptual overview and leave it to regulations to
get into the weeds. On the state law side, however, everything is in the business
statute, weeds and all. That means that the business statute is much longer than
it would be if some of the details could be diverted to regulations.
B. THE IMPORTATION OF CORPORATE LAW INTO RUPA
1. In General
There is no reason the statutory reform of the law of any business organization
should reinvent the wheel. It can be efficient to borrow from successful provi-
sions of other statutes. For example, it makes sense for a partnership or LLC
drafting committee to borrow from other statutes defining when a firm is
imputed with the knowledge or notice of its owners. Borrowing successful pro-
visions in existing law not only makes the drafting process less costly, it also low-
ers the information costs to the ultimate readers of the statutes. The reader has to
spend less time parsing the partnership knowledge and notice rules if she recog-
nizes them from the Uniform Commercial Code or from LLC law.
It was therefore expected and perhaps commendable that real estate and law
firm experts wanted the best of partnership law continued, estate planners and
investment groups wanted the best of limited partnership law reflected, and cor-
porate lawyers wanted their favorite corporate law reflected. A major problem
with this borrowing is that rules from other business forms do not always fit.
2. An Example of a Bad Fit Within the RUPA Buyout Rules
RUPA provides that a partner who dissociates from a term partnership has the
right to be bought out for a statutorily defined buyout price. The partnership
must tender either cash or a promise to pay it at the end of the term. However,
RUPA went further and imported from corporate law certain procedural rules
about how the buyout right is to be exercised. Those rules require a partnership
to give its estimate of the buyout price and either pay the amount, or tender a
promise to pay it,19 “within 120 days after a written demand20 for payment.”21
A dissociated partner who wants to sue the partnership to determine the buyout
price must do so “within 120 days22 after the partnership has tendered payment
or an offer to pay or within one year after written demand for payment if no pay-
ment or offer to pay is tendered.”23
19. R.U.P.A. § 701(f ).
20. RUPA section 701 does not contain a requirement that the dissociating partner make a written
demand for payment, but a written demand triggers the limitation period.
21. Id. § 701(e). Four things must accompany the partnership’s tender, including financial state-
ments, an explanation of how the written estimate was calculated, and “written notice that the pay-
ment is in full satisfaction of the obligation to purchase unless, within 120 days after the written no-
tice, the dissociated partner commences an action to determine the buyout price.” Id. § 701(g).
22. The Official Comments oddly describe the 120 days as a “cooling off ” period, even though it is
a statutory limitation period. If it were a cooling off period, neither party could take any action.
23. Id. § 701(i).158 The Business Lawyer; Vol. 76, Winter 2020–2021 These procedural provisions, and the statutes of limitations within them, were drawn from “the dissenter’s rights provisions” of the Revised Model Business Corporation Act.24 There are two basic reasons they do not quite fit in RUPA. First, they are inconsistent with the fundamental rule that a partnership can be formed and operated without the need for a writing. Indeed, no writing is re- quired to dissociate from a partnership. These procedural rules, however, make writings particularly important. Second, the 120-day statute of limitations, for example, is inconsistent with the fundamental rule of RUPA section 405 that general law determines the limitation periods on actions between a partner and the partnership. RUPA intended the partnership agreement to be treated as a normal commercial contract, and as such be subject to normal limitation periods. A more fundamental problem with inserting these corporate rules25 is that even attorneys with a deep expertise in all other areas of partnership law— indeed, with every other provision of RUPA—could be completely blindsided by these dissonant procedural rules and their statutes of limitations. These rules are also likely to serve as a trap for unwary members of our target group, both dissociating partners and the continuing partners.26 Dissociating partners may not be aware that they need to make a written demand for pay- ment. The continuing partners may not be aware that they have only 120 days to respond. Indeed, even if the continuing partners know of the 120- day period, they may find the deadline difficult to meet. Partnerships without counsel or sophisticated accountants may find it difficult to mark as- sets up or down to market, estimate known and unknown liabilities against which they are required to indemnify the dissociating partner, and estimate any damages from wrongful dissociation, all within 120 days. Finally, the dis- sociating partner may then not realize she has only 120 days to respond to the partnership’s tender or be barred from suing the partnership to determine the buyout price. The only people who will not be surprised are the very sophis- ticated corporate lawyers whom we assume our target group does not have at its disposal. 24. Id. § 701 cmt. 8 (citing MODEL BUS. CORP. ACT § 13.25(b) (AM. BAR ASS’N 2016)). 25. If an LLC adopts a corporate structure, courts may apply by analogy other corporate princi- ples. Llamas v. Titus, CV 2018-0516-JTL, 2019 WL 2505374 (Del. Ch. 2019). 26. See ROBERT W. HILLMAN, DONALD J. WEIDNER & ALLAN G. DONN, THE REVISED UNIFORM PARTNERSHIP ACT 569 (2020) [hereinafter HILLMAN, WEIDNER & DONN] (“Just as they may be unaware of the need to make a written demand for payment, partners may fail to appreciate that the more general written statements they do make may be interpreted as a demand for payment under Section 701(e). Iden- tifying whether a communication is a written demand for payment is important to both the partner- ship and the dissociated partner. For the partnership, the demand triggers the 120 day period for arriving at an estimate of the amount due the dissociated partner and tendering payment. For the dissociated partner, the demand triggers a one year limitation period for initiating a judicial action to determine the buyout price.”).
LLC Default Rules and Member Liquidity 159
II. LLC ACTS FIRST ADOPT WITH MODIFICATION, THEN ELIMINATE,
RUPA’S LIQUIDITY RIGHTS
A. RUPA LIQUIDITY RIGHTS
A partner’s liquidity rights under RUPA vary depending upon whether the part-
nership is at-will or for a term. If there is no agreement “to remain partners until
the expiration of a definite term or the completion of a particular undertaking,”27
the partnership is classified as “at-will” and each partner has a right to dissociate
and cause a winding up of the business and be paid a share of the surplus after
creditors are satisfied.28 On the other hand, if a partnership is for a term or par-
ticular undertaking, each partner has the power to dissociate, but is denied the
right to trigger a business windup. Instead, the other partners have the right to
continue the business, provided they buy out the dissociating partner for a statu-
torily defined buyout price,29 which is determined at the date of the dissociation.30
The buyout price generally does not have to be paid until the end of the
term.31 If a partner were allowed to exit prematurely and force the continuing
27. R.U.P.A. § 101(8).
28. Id. § 801(1). This rule has for decades been regarded by some as giving too powerful a remedy
to the departing partner.
29. Id. § 701(a). The buyout price is the amount that would have been distributable to the partner
if, on the date of dissociation, the partnership had wound up its affairs and liquidated its assets, at the
greater of liquidation value or the value based on a sale of the business as a going concern without the
dissociated partner. Delaware replaced RUPA’s liquidation/going concern valuation approach with a
more general standard: “The buyout price of a dissociated partner’s partnership interest is an amount
equal to the fair value of such partner’s economic interest as of the date of dissociation based upon
such partner’s right to share in distributions from the partnership.” DEL. CODE ANN. tit. 6, § 15-701(b)
(2019). The buyout price is reduced for damages caused by the wrongful dissociation and other
amounts owed by the dissociating partner, including any share of partnership liabilities. RUPA sec-
tion 701(c) provides that the buyout price is reduced by “all amounts owing, whether or not due,
from the dissociated partner to the partnership.” The partnership, in turn, “shall indemnify a disso-
ciated partner whose interest is being purchased against all partnership liabilities, whether incurred
before or after the dissociation.” R.U.P.A. § 701(d). To the extent the partnership must indemnify
against liabilities that did not reduce the buyout price, the statutory requirement goes beyond its
proper function of protecting the dissociated partner from being charged twice for a liability,
first through a reduction in the buyout price and later when it is subsequently asserted. HILLMAN,
WEIDNER & DONN, supra note 26, at 577.
30. Most simply, dissociation takes place upon “the partnership’s having notice of the partner’s
express will to withdraw as a partner or on a later date specified by the partner.” R.U.P.A.
§ 601(1). It may be unclear when a partnership has notice of a dissociation, especially when a partner
has dissociated by conduct or abandoned the partnership. The issue can be important because the
value of assets, and of the overall business, can change dramatically. In Brennan v. Brennan Associates,
113 A.3d 957 (Conn. 2015), the court addressed when dissociation occurs if a partner was dissoci-
ated by court order but judgment was stayed pending the partner’s appeal of the order, which
ultimately was unsuccessful. A divided court held that the dissociation date for the purpose of com-
puting the buyout price was the later date on which the unsuccessful appeal was concluded. The
partner had continued to participate in management during the pendency of the appeal. Courts at-
tempt to avoid hindsight bias when determining value as of the time of dissociation. See, e.g., R4
Props. v. Riffice, No. 3:09-CV-400 JCH, 2015 WL 3770920, at *2 (D. Conn. 2015) (“At the thresh-
old, the court points out that the date of dissociation was in the midst of the 2008 financial crisis. To
the extent possible, the court’s goal is to find the value that a willing seller and a willing buyer would
have agreed to on the date of dissociation, not knowing with any certainty what the coming months
would bring. Put simply: the court does its best to avoid hindsight bias.”).
31. R.U.P.A. § 701(h).160 The Business Lawyer; Vol. 76, Winter 2020–2021
partners to pay the buyout price in cash, the continuing partners could be hurt
in any number of ways. In order to pay the buyout price, they might be forced to
sell or mortgage firm assets. Therefore, the default rule allows the continuing
partners merely to promise to pay the buyout price in the future—at the end
of the term—provided they secure their promise to pay.32 However, a dissociat-
ing partner may demand earlier payment if she “establishes . . . that earlier pay-
ment will not cause undue hardship to the business of the partnership.”33
B. THE 1996 LLC ACT ELIMINATED THE LIQUIDATION RIGHT BUT
PROVIDED TWO DIFFERENT BUYOUT RIGHTS
1. Same Target Group as RUPA: Similar Liquidity Rules
The liquidity rights of members under the 1996 Uniform LLC Act are very
similar to RUPA’s liquidity rights of partners because the drafters had the
same target group in mind. They “maintained a single policy vision—to draft
a flexible act with a comprehensive set of default rules designed to substitute
as the essence of the bargain for small entrepreneurs.”34 They “recognized that
small entrepreneurs without the benefit of counsel should also have access to the
Act. To that end, the great bulk of the Act sets forth default rules designed to
operate [an LLC] without sophisticated agreements and to recognize that mem-
bers may also modify the default rules by oral agreements defined in part by their
own conduct.”35
2. At-Will Versus Term: One of Two Key Designations
As under RUPA, the liquidity rules of the 1996 Act were based upon the fun-
damental distinction between at-will firms versus those for a term or particular
undertaking. It also continued the default rule that LLCs are at-will.36 The at-
will versus term designation was one of two “key designations” under the
32. R.U.P.A. § 701(f ), (h). The latter specifically provides: “A deferred payment must be ade-
quately secured and bear interest.” In general, the buyout provisions are subject to modification
by agreement because they are not listed in section 103(b)’s mandatory rules. But see R.U.P.A.
§ 701 cmt. (suggesting that other principles of law may render unenforceable a complete waiver
of the right to be bought out). An arbitration agreement has been held applicable to a statutory
claim for a buyout. Wetli v. Bugbee & Conkle, L.L.P., 2015-Ohio-4213, 2015 WL 5918066 (Ct.
App. 2015).
33. R.U.P.A. § 701(h).
34. As ULLCA was being finalized, RUPA was being amended to include the “shield” of a limited
liability partnership. The shield states that a partner is not liable for the contracts or torts of the part-
nership solely by reason of being a member. Id. § 301(c).
35. U.L.L.C.A., Prefatory Note at 2–3. (emphasis added). ULLCA anticipated the “check the box”
regulations from the Internal Revenue Service, which provided an “unincorporated” business entity
will be taxed either as a partnership or as a disregarded entity unless it elects to be taxed as a cor-
poration. In short, for tax purposes, the LLC was freer, although not required, to deviate more
from a partnership model and more toward a corporate model.
36. Unless the articles of organization “reflect that a limited liability company is a term company
and the duration of that term, the company will be an at-will company.” Id. It is therefore more dif-
ficult under ULLCA to become a term LLC than it is to become a term partnership, which can be
established without a writing.LLC Default Rules and Member Liquidity 161
1996 Act. The other was whether the LLC is member-managed or manager-
managed. According to the Prefatory Note, “[a]ll default rules under the Act
flow from one of these two designations.”37 The liquidity rules in particular flo-
wed from the at-will versus term designation.
3. Member Dissociating from At-Will LLC Denied Windup
Right but Given Immediate Buyout
Unlike RUPA, the 1996 Act does not give a dissociating member in an at-will
LLC the right to force a business windup. The drafters eliminated the windup
right in part because of criticism that said that the right to “blow up” an at-
will partnership gives the dissociating partner too much leverage over the part-
ners who wish to continue the business.38 The drafters also wanted to take
advantage of new tax rules providing that LLCs could be taxed as partnerships
even if they more nearly resembled corporations.39 Instead of a windup right,
members of an at-will LLC “may demand a payment of the fair value of their
interests at any time,”40 with fair value41 “determined as of the date of the
member’s dissociation.42 Because valuation is set at dissociation, a dissociated
37. U.L.L.C.A., Prefatory Note at 3.
38. Or, as one economist puts it, “if an investor’s death or withdrawal can provoke the firm’s de-
mise,” it “implies that firm-specific, illiquid investments may not realize their full return.” Timothy
W. Guinnane, Creating a New Legal Form: The GmbH (Yale Univ. Econ. Growth Ctr., Discussion
Paper No. 1070, Mar. 6, 2020), https://egcenter.ecoomics.yale.edu.
39. U.L.L.C.A., Prefatory Note at 3 (“[N]ew and important Internal Revenue Service Announce-
ments . . . generally provide that a limited liability company will not be taxed like a corporation re-
gardless of its organizational structure. Freed from the old tax classification restraints, the [final Act]
modifies the Act’s dissolution provision by eliminating member dissociation as a dissolution event.
This important amendment significantly increases the stability of a limited liability company and
places greater emphasis on a limited liability company’s required purchase of a dissociated member’s
interest.”).
40. U.L.L.C.A., Prefatory Note at 3. See also U.L.L.C.A. § 601 cmt. (citation omitted) (“Member
dissociation from . . . an at-will . . . company, whether member- or manager-managed is not an
event of dissolution of the company unless otherwise specified in an operating agreement. However,
member dissociation will generally trigger the obligation of the company to purchase the dissociated
member’s interest under Article 7.”). Similarly, U.L.L.C.A. § 701 cmt. provides that an at-will com-
pany “must cause the member’s distributional interest to be purchased under [Article] 7 when that
member’s dissociation does not result in a dissolution of the company under [Article 8].” Partnership
law does not use the term fair value.
41. Under the broad fair value standard, “a court is free to determine the fair value of a distribu-
tional interest on a fair market, liquidation, or any other standard deemed appropriate under the cir-
cumstances.” Id. § 703 cmt.
42. Id. § 203(5) cmt. (citations omitted). If an at-will LLC fails to purchase the interest of a
dissociated member, that member may use the failure to purchase to seek judicial dissolution. Id.
§ 801(4)(iv). However, the dissociating member from an at-will LLC has no automatic right to a de-
cree of judicial dissolution. The court must determine that it is “equitable” to wind up the at-will LLC
at the request of a transferee. ULLCA section 801(5)(ii) provides that, on application by a transferee
of a member’s interest, there is a dissolution and winding up on a “judicial determination that it is
equitable to wind up the company’s business . . . at any time, if the company was at will at the time
the applicant became a transferee by member dissociation, transfer, or entry of a charging order that
gave rise to the transfer.” The Official Comment cautions that “a court should not grant involuntary
dissolution of an at-will company if the applicant member has the right to dissociate and force the
company to purchase that member’s distributional interest.” U.L.L.C.A. § 801 cmt. This Comment,
somewhat inconsistently, also provides: “A dissociated member is not treated as a transferee for162 The Business Lawyer; Vol. 76, Winter 2020–2021
member in an at-will company “receives the fair value of their interest sooner
than in a term company and does not bear the risk of valuation changes for
the remainder of the specified term.”43
4. Member Dissociating from Term LLC Has Diminished
Deferred Buyout Right
If, on the other hand, the LLC is for a term, a dissociating member “must gen-
erally await the expiration of the agreed term.”44 However, unlike the buyout
from a term partnership, the fair value of the interest is not determined at the
time of dissociation. Instead, it is determined as of “the date of the expiration
of the term.”45 Thus, a member who dissociates from a term LLC bears the
risk of further declines in value between the time of her dissociation and
the end of the term. If the LLC extends its term after the member dissociates,
the term that matters is the term “at the time of the member’s dissociation.”46
C. RULLCA ELIMINATED BOTH BUYOUT RIGHTS: THE QUESTION IS
WHY?
1. Elimination of Buyout Rights and the “Necessary”
Oppression Action
Like the 1996 Act, RULLCA denies dissociating members the right to trigger a
windup. However, RULLCA also denies dissociating members a right to be
bought out, either in an at-will LLC or in a term LLC. Indeed, the labels
“term” and “at-will” no longer appear in the statute. Instead, LLCs are declared
to be entities that have “perpetual duration,”47 just like corporations and, more
recently, limited partnerships. A member’s liquidity right is simply the right to
purposes of subsections (a)(4) and (a)(5).” Unfortunately, there are no subsections (a)(4) and (a)(5),
and the Comment presumably means simply subsections (4) and (5). Subsection (5) appears to be an
imperfect importation of RUPA section 801(6), which did not need to include partners dissociating
from at-will partnerships because they had an absolute right to dissolve simply by giving notice of an
intent to withdraw. R.U.P.A. § 801(1).
43. U.L.L.C.A. § 203(5) cmt. (citations omitted).
44. Id. § 203(5) cmt. (citations omitted); see also id. § 603 cmt. (“Dissociation from a term com-
pany that does not dissolve the company does not cause the dissociated member’s distributional in-
terest to be purchased under Article 7 until the expiration of the specified term that existed on the
date of dissociation.”). Note that here the dissociated member is apparently not being bound to a term
changed after the dissociation. See also id. § 401 cmt. (“An agreement to contribute to a company is
controlled by the operating agreement and therefore may not be created or modified without amend-
ing that agreement through the unanimous consent of all the members, including the member to be
bound by the new contribution terms.”).
45. Id. § 203(5) cmt. (citations omitted).
46. ULLCA section 603(a)(2)(ii) provides that, if a term “company does not dissolve and wind up
its business on or before the expiration of its specified term, the company must cause the dissociated
member’s distributional interest to be purchased under [Article] 7 on the date of the expiration of the
term specified at the time of the member’s dissociation.” Id. § 603(a)(2)(ii) (emphasis added).
47. R.U.L.L.C.A. § 108(c). The Prefatory Note to RULLCA also refers to “the perpetual duration”
of LLCs. It does so by explaining why it introduces a remedy for oppressive conduct: “This provision
is necessary given the perpetual duration of an LLC formed under this Act, Section 104(c), and this
Act’s elimination of the ‘put right’ provided by U.L.L.C.A. § 701.”LLC Default Rules and Member Liquidity 163
share in distributions of any surplus whenever, if ever, the perpetual entity is
wound up.48 While awaiting a liquidating distribution, a member still has the
right to her share of any current distributions. If she dissociates, her interest
is “degraded” to that of a mere transferee.49
It is remarkable that there is virtually no explanation in the Prefatory Note or
Official Comments about the elimination of all buyout rights. The only mention
of their elimination is in a statement in the Prefatory Note that, because members
are being denied the right to be bought out from entities now deemed to be per-
petual, it is “necessary” to give them a right to seek judicial dissolution in the
event of oppressive conduct.50 There are three responses to this language,
which at a minimum supports the inference that the remedy for oppressive con-
duct is being added because members are now being locked in. First, the 1996
Act, which included two buyout rights, already gave members and dissociated
members a right to judicial dissolution in the event of oppressive conduct.51 Sec-
ond, RULLCA actually reduces access to the oppression remedy by taking it away
from dissociated members.52 Third, not all states that adopted RULLCA included
its oppression remedy. Florida, for example, eliminated the buyout rights but re-
jected its “necessary” protective remedy in the event of oppression.53
Commentators were of course quick to point out that minority members of
LLCs were being “locked in” and made as vulnerable to abuse as minority share-
holders in closely held corporations.54 Some defenders of the new regime have
suggested that the LLC “lock in” is not as bad as the corporate lock in. The mi-
nority shareholder is typically locked in to a corporate regime that is governed by
48. Id. § 707(b).
49. See Styslinger v. Brewster Park, LLC, CV136039748S, 2014 WL 6843565 (Conn. Super. Ct.
2014).
50. The Prefatory Note states:
A Remedy for Oppressive Conduct. Reflecting case law developments around the country, the
new Act permits a member (but not a transferee) to seek a court order “dissolving the company
on the grounds that the managers or those members in control of the company . . . have acted or
are acting in a manner that is oppressive and was, is, or will be directly harmful to the [mem-
ber].” Section [701(a)(4)(C)(II)]. This provision is necessary given the perpetual duration of an
LLC formed under this Act, Section [108(c)], and this Act’s elimination of the “put right” pro-
vided in ULLCA § 701.
R.U.L.L.C.A., Prefatory Note at 2.
51. Id. § 801(4)(v).
52. Id. § 701(a)(4) (limiting the availability of the oppression action to an action “by a member”).
53. See, e.g., FLA. STAT. § 605.0702(b)(3) (2019) (limiting the availability of a member’s dissolution
action to situations in which the managers or members in control have acted “in a manner that is
illegal or fraudulent”).
54. Certain scholars were resisting this change as it was being made. See Sandra K. Miller, What
Buy-Out Rights, Fiduciary Duties, and Dissolution Remedies Should Apply in the Case of the Minority Owner
of a Limited Liability Company?, 38 HARV. J. ON LEGIS. 413, 440 (2001) [hereinafter Buyout Rights] (“At a
minimum, a default buy-out right should be made available to LLC owners who find themselves in a
dispute with the majority without any operating agreement or with ineffectual contractual protec-
tion.”); see also Douglas K. Moll, Minority Oppression and the Limited Liability Company: Learning (or
Not) from Close Corporation History, 40 WAKE FOREST L. REV. 883 (2005) [hereinafter Moll].164 The Business Lawyer; Vol. 76, Winter 2020–2021
majority rule. Hence, the minority shareholder is vulnerable to changes made by
the majority. By contrast, in the typical LLC, the minority member has some pro-
tection because the operating agreement cannot be changed without unanimous
consent.55 Despite this difference, there is no question that the elimination of
liquidity rights still leaves minority members vulnerable to the majority, for
example on important issues such as employment, compensation, and fringe
benefits.56
2. Why the Course Reversal?
The obvious question is why RULLCA reversed course on the issue of member
liquidity. Either the target group changed, its presumptive intent had been re-
evaluated and determined to be different than what was originally thought, or
the tail of the entity theory came to wag the dog of the substantive default
rules. The answer appears to be primarily twofold: a new target group came
to the fore and there was a desire to create a more corporate entity.
a. Target Group Shifted to Include Family Businesses Engaged in
Sophisticated Estate Planning
The first thing that happened, well before RULLCA, is that the target group for
setting LLC default rules, at least the default rules on liquidity rights, shifted to
family businesses engaged in sophisticated estate planning.
Tax planners for family businesses had become used to contracting away liq-
uidation rights in order to reduce the value of ownership interests in businesses
for estate tax purposes.57 In 1990, Congress adopted a provision58 that disre-
garded contractual restrictions on liquidation rights “that are more restrictive
than the limitations that would apply as a default rule under the state law gen-
erally applicable to the organization in the absence of the restriction.”59 In short,
55. R.U.L.L.C.A. § 407(b)(4) (in the case of a member-managed LLC), § (c)(3)(B) (in the case of a
manager-managed LLC).
56. Cf. Meiselman v. Meiselman, 307 S.E.2d 551, 559 (N.C. 1983), a famous discussion of illi-
quidity effects in closely held corporations:
[W]hen the personal relationship among the participants in a close corporation breaks down,
the minority shareholder has neither the power to dissolve the business unit at will, as does
a partner in a partnership, nor does he have the “way out” which is open to a shareholder in
a publicly held corporation, the opportunity to sell his shares on the open market. Thus, the
illiquidity of a minority shareholder’s interest in a close corporation renders him vulnerable
to exploitation by the majority shareholders (citations omitted).
57. Robert R. Keatinge, Universal Business Organization Legislation: When Will It Happen? Why and
When?, 23 DEL. J. CORP. L. 29, 53 (1998).
58. I.R.C. § 2704(b) (2018).
59. Moll, supra note 54, at 938 n.179 (“Thus, the valuation under I.R.C. section 2704(b) will be
determined by reference to the default provisions of the organic statute pursuant to which the orga-
nization is formed, rather than by considering the extent to which the owners could actually create
liquidation rights less restrictive than those imposed by the organic statute or could actually liquidate
the interest. As such, I.R.C. section 2704(b) encourages the development of organic statutes which
contain default rules that restrict or eliminate the right of an individual to liquidate the individual’s
interest.”).LLC Default Rules and Member Liquidity 165
restrictions in statutory default rules could result in valuation discounts whereas
restrictions in operating agreements could not. This change created “a tax incen-
tive to create restrictive state law provisions regarding the ability to sell, redeem,
or otherwise liquidate an ownership interest in a business entity.”60 Practitioners
started “lobbying their state legislatures to eliminate all dissociation rights,” both
in LLC acts61 and in limited partnership acts. Their lobbying was successful, and
by the time RULLCA was promulgated, the target group for the liquidity rules
had shifted from small groups of entrepreneurs unrepresented by counsel to af-
fluent families engaging in sophisticated estate planning. To protect the repre-
sented few, RULLCA denied liquidity rights to the unrepresented many.62
b. The Desire for a More Corporate Entity
The second and related thing that happened was an increased demand for a
more corporate entity. As the 1996 Act was being finalized, the Internal Revenue
Service issued its now-famous “check the box” regulations, which allowed LLCs
to elect to be taxed as partnerships even if they possessed a preponderance of
corporate characteristics.63 There was, of course, no tax requirement to make
LLCs more like corporations. Nevertheless, it is clear that the drafters of RULLCA
intended to take advantage of the newfound freedom to make LLCs more like
corporations.
Like RUPA and the 1996 Act, RULLCA states that an LLC “is an entity distinct
from its . . . members.”64 However, RULLCA goes further and also provides that
an LLC “has perpetual duration,”65 conforming LLC law to corporate law66
60. Buyout Rights, supra note 54, at 432; see also Joseph M. Mona, Advantages of Using a Limited
Liability Company in an Estate Plan, 25 EST. PLAN. 167 (1998).
61. Laura Wheeling Farr & Susan Pace Hamill, Dissociation from Alabama Limited Liability Compa-
nies in the Post Check-the-Box Era, 49 ALA. L. REV. 909, 936 (1998).
62. Professor Moll catalogued the avalanche of literature saying that minority members in LLCs are
now as susceptible to oppression as minority members in closely held corporations. His solution was
a responsive right to dissolve in the case of oppression, an approach ultimately adopted in RULLCA.
He identifies the following four “seeds” of minority oppression: 1. the lack of exit rights; 2. majority
rule; 3. the deference given by the business judgment rule; and 4. the lack of ex ante contracting.
Oppression is generally defined as conduct that defeats the “reasonable expectations” of the minority
member. Conduct can include eliminating or substantially restricting distributions, removing the mi-
nority member or her family members from management or employment, increasing the compensa-
tion or other payments to the majority members or their families. Moll, supra note 54, at 895–916. “In
light of [the] apparent diverse use of LLCs, it may be more sensible to retain default buy-out rights in
each state’s LLC statute while removing default buy-out rights in a different statute such as the state’s
limited partnership statute.” Buyout Rights, supra note 54, at 442. A separate form for family busi-
nesses has also been suggested.
63. Treas. Reg. §§ 301.7701-1 to -3 (1996).
64. R.U.L.L.C.A. § 108(a).
65. Id. § 108(c). The RULLCA Official Comment to the “perpetual duration provision” also points
out that the public record will not reveal whether or when a limited liability company has come into
existence or “whether the company actually has a perpetual existence or has in fact dissolved.”
RULLCA “provides several consent-based methods to dissolve a limited liability company,” and
“none of these methods involve a public filing.” Id.
66. MODEL BUS. CORP. ACT § 3.02 (AM. BAR ASS’N 2016) (providing that, unless the articles of incor-
poration provide otherwise, “every corporation has perpetual duration”).166 The Business Lawyer; Vol. 76, Winter 2020–2021 and to recent limited partnership acts.67 Despite this unqualified statement of perpetuity, the Official Comments are equivocal: “The word ‘perpetual’ is a mis- nomer, albeit one commonplace in LLC statutes. In this context, ‘perpetual’ means that the act: (i) does not require a definite term; and (ii) creates no nexus between the dissociation of a member and the dissolution of the entity.”68 The question is obvious: why say in the statute that the LLC is perpetual and then say in the Official Comments that you don’t really mean it? By embracing the corporate “perpetual entity” model, the drafters appear to be providing a the- oretical foundation for eliminating both the present buyout right in an at-will LLC and the deferred buyout right in a term LLC. At the same time, the perpet- ual entity model provides a rationale for importing corporate restrictions on member access to judicial remedies.69 For whatever mix of reasons, it is clear that the RULLCA drafters sought to make a more perfect entity. For further ex- ample, section 105(c)(2) states the very modest mandatory rule that an operating agreement may not “vary a limited liability company’s capacity under Section 109 to sue and be sued in its own name.” By contrast, the Official Comment to that relatively narrow provision is much broader. It states that the now- perpetual LLC “is emphatically an entity, and the members lack the power to alter that characteristic.”70 Despite the intent to give LLCs more entity features than partnerships or early LLCs, it is an overstatement to say that members “lack the power to alter” the entity characteristic. Indeed, RULLCA itself continues to treat the association of members in an LLC as an aggregation to the extent it provides that a member of a member-managed LLC “owes to the company and, subject to Section 801, the other members the duties of loyalty and care.”71 The monkey-wrench in this statement is, of course, the reference to section 801, which imposes a distinction from corporate law that limits a member’s remedies for contractual and statutory breaches by classifying many member claims as derivative rather than direct. Like almost all the rules in RULLCA, this limitation on the right to bring a direct action can be contracted away in the operating agreement.72 Just as shareholders in a corporation, members can add aggregate features to their relationship. For example, they may agree to be personally liable for third-party claims against the entity or to one another if they breach the operating agreement. Whether such 67. UNIF. LTD. P’SHIP ACT § 110(c) (UNIF. LAW COMM’N 2013) [hereinafter Re-R.U.L.P.A.] (“A limited partnership has perpetual duration.”). 68. R.U.L.L.C.A. § 108(c) cmt. The second of these statements is puzzling, given that ULLCA did not dissolve the entity on the dissociation of a member. The Re-RULPA Official Comments are vir- tually identical. 69. See infra Part III. 70. R.U.L.L.C.A. § 105(c)(2) cmt. (emphasis added). 71. Id. § 409(a). Although corporations are still regarded as entities even if their majority or con- trolling shareholders are held to be under fiduciary duties to other shareholders, the imposition of these fiduciary duties can be viewed adding an aggregate characteristic to the entity. 72. Id. § 105(a). Compare Delaware’s law providing that partnerships are entities unless otherwise provided. DEL. CODE ANN. tit. 6, § 201(a) (2019).
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