The compliance of the members of New Hampshire multi-member LLCs with the duty of loyalty imposed by the New Hampshire LLC Act is arguably the most important fiduciary duty to which these members are subject, and the members’ compliance with this duty may affect the LLC’s very survival.

However, because the statutory duty of loyalty involves eight subsidiary duties, it is also the most complex LLC fiduciary duty and the hardest for the members to understand and thus to comply with.

The first of these subsidiary duties is the duty of the members not to compete against their LLC.

On operating agreements, this duty not to compete arises above all when a member retires from her LLC. But retirement is just one of six or more “events of dissociation” which, under a well-drafted operating agreement, will terminate a member’s LLC membership.

These events are addressed in the New Hampshire LLC Act itself, but they should also be addressed in detail in any multi-member LLC operating agreement. Thus, before I address the subsidiary duty not to compete in this column, I want to put duty in context by writing a few words about each of these events of dissociation.

— The first event is the death of a member while she is a member. In this event, the member obviously won’t have either a general duty of loyalty or any subsidiary duty. However, if the operating agreement provides that the deceased member’s membership must pass to her heirs upon her death, this by itself may raise the issue of the non-competition duty of these heirs. The operating agreement should address this issue.

— The second event is retirement. As noted, non-competition issues will inevitably arise when a member resigns from membership. In particular, the governing operating agreement should often provide that the resigning member will be entitled to a buyout, but that the buyout price will be much higher if, upon resigning, the member agrees that she will not compete with the LLC than if she does not so agree.

— The third event is disability. Presumably, if the disability of the affected member is severe, she will simply be unable to compete against her LLC. However, if the disability prevents her partially but not fully from performing her LLC duties, non-competition may be a significant disability issue.

— The fourth event arises if, for estate planning reasons or otherwise, the member transfers all or a part of her interest in her LLC’s profits to her child or other third party. But a reduction in the transferring member’s economic interest in the LLC may also affect her willingness not to compete against the LLC.

— The fifth event is the member’s personal bankruptcy. In this event, the other members may want the right under their operating agreement to require the bankrupt member to sell her membership to the LLC, since this will prevent a bankruptcy court from ordering her to transfer her membership to a third party whom the other members may not want as a new co-member. However, if a member becomes bankrupt but is not bought out, she may well feel less committed to her non-competition duty.

— The sixth event is the member’s expulsion. Well-drafted multi-member LLC operating agreements will normally provide that a member may be expelled from membership by vote of the other members because the other members believe she has engaged in misconduct that will significantly harm the LLC. But an expelled member may well take the view that because the other members have expelled her, she is no longer subject to a non-competition duty.

— Finally, a multi-member LLC operating agreement may provide for one or more events of dissociation besides those listed above. For example, it may provide for the dissociation of a member who becomes divorced or who is a party to a divorce proceeding, since this proceeding may seriously disrupt the affected member’s performance of her duties toward the LLC, including her non-competition duty.

In other words, while the impact of a member’s resignation from a multi-member LLC will unavoidably raise non-compete issues, so too may one and possibly all of the other events of dissociation addressed in a multi-member LLC operating agreement. If you’re forming a new multi-member LLC or if you want to protect an existing one, you need to address in your operating agreement the effect of each of these events on the members’ non-competition duty.

 

 

John Cunningham is a lawyer licensed to practice law in New Hampshire and Massachusetts. He is of counsel to the law firm of McLane Middleton, P.A. His practice is focused on LLC law and tax, LLC formations and the handling of LLC disputes and lawsuits. His telephone number is (603) 856-7172. His email address is lawjmc@comcast.net. His website link is llc199a.com. For access to all of his Law in the Marketplace columns, visit concordmonitor.com.