The Ties That Bind: When Will a Court Expel a Member of an LLC?
In IE Test, LLC v. Carroll, the New Jersey Supreme Court addressed when a limited liability company (LLC) can expel a member under a statute authorizing a member’s disassociation for conduct that has made it “not reasonably practicable to carry on” the LLC’s activities.
IE Test had three members, two of whom actively ran the business and drew salaries, and a third who played no role in the LLC’s day-to-day affairs. Before an operating agreement was executed, a dispute arose between the two active members and the passive member over the passive member’s compensation. Consequently, no operating agreement was ever signed. The two active members then sought to judicially disassociate the passive member on the statutory ground that the impasse and absence of an operating agreement made it “not reasonably practicable” that he could continue as a member. The trial court granted summary judgment, expelling the passive member, and the Appellate Division affirmed.
The Supreme Court reversed, focusing on the key undefined phrase, “not reasonably practicable.” Characterizing the “not reasonably practicable” standard as “stringent” and a “high bar,” the Court held that disassociation is permissible only when it is “unfeasible, despite reasonable efforts, to keep the LLC operating while the disputed member remains affiliated with it.” The impasse among the IE Test’s three members did not necessarily rise to this level because the default statutory provisions governing the LLC in the absence of an operating agreement provide for majority rule of the LLC, thus allowing the business to continue to operate.
To guide courts in evaluating a member’s conduct and assessing whether it is reasonably practicable for an LLC to continue with a dissenting member, the Court adopted this seven-part test: “(1) the nature of the LLC member’s conduct relating to the LLC’s business; (2) whether, with the LLC member remaining a member, the entity may be managed so as to promote the purposes for which it was formed; (3) whether the dispute among the LLC members precludes them from working with one another to pursue the LLC’s goals; (4) whether there is a deadlock among the members; (5) whether, despite that deadlock, members can make decisions on the management of the company, pursuant to the operating agreement or in accordance with applicable statutory provisions; (6) whether, due to the LLC’s financial position, there is still a business to operate; and (7) whether continuing the LLC, with the LLC member remaining a member, is financially feasible.”
The Court directed that in determining whether to order the expulsion of an LLC member, courts should engage in a case-specific analysis using these factors, in addition to other relevant considerations, with no requirement that all factors favor expulsion, and no single factor settling the outcome.