What course of action can a partner in an LLC take if another partner is inactive?
I have a client whose business is compromised of 3 partners (50/40/10). The 40% partner has not contributed or been involved in the business for almost 2 years. What can the 50% & 10% partners do to remove the 40% partner? The partnership is in Utah, has $0 revenue, and has no assets or liabilities.
As others described it - the operating agreement is the place to look at. Often the agreement may require a 80% vote for capital structure decisions. In that case you will not be able to do anything with the partner that owns 40% - especially if the idle partner got that equity due to an investment they made which would be in the capitalization table as part of the operating agreement. I am not sure that when you say that the partner has no assets or liabilities this is what you mean.
Let me add some points others have not addressed:
1) Tax advantages of having the Utah partner on board. Because you are an LLC that partner is getting a Schedule K-1 so he is paying taxes to the tune of 40% of the profit of the company. Now as you say if he has 0% revenue he may not be getting a K-1. Legally he is required to pay taxes - even if your Operating Agreement absolves him of this obligation. Hence this is real cash he has to pay to government on your behalf. Ask him to pay this annually. If he does not want to he will come to you and ask him to be taken off the partnership. End of story.
2) Compensation: Since the other 2 partners are working partners you are entitled to a salary. Again based on the Operating Agreement you will likely have 2 clearly defined committees: the Owners and the Managers of the company. The Owners decide capital structure and key decisions for the company: M&A, sale, options issue. However other decisions such as Compensation, hiring, etc. are left to the Managers of the company. Seems like you two would be managers of the company and Utah guy is only on the Owner committee. If so you can draw a salary for services rendered. This is obviously fair and legal too. This way you will be compensated somewhat for the fact that he does not work in the company.
Remember that ownership in the company may seem very valuable to you and it is easy to emotionally attached to your 'baby'. Hence equity matters. But in the big picture cash is king (so is time).
We all know about hindsight & foresight. When we set up our LLC, we appended a compensation agreement signed by all members, to the operating agreement. It spelled out compensation separately from shares of ownership.
It depends on the operating agreement and the relevant State laws under which the LLC was formed, e.g. Utah ( or maybe Delaware?). The operating agreement must specify the time, place and procedures for any member withdrawal or expulsion. If the operating agreement is silent on these topics, and absent a member being convicted of something serious, most states prohibit a member being expelled. In other words you can't just decide to kick someone out of a business they helped form unless you all agreed that could happen up front. If the latter is the case you may have to dissolve the LLC (again per the operating agreement) and reincorporate without the member in question.
Without additional structured details it would be extremely hard to consult short of saying to look around for someone to buy out the partnership position.
Discuss with them what it would take to buy their position out and go from there.
Also definitely consult with an attorney and show cause as to why there is a issue and decide on the best route to solve the issue.
1. Legally it would depend on the share structure.
2. Finacially it would depend on the tax position and types of shares issued to each shareholder.
3. Ethically the advice should be to see a lawyer as giving advice without accreditation is like doing brain surgery without being a surgeon;-)
I'm no lawyer, but the 50% and 10% partners should be able vote out the 40% partner. They would have to agree upon a buy-out settlement.
Without any assets, the company is worth nothing. The 40% partner will argue there is future value, which is what he invested in. If they can get the 40% partner to agree, then buying his initial investment + interest would be a fair value, IMO.
The operating agreement will detail how to dissolve a partner if they hired a good attorney to write it.
Another option is just voting to lower the 40% owners shares to 5% or less - depending on his involvement so far.
Hopefully you can do this without argument...otherwise a tough legal battle is in your near future. Good Luck!