Do you have a parasitic partner? A partner who is no longer contributing? Absent without leave? Taking credit for the work of others? It may be time to reconsider the contours of your partnership.
The genesis of a new business venture often follows a predictable pattern. A group of entrepreneurs unite around a new product, technology, or service that is all but guaranteed to disrupt an industry. Full of optimism, they form an LLC. They choose this type of legal entity because they feel it will keep the control right where it should be: in the hands of its owners.
Among the new company’s founders are all the usual suspects: the member who raises capital, the mad scientist with the technical “know-how,” some junior mad scientists, a marketing and sales guru, and one member to manage them all. All of them are expected to contribute to the business according to their expertise. The bonus? They’re all friends, and they trust each other.
So, what happens if down the road, one founding member doesn’t pull their weight, but still wants their share of the business and its profits, feeding off the toil of the others like a leech?
This is precisely the explosive situation some of our clients have found themselves in—and from which our attorneys have been able to liberate them. We call these non-performing members “parasitic partners.”
The Pathology of a Parasitic Partner
Perhaps at first, when the founders of a company were excited to get things up and running, the parasitic partner had some illusory value. The honeymoon was not yet over, and each member believed in the others’ utmost dedication to their cause. Over time, however, the parasitic partner became divisive, disruptive, lazy, or incompetent at their job. Promises went unfulfilled and excuse was piled upon excuse. The parasite might have stopped showing up, missed deadlines, blamed others for failures, taken credit for others’ work, or even secretly worked outside the common business. Meanwhile, the other partners were forced to cover for the parasite’s shortfalls.
When matters reach this state, the other members tend to wake up, smell the coffee, and realize that they gave a nice piece of the business to someone who feeds off their hard work in return for nothing but empty words. Why should they have to share their profits with a partner who doesn’t deserve their interests in the business? It seems like a simple matter of principle, and yet it becomes increasingly clear that the parasite will never willingly surrender their unearned share of the business and profits.
Infuriated by the injustice of their partnership, the other founders retain experienced legal counsel to investigate the grounds for “divorcing” their parasitic partner.
Operating Agreements: An Ounce of Prevention Is Worth a Pound of Cure
Every LLC begins with an operating agreement, and it is common for our clients to assume that the off-the-shelf operating agreement they originally enacted included provisions for ridding the company of a partner who failed to deliver as expected. However, dusting off the operating agreement reveals often nothing legally helpful. Unless the founders had the forethought to include a “member expulsion” clause in the operating agreement, there is no automatic means the courts can apply to dissolve the parasite’s interest in the LLC.
If no such clause was included in the operating agreement, can the parasitic partner continue to sit on the sidelines and cash in without contributing to the success of the company?
Options for Expelling a Parasitic Partner
The LLC is a creature of contract, and courts are often reluctant to intervene on matters not clearly outlined in those contracts. That said, every state has at least a minimum of rules surrounding what happens when an organizational agreement fails to set forth how a company may rid itself of a parasitic partner.
Delaware and New York give great deference to the language of LLC contracts and a well-drafted agreement is paramount for companies in those legal jurisdictions. Those courts give very little guidance on dealing with the expulsion of a member who is no longer contributing to an LLC, and a challenge can often, though not always, lead to the dissolution of the LLC.
In New Jersey and Pennsylvania, however, aggrieved owners of LLCs bound to parasitic members have a clearer track to freedom even if the underlying agreement is less than clear on how to deal with the parasite. Both these states have adopted the Revised Uniform Model LLC Act. Section 602 provides for dissociating a member by judicial act for reasons other than an explicit violation of the operating agreement terms. One of the broader reasons a company can seek dissociation is that a member “has engaged in conduct relating to the company’s activities and affairs which makes it not reasonably practicable to carry on the activities with the person as a member.”
The New Jersey Supreme Court was among the first state supreme courts to set forth expulsion factors to consider when it found that “not reasonably practicable” must mean more than animosity and personal conflicts (IE Test, LLC v. Carroll, 226 N.J. 166 (2016)). Likewise, on February 21, 2017, Pennsylvania enacted mechanisms to expel, through judicial intervention, a parasite partner for cause without regard to the underlying agreement (15 Pa.C.S. § 8861(6)). While vague, these statutes at least open the door for judicial involvement.
Ready to Fight? Consider the Costs
Even if an LLC’s operating agreement isn’t explicit on the issue of grounds for expulsion, it is possible for a company to seek a legal remedy and be successful. If negotiation is impossible and litigation is the only practical course of action, the other LLC members will have to first decide what it would consider to be a “win” for the company. Does it involve ownership? Control? Removal? Dissolution?
Though it is human to be motivated by honor, pride, and principle, companies seeking to expel a member should consider both the actual cost of litigating their case and the cost of time. Can the parasite outlast, outgun, and outspend the other founders? This means the other founders will have to use to get what they want in alignment with the company’s goals, and with the interests of third parties such as banks, investors, major customers, family members, landlords, and unions.
If your company has a parasitic member who is unjustly holding on to profits and power, or you are considering forming an LLC and require assistance in drafting a robust operating agreement, contact us today.