¶ 3001
Overview
Scope of the chapter. This chapter examines the contractual mechanisms by which the members of an LLC control who may own an interest in the company, how an owner may leave, and at what price. The mechanisms fall into three families. The first is the buy-sell agreement, which obliges or permits the company or the remaining members to purchase an interest when a stated event occurs, such as a member's death, disability, divorce, bankruptcy or departure from employment. The second is the preemptive right, which gives the company or the other members a prior opportunity to acquire an interest that a member proposes to sell: the right of first refusal and the right of first offer. The third is the group of exit and liquidity rights that operate on a sale of the business or of a controlling block: drag-along rights, which compel minority holders to join a sale, tag-along rights, which permit them to join it, and the shotgun clause, which forces one of two deadlocked owners to buy out the other.
Why the agreement matters. The LLC statutes leave most of these questions to the operating agreement. Neither the Delaware act nor the uniform act gives a departing member a statutory right to be bought out at a fair price, and both make the transferee of an interest a holder of economic rights only. A member who dies, divorces or leaves without a buy-sell provision may leave behind an estate, a former spouse or a creditor holding distribution rights in a company it does not manage, alongside members who did not choose it and owe it little. The buy-sell agreement replaces that default outcome with a negotiated one. It determines who buys, when, at what price, on what terms and with what money. Each of those choices carries legal, valuation and tax consequences that this chapter examines in turn.
Organization. The chapter proceeds in nine parts:
- the purposes of buy-sell provisions and their statutory setting (¶ 3010);
- the events that trigger a purchase (¶ 3020);
- the structure of the obligation: redemption, cross-purchase and hybrid agreements, mandatory and optional purchases, and puts and calls (¶ 3030);
- price and valuation, including the distinction between fair value and fair market value and the conduct of appraisals (¶ 3040);
- funding, including life insurance after Connelly v. United States (¶ 3050);
- the effect of the agreement on estate and gift tax value under I.R.C. § 2703 (¶ 3060);
- rights of first refusal and first offer (¶ 3070);
- shotgun clauses, drag-along rights and tag-along rights (¶ 3080); and
- income tax consequences, the relation of these provisions to transfer restrictions and deadlock remedies, and a drafting checklist with sample clauses (¶ 3090).
Relation to other chapters. The statutory rules on transfer of interests and admission of transferees are examined supra ch. 29, and this chapter assumes them. Dissociation, withdrawal and expulsion, which are frequently the events that trigger a buy-sell obligation, are examined infra ch. 31. Deadlock and the judicial remedies for oppression, including court-ordered buyouts, are examined infra ch. 32. Charging orders, which a well-drafted buy-sell agreement often treats as a triggering event, are examined supra ch. 27. The income tax treatment of sales and liquidations of partnership interests is examined infra ch. 41, and the use of LLCs in estate planning, including valuation discounts, infra ch. 50. Clause-by-clause drafting guidance for the operating agreement as a whole appears infra ch. 56.
Terminology. This chapter uses "buy-sell agreement" for any provision, whether in the operating agreement or in a separate contract among the members, that obliges or permits a purchase of an interest on a stated event. A "redemption" agreement is one under which the company is the purchaser. A "cross-purchase" agreement is one under which the other members are the purchasers. A "call" is the right of the company or the members to require a sale, and a "put" is the right of the member or the member's successor to require a purchase. The Delaware act speaks of the "assignee" of a limited liability company interest, and the uniform act and most modern statutes speak of the "transferee" of a "transferable interest." The terms are used interchangeably here except where a statute is quoted.