One of the hot button issues frequently leading to litigation in “The LLC Jungle” is the removal of an LLC’s manager.
Thoughtfully drafted LLC Operating Agreements contain provisions addressing the criteria and procedures for removing an LLC’s manager from his or her post. Unfortunately, most LLC Operating Agreements are not thoughtfully drafted.
One recent opinion by California’s Fourth Appellate District — Hillsborough Development Company, LLC v. Annen — sheds light on how courts deal with manager removal disputes. While the Hillsborough opinion is unpublished (and therefore not binding precedent), it provides a useful guidepost.
Hillsborough Development Company, LLC was formed in 2004 by members Richard Sparber, Richard Annen (through his IRA), Gary Rudolph, and Rick Seideman. The Operating Agreement stated that Hillsborough was a manager-managed LLC, and appointed Sparber as manager.
But the Operating Agreement said nothing regarding removal of the manager or installation of a new manager. Predictably, that led to a dispute later on.
In 2018, Annen and Rudolph, who together owned 53.3 percent of the membership interests in the LLC, sent notice to Sparber and Seideman that, based on their majority vote, they were removing Sparber as manager and installing Annen as the new manager. Annen and Rudolph asserted that only a majority vote was required under the “default” provisions of California’s Revised Uniform Limited Liability Company Act (“RULLCA”) — specifically, Corporations Code section 17704.07.
Sparber, still purporting to act as manager, filed a lawsuit on behalf of the LLC against all four of its members seeking declaratory relief, contending that a unanimous vote of the LLC’s members (including Sparber himself) was required to remove the manager. Sparber acknowledged that the Operating Agreement did not address manager removal, but pointed to other general provision of the Operating Agreement requiring a unanimous member vote for “all matters in which a vote … is required.”
Sparber applied for a preliminary injunction, seeking to enjoin Annen from acting as Hillsborough’s manager.
The trial court granted the injunction, barring Annen from acting as the LLC’s manager.
The trial court relied on the Operating Agreement’s general terms requiring a unanimous vote for all matters in which a vote is required. Based on those terms, the court held that Corporations Code section 17704.07 (the default law requiring only a majority vote) did not apply.
The Court of Appeal reversed, and vacated the trial court’s injunction order.
The court held that the default rules set forth in RULLCA apply whenever “the parties have otherwise failed to address a particular matter in their operating agreement.” Here, the LLC’s Operating Agreement “provides no insight into the parties’ intentions with respect to the procedure for selecting or removing Hillsborough’s manager.”
Due to the Operating Agreement’s silence on that specific issue, the court held, the default rule of section 17704.07 applied. Under that statute, a “manager may be removed at any time by the consent of a majority of the members without cause[.]”
The generic provisions of the Operating Agreement requiring a unanimous vote on “all matters in which a vote” is required was not specific enough to govern the issue of manager removal. The court emphasized that LLC members are free to structure their own rules and procedures for the governance of the LLC (including removal of a manager) in their Operating Agreement, and if they do so with sufficient specificity, the Operating Agreement will control. But here, the Operating Agreement did not reveal any “specific intention to deviate from the majority vote rule provided in section 17704.07.”
The court also noted that the Operating Agreement’s provisions requiring a unanimous vote did not apply to “all matters” generally, but only to matters in which a vote “was required” by the Operating Agreement. The Agreement listed a few examples of those matters — additional capital contributions, withdrawal of a member, and selling the company’s assets — but none of them involved manager removal.
Not addressing an issue as critical as manager removal in an LLC’s Operating Agreement almost guarantees litigation in the future.
One of the main advantages of an LLC is the ability to structure the relationship of the members and manager(s) with specific provisions in an Operating Agreement. Manager appointment and removal should always be addressed. If the parties want a different manager removal rule than the “majority vote, without cause” default rule set forth in section 17704.07, all they need to do is say so in the Operating Agreement.
Addressing a sensitive issue like manager removal at the outset of the enterprise might be uncomfortable for some, since it involves contemplating a “divorce” of sorts between the members and manager. But setting the ground rules up front can prevent many headaches and enormous litigation expenses down the road.