Disputes among LLC members are not uncommon, even in companies with a small number of members or in family businesses. The most common causes of conflict are disagreements regarding company management, distribution of profits, sale of shares, or breach of members’ specific duties.
The Company Law provides several mechanisms for resolving such disputes, including judicial protection, exclusion of a company member, withdrawal of a member, or transfer of shares.
It is very important that relationships among members are clearly regulated by the memorandum of association in order to reduce the risk of lengthy and costly court disputes.
Why do disputes arise among LLC members?
A limited liability company is often formed as a partnership between several individuals who share a common business idea. At the beginning, relationships among members usually function well, without major issues, but as the company grows, potential sources of conflict begin to emerge.
Disputes among LLC members may arise due to:
• different visions of the company’s development
• disagreements regarding management and decision-making
• distribution of profits
• sale or transfer of shares
• abuse of rights or position within the company
Disputes among LLC members are particularly common in companies with a small number of members, where each member has significant influence over decision-making. In such situations, a conflict between two members can lead to a complete blockage of the company’s operations.
The most common disputes among LLC members
Certain types of disputes occur much more frequently than others:
Disputes regarding company management
One of the most common causes of conflict is disagreement over company management. Members often have different ideas about business strategy, investments, or the way the company should be run.
If no member has a majority share in the capital, such disagreements may lead to a deadlock in decision-making at the company’s assembly (so-called deadlock). This occurs, for example, when two members hold 50:50 shares or when four members each hold 25% and two vote for one option while two vote for another.
Disputes regarding profit distribution
Another common reason for conflict is the distribution of profits. Although members have the right to participate in profits proportionally to their shares, in practice disputes among LLC members often arise regarding:
• whether profits should be distributed or reinvested, and
• whether a decision on profit distribution will be made at all, i.e., whether profits will remain undistributed
Disputes regarding transfer of shares
The transfer of shares in an LLC can be a particularly sensitive issue. When one member wants to sell their share to a third party, the other members often wish to retain control over the composition of the company.
For this reason, the law provides for the right of first refusal, allowing existing members to have priority when purchasing shares. Some memoranda of association provide that a member cannot transfer their share without the company’s consent, which creates additional potential for conflict among members.
Disputes due to breach of specific duties
Members of a company have certain specific duties towards the company, such as the duty of loyalty or non-compete obligations.
When a member (among other things):
• uses company information for personal benefit
• fails to disclose a personal interest in a company transaction
• discloses the company’s business secrets
• starts a competing business
• causes damage to the company
this may constitute grounds for a serious dispute and even for initiating proceedings for the exclusion of a member.
How does the law regulate disputes among LLC members?
The Company Law provides several mechanisms for resolving conflicts among company members.
One of the most important instruments is judicial protection of members’ rights.
In many cases, a member may initiate court proceedings to protect their rights, especially if they believe that company decisions have been made contrary to the law or the memorandum of association.
The law also allows minority members (holding at least 5%) to initiate court proceedings when the assembly ignores their proposals or fails to implement adopted decisions.
In addition, the law provides for the possibility of excluding a member.
According to Article 196 of the Companies Act:
“A company may request expulsion of a company member by filing an action to the competent court, for the reasons prescribed by the memorandum of association or other justified reasons, and in particular if the member of the company:
1) Deliberately or by gross negligence inflicts damage to the company;
2) Fails to execute special duties towards the company prescribed by this Act or the memorandum of association;
3) By his actions or failures to act, contrary to the memorandum of association, law or good business practices, obstructs or significantly hinders the company’s business operations.”
From this, it can be concluded that exclusion is a measure used in situations where a member’s behavior seriously jeopardizes the company’s interests.
Can a dispute among members block the company’s operations?
A decision-making deadlock is one of the most common consequences of conflicts among members.
When members have equal participation in the capital or when the balance of power is such that no side can make decisions without the other, a so-called decision-making deadlock occurs.
Such a situation may lead to:
• inability to make business decisions
• inability to appoint a director
• interruption of the company’s operations
In ideal cases, the resolution of such deadlocks is provided in the memorandum of association, as the founders have anticipated potential disputes in advance.
If that is not the case, it is advisable to consider negotiations and mediation between the members.
In practice, solutions are often found through:
• transfer of shares
• withdrawal of a member from the company
• voluntary liquidation
What are the options for resolving disputes among LLC members?
Disputes between members can be resolved in several ways.
Amicable resolution
The simplest method is an agreement among the members. This may include:
• sale of shares
• buyout of shares by the company
• restructuring of the management structure
Transfer of shares
In many cases, the conflict is resolved by one member transferring their share to another member or to a third party.
Withdrawal of a member from the company
A member may decide to withdraw from the company and request compensation for the value of their share.
Court proceedings
When a dispute cannot be resolved amicably, members holding at least 20% of the share capital (individually or jointly) may initiate court proceedings. In such cases, the court examines the existence of legal grounds (deadlock of corporate bodies, oppression of minority members, dissipation of assets, etc.) and, if necessary, orders the dissolution of the company or another measure to overcome the deadlock.
Why is the memorandum of association crucial for preventing disputes?
A large number of disputes among LLC members could be avoided if relationships among members were clearly regulated in the memorandum of association.
Within the memorandum of association, founders may deviate from statutory rules and regulate many important matters in more detail – for example, reimbursement of formation costs, duration of non-compete obligations, distribution of voting rights, rules on transfer of shares or inheritance, and even extension of confidentiality obligations.
If these relationships are not defined in the memorandum of association, general statutory rules will apply, which may not suit the needs of a particular company.
A well-drafted memorandum of association prevents misunderstandings regarding the rights and obligations of founders, clearly defines decision-making processes, and provides mechanisms for resolving potential deadlocks in governance.
Frequently Asked Questions about disputes among LLC members
Can a member of an LLC sue the company?
Yes. A member may initiate court proceedings if they believe that their membership or property rights have been violated.
What happens if members cannot make a decision?
If there is a decision-making deadlock, the dispute is often resolved through transfer of shares, withdrawal of a member, or court proceedings.
Can a member be excluded from the company?
Yes. The company may initiate proceedings for exclusion if the member’s conduct causes damage to the company or seriously disrupts its operations.
How are disputes among LLC members most commonly resolved?
Disputes are most often resolved amicably, through transfer of shares or the exit of one of the members. Court proceedings are initiated when an agreement is not possible.
Conclusion
Disputes among LLC members are a common occurrence in business practice. They most often arise due to disagreements regarding company management, profit distribution, or transfer of shares.
The Company Law provides various mechanisms for resolving such disputes, including judicial protection, transfer of shares, or exclusion of a member.
However, the most effective way to prevent conflicts is to clearly regulate relationships among company members through a memorandum of association that reflects mutual trust among LLC members.
