(Un)Common Sense Lawyer: Portland, Oregon Small Business Law Blog

Small business breakups are a lot like divorce.  One minute things are going good, you and your business partners see eye-to-eye, and the next thing you know all hell has broken loose and you’re fighting over every last scrap of the business.  Poor planning for disagreements over the management of an LLC, particularly a two-member LLC with 50/50 ownership and voting rights, can be disastrous.  Without a solution to management deadlock, dissolution of the LLC may be the only choice.

An all too-common hypothetical: friends doing business don’t plan for deadlock and the business dissolves as a result

Two friends, Joe and Bob, start up an Oregon LLC.  They file their articles of organization with the Secretary of State Corporation Division online, and create Hypothetical Restaurant LLC (this is a hypothetical, so the name seems appropriate).  They’ve been friends for years, agree on all aspects of the new business, and can’t wait to get started.  And here’s where they went wrong:

• They don’t draft an operating agreement or a buy-sell agreement, believing that they’ll be able to work any disagreements out amongst themselves.
• They don’t consult with an Oregon small business lawyer because they can’t envision a situation where they won’t be able to figure things out for themselves.
• They are now subject to the default provisions of the Oregon Limited Liability Company Act.  Each member has a proportional ownership of the business at 50 percent, and each has an equal say in how the business is run.

Let’s say Hypothetical Restaurant LLC’s two members face the following dilemma: after opening 3 years ago they were a smash hit.  Business was booming, and they opened up a second location.  They secured a loan, and each of them is a personal guarantor for the loan.  They signed a 5-year lease on the new space.  After another two years, the second location isn’t performing.  They’re losing money by staying open and it’s draining their savings.  Bob wants to close down and sublet the space to recoup costs, but Joe wants to ride out the down cycle and wait for the second location to become more profitable.  Our two friends, who have never had a disagreement over the future of the business until now, are at a management deadlock.

Without deadlock provisions or a suitable buy-sell arrangement, dissolution rears its ugly head

The problem is, the Oregon Limited Liability Company Act doesn’t provide guidance or provisions that apply to deadlock.  LLC members are free to contract for whatever legally acceptable provisions they want, and these provisions can be put into an operating agreement that governs the LLC.  When Oregon LLC members fail to draft their own deadlock provisions, and they ultimately arrive at a fork in the road and can’t come to agreement, the business comes to a grinding halt.  Common operating agreement mechanisms to resolve deadlock include mediation or arbitration.  A buy-sell agreement can also assist in planning for the exit of one partner who no longer wishes to continue in the business because he wants to take it in a different direction.

In the case of our two friends, neither one can afford to buy the other out, and neither one wants to go along with the other’s plans.  They each have an equal say in how the business is run, and they have nowhere to go but to court.  ORS 63.661(2) provides that judicial dissolution of an LLC is appropriate when it is “not reasonably practicable to carry on the business of the limited liability company in conformance with its articles of organization or any operating agreement.  If two members are at odds to the point of management deadlock with no governing provisions to resolve deadlock, judicial dissolution is the likely result as soon as one partner gives up trying to convince the other of the error of his ways.

ORS 63.661 Grounds for judicial dissolution.

The circuit courts may dissolve a limited liability company:

(1) In a proceeding by the Attorney General if it is established that:

(a) The limited liability company obtained its articles of organization through fraud; or

(b) The limited liability company has continued to exceed or abuse the authority conferred upon it by law.

(2) In a proceeding by or for a member if it is established that it is not reasonably practicable to carry on the business of the limited liability company in conformance with its articles of organization or any operating agreement.

(3) In a proceeding by the limited liability company to have its voluntary dissolution continued under court supervision. [1993 c.173 §66]