Family-owned businesses that are organized as limited liability companies typically reflect the terms of the company’s governance, along with the members’ financial rights and obligations, in a written operating agreement. The terms of the operating agreement often specifically include what, if any, payments a member is entitled to if he or she withdraws as a member of the LLC before the LLC dissolves. For example, the operating agreement may limit the right to payment of a withdrawing member to the return of any balance in his or her capital account. An operating agreement may even provide that a member is entitled to no payment whatsoever upon withdrawal. In any case, agreed-upon provisions concerning payments upon withdrawal will reflect the members’ expectations from the outset. Such provisions can also protect the LLC from having to make large and unplanned payments upon a member’s unilateral decision to withdraw at a point in time when the LLC may not have the funds to pay such a withdrawal distribution.
When a family business operated as a limited liability company brings on professional management, the parties typically focus on items in the operating agreement such as capital contributions, allocations and distributions, and governance. However, a recent Delaware Chancery Court case serves as a reminder that all provisions of a limited liability company operating agreement must be given careful consideration, including the provisions relating to advancement and indemnification rights. In Harrison v. Quivus Systems, C.A. 12084-VCMR, the Delaware Chancery Court ruled on cross motions for summary judgment in a case where the plaintiff, the former CEO of the defendant, sought indemnification and advancement from the defendant corporation. The court ruled in favor of the plaintiff, and awarded not only the advancement and indemnification sought, but also “fees on fees” incurred by the plaintiff in bringing the action in Delaware.
John Harrison (the plaintiff in this action) had served as the CEO of Quivus Systems, LLC (the defendant), since its inception in 2007. In 2014, the controlling shareholder of Quivus removed Harrison as CEO, and in 2015 filed suit against Harrison in the Superior Court for the District of Columbia, alleging mismanagement and corporate malfeasance. In response to this lawsuit, Harrison made a demand for indemnification (including advancement of expenses), which was refused by Quivus. After this refusal, Harrison sued Quivus in the Delaware Chancery Court, leading to the ruling issued by Vice Chancellor Montgomery-Reeves on August 5, 2016. Continue Reading Family Businesses Should Carefully Consider Indemnification and Advancement Obligations Included In Limited Liability Company Operating Agreements