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Thomas D. Kearns
tkearns@olshanlaw.com

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What does “Control” mean in 50/50 LLCs?

What are the minimum market protections for LLC agreements when a 50% member of a proposed LLC agrees that the other member may “control” the proposed new commercial real estate venture?

Back to the proverbial meeting of two business people discussing the terms of a proposed new real estate investment:  one partner says to the other:  “But, of course, I have to control the business.”  Assuming the other partner agrees and no other specifics are discussed, what did he or she agree to based on my experience of what is market?  My most recent experience involved an LLC agreement between a 50% member, who brought the opportunity to a real estate operator who insisted on control even though both members put up half of the required capital.

  1. Written LLC Agreement.  First, the basics:  it’s universal for 50/50 partners in any significant transaction to enter into a written LLC agreement and, except for immaterial changes required by third party lenders, the controlling 50% member is not permitted to amend the agreement without consent of the non-controlling member.

  2. No Affiliated Contracts or Dealings.  It is typical for the controlling member to agree in the LLC agreement not to cause the LLC to enter into arrangements with affiliates.  For example, the controlling member may not hire an affiliated entity to serve as the on-site property manager unless approved by the other member.  Similarly, under that LLC agreement clause, the controlling member could not sell the property owned by the LLC to an affiliate without the other member’s consent. 

  3. Fiduciary Duty.  In a 50/50 deal the controlling member should agree to be governed by Delaware fiduciary duty.  See my blog posts about the current issue in Delaware regarding default fiduciary duties.  To be safe, include an express provision. [Note: as of August 1, 2013, the Delaware statute has been amended to provide for default fidicuary duty.  Care should still be taken, however, since the terms of the LLC Agreement will control over the default duties.]

  4. Purpose and Scope.  The purpose of the business should be expressly set forth in the agreement as should the scope.  By scope, I mean the extent of the project, anticipated capital improvements and, in a residential ground up development, whether it will be a rental or a for sale condo – this type of structure impacts the economics of the deal and the promote waterfall.

  5. Financials.  The agreement should provide for periodic financial reporting including at least annual financial statements and the audit or at least review of the financials by an independent CPA approved by the non-controlling member.

  6. Distributions.  The agreement should require regular distributions subject to reasonable reserves.

  7. Buy/Sell.  Just because one member controls the business does not mean mutual buy/sell rights would not apply.  In addition, the non-controlling member needs to be protected from the sale by the controlling member of its interest; after all the agreement to permit control was likely personal to that individual.  The right to consent to such transfer and the loss of the right to control are two ways to protect the non-controlling member from transfers of the controlling interest.

  8. Removal.  Fraud, breach, felony convictions or other events should give rise to a right to remove the controlling member from its position of control.

The above items represent my view of the market provisions when one 50% partner agrees to let the other 50% partner control.  Of course, dozens of other issues could be addressed including budget approval, approval of major capital expenditures, etc., but those are deal by deal dependent.  The typical way lawyers refer to those rights are to call them “major decisions.”  The next time you are in a meeting about a new real estate deal and your 50/50 partner says he or she will control, you should answer:  “OK but subject to approval of major decisions.  I’ll ask my lawyer to create a list.”

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