Case Number 3 – Mike and Amy
Mike and Amy are movie producers. They have produced some of the greatest low budget films of all time. Each movie has the common elements of cheerleaders, motorcycles, misunderstood psychos and at least one nerd. Mike and Amy know their audience well, and it has made them very wealthy.
To raise money for each movie Mike and Amy use a separate LLC. They follow all the securities laws and provide the proper documentation. Each investor receives a percentage of the LLC. When profits are made they flow through the LLC directly to the investor. An issue for Mike and Amy is that each movie LLC has over 200 investors. The business can’t possibly be managed by all those people. Some of their money people are as oddly strange as the psychos in their movies. (One investor was even cast as a weirdo. He was brilliant, but then he wasn’t acting.) So they have to come up with a way to separate investment from management.
As such, Mike and Amy decide that their LLCs will be manager-managed. They will do the managing for all their investor members who, although they have plenty of opinions and grand artistic visions, have no experience managing a movie production.
Term
Managers serve for an indefinite term in most LLCs. Instead of holding an annual shareholders’ and directors’ meeting and electing directors and officers for the upcoming year as with a corporation, unless provided otherwise in the Operating Agreement, the managers serve until the members take a vote to remove them. In smaller, more informal LLCs, the initial managers will be installed and start managing. No one will give the matter of a manager’s term much thought until there is a problem and one or more of the managers must be removed.
In larger LLCs, or those in which investors have placed their money and trust in the managers, set terms for the managers may be established. The Operating Agreement may be drafted providing for, as an example, one-year terms for managers after which time the members shall review the managers’ performance and hold a new election.
It should be noted that unlike certain areas of corporate law, such as directors’ terms and meetings, which have a defined structure and procedure, the law of LLCs is much less formal. If you want to have terms for your managers, you can put them into your Operating Agreement. If you’d rather not bother, so be it. That’s your choice. If you run into a problem with your managers, state law lets you hold a vote of all the members, and the majority wins. For many, the laissez faire flexibility of the LLC is one of its endearing qualities. However, as discussed throughout this book, sometimes the following of certain formalities can be a useful and productive strategy.
Voting Rights
In a manager-managed LLC the members retain certain voting rights under most state statutes. (In a member managed LLC this isn’t much of an issue since all members vote on everything anyway.) Besides the right to remove and replace managers, non-managing members also have the right to:
• Approve membership changes to the LLC.
• Approve or deny the admission of new members.
• Approve or deny the transfer of a membership interest to an outsider.
• Approve fundamental changes through amendment of the Articles of Organization or Operating Agreement.
• Approve the merger or dissolution of the LLC.
Voting Power
The number of votes each member and/or manager is allowed to exercise should be clearly set out in the Operating Agreement. If your Operating Agreement is silent on this issue, your state’s statute will apply by default. Typically, state laws allocate voting power according to each member’s ownership interest as represented by his or her capital contribution. Some states’ default rules apply a per capita standard of one vote per member. Neither of these defaults may be right for your particular situation. Be sure to set out your own standards for voting in your Operating Agreement.
Whether the members of the LLC have a voting power based upon one vote each or a percentage of ownership, state law requires that most company matters be approved by at least a voting power majority. In addition, your Operating Agreement may be drafted so that certain key votes must be decided by a supermajority. Thus, for example, the removal of a manager may require a vote of not 51 percent but 81 percent of the voting power.
There is flexibility in the realm of manager-managed LLC decision-making as well. Although most state law default provisions provide for one vote per manager and a majority vote for all manager decisions, the Operating Agreement can be drafted to provide for different standards.
Case Number 3 – Mike and Amy
As mentioned, movie investors are an interesting class. They are drawn to a project by the hopes and dreams of Hollywood, only to learn that the reality is a group of hard-nosed businessmen involved in a crapshoot where no one is ever sure of winning. But when they do win it is huge, which keeps everyone coming back for more.
Mike and Amy find that some investors are easily upset by their inevitable disillusionment with the realities of Hollywood, and that they tend to take it out on the managers by trying to vote them out.
Being sharp people, Mike and Amy draft the Operating Agreement to create two classes of membership interests. One class, held by Mike and Amy, is able to exclusively vote for the two managers. The other class of membership interests, held by all the other investors, has no say or vote in electing the managers. This arrangement is freely disclosed to all potential investors in the LLC’s investment prospectus. No one can say they aren’t aware that they can’t vote for a manager.
As a result, when the investors get mad, as they sometimes do, their recourse is not to hold an election and remove the managers. Mike and Amy are the only managers and, absent a court order, that will not change. The investor’s recourse is to demand accounting and financial records, which Mike and Amy happily provide. They have nothing to hide. And by maintaining management control they are able to conduct the business to the benefit of all their investors.
Meetings
Another distinctive feature of the LLC format is that most states do not require LLC meetings. Unlike the corporate regime of detailed procedures for the notice and call of annual and special meetings, the LLC rules are very hands-off. Several states require meetings as a default, meaning that you can provide in your Operating Agreement for no meetings and avoid the state’s requirement.
Interestingly, while no meetings are required, as mentioned earlier, the members are required to vote on such major issues as dissolution of the LLC, removal of managers, if allowed, and amendment of the Operating Agreement. How can members vote without holding a meeting? If allowed in the Operating Agreement, the members can register their votes informally without holding a meeting or preparing meeting minutes. In some cases, they can simply sign a consent to the action taken without the need for a meeting. Otherwise, most states have default procedures allowing LLC members or managers to call a special meeting for the taking of votes on major issues.
As discussed throughout this book, no-meeting flexibility is not ideal. The following example illustrates why:
Case Number 4 – Eric and Sherry
Eric and Sherry operate a dry cleaning business. They have borrowed money from friends and family to open the business and formed an LLC to conduct their enterprise. Each of their investors receives an LLC membership certificate reflecting the amount of money they have invested. Their Operating Agreement does not call for annual meetings or even special meetings to decide major issues. Eric and Sherry get actively involved in running the business, and before long, several years go by without any communication with the investor/members.
One of their investors, a Mr. Beye, has put more into the LLC than he probably should have. Now, he needs his $10,000 investment back for certain upcoming medical expenses. Mr. Beye calls Eric and demands