This is the third in a series discussing eight bad “D”s to consider when drafting an operating agreement for an LLC.
3. DIVORCE
Given the prevalence of divorce, particularly among individuals who are in the entrepreneurial space, it is a reality that you need to consider when drafting an operating agreement for an LLC. Public policy has pretty much mandated in all family courts that irrespective of how craftily and creatively an LLC operating agreement is drafted, that LLC membership interest is a marital asset unless there is a clear and specific signoff to the contrary by the non-member spouse at the time the LLC is formed.
In the event one of the business partners in an LLC goes through a divorce, you need to be aware of two things. First, that business partner did not go away, but that partner has been severely hampered with things that are draining their time, energy, and focus. Hopefully, you and the other members of the LLC will look at things from the perspective of if you were in that business partner’s shoes, and you would extend to that hurting business partner the grace and kindness you would want extended to you if you were in that situation.
Second, you need to understand that part of the LLC or a profits interest in the LLC is now going to end up in the hands of someone who may be hostile by virtue of the way the divorce occurred. That potentially hostile person needs to be bought out or minimized in a fair and equitable manner.
It is very important that the LLC operating agreement be amended pursuant to the terms of the final divorce decree so there is a division of the LLC ownership interest between the divorcing parties. The original member will remain a member but at a reduced percentage. The former spouse will get a “profits interest”. This will result in a change to the operating agreement as well as a change to the LLC tax return, meaning an additional K-1 will now be generated. Each of the parties in the divorce, if they divide the membership profits interest of the LLC between them, will now get separate K-1s. It is imperative that this be diligently done as expeditiously as possible. Buyout language should be carefully talked through and included if feasible.
