Before you buy any interest in a business, it is crucial to confirm what you are buying and take all of the formal steps necessary to complete the transaction. In the case of purchasing an LLC interest, the most important document to be reviewed is the LLC Operating Agreement.

An LLC Operating Agreement (or Shareholder’s Agreement for a corporation) details the procedures by which the LLC will operate. It helps ensure that all of the owners of an LLC are on the same page about how the business will operate. In most cases, provisions of this agreement trump contrary provisions of a state’s LLC Law and/or Business Corporations Law.

When purchasing an LLC interest, some of the key provisions of the operating agreement to review include the following:

• Governing law.The LLC may have been formed outside of New York, even if it operates in New York. In this case, the other jurisdiction’s law may govern the agreement. For example, many shareholders choose Delaware law because it tends to be more favorable to the business owners. This may have a substantial impact on the buyer’s rights because the governing state’s default laws apply where the agreement doesn’t specify otherwise.
• Transfer restrictions.Buyers should note whether the agreement contains certain provisions such as the following:

1. Right of first refusal.The agreement could provide that the entity or other members/shareholders be given the opportunity to buy the interest of a member who wants to sell its interest, before it can be sold to a third party. Typically, the entity or member must match the terms of the buyer’s offer.
2. Drag-along rights.These permit one shareholder/member who has an opportunity to sell the majority of the membership interest to a third party to force the others to sell their interests as well. In other words, if one member wants to sell his/her interest to a buyer, the other members also must sell their interests.
3. Tag-along rights.These rights state that if one member wants to sell his/her interest, other shareholders/members can force the buyer to purchase their interests as well, on identical terms.
4. Permitted transferees.Members/shareholders may be allowed to transfer their interests to certain classes of transferees, such as family members, trusts, etc.

• Rights of the purchaser.Most operating agreements establish certain requirements for a purchaser to be admitted as a full member of the entity. Typically, these provisions state that there must be consent of some or all of the other members or that the purchaser must sign a joinder or other agreement by which he/she agrees to abide by the terms of the Operating Agreement. Unless these requirements are met, a purchaser of an interest does not become a full member and is only entitled to the economic rights of the seller (i.e., the right to the seller’s interest in any distributions). The buyer cannot vote or participate in the operations of the business. He/she also cannot sue the other members for claims not involving the purchase (i.e., derivative claims).

This was confirmed in a recent New York appellate court decision, Kaminski v. Sirera, in which the Court held that the Plaintiff did not have the right to bring a derivative action against the members or counsel of the LLC because she did not meet the requirements in the operating agreement for becoming a member.

As a buyer, it is important to evaluate these provisions to understand what prerequisites may exist for your purchase and becoming a member of the LLC. It also informs you of the rules which may apply to you in the future.

Consult experienced counsel to represent you in the purchase of a business interest. If you are considering purchasing an LLC, contact us to discuss how we can help.

Learn more about LLC operating agreements in our related post.