From Cash Out to Let it Ride: Wisconsin’s New LLC Laws Change Members’ Rights After Withdrawal
Nicole S. Schram | 04.11.23
Creating or investing in a business isn’t always a sure bet. The owners of an LLC (the LLC’s “members”) contribute significant cash or services to an LLC to acquire their ownership interest in the LLC; in exchange, they expect the LLC to run smoothly and provide a return on their investment. But what happens when the gamble doesn’t pan out, or personalities collide, and a member wants to throw down the cards and walk away? Is the member entitled to cash out its ownership interest in the LLC, or can the LLC force the member to let it ride?
A member’s right to payment after withdrawing from the LLC depends on what law or agreement governs the LLC. If the LLC is governed by the Old Law, a member would be entitled to cash out; if the LLC is governed by the New Law, the member is required to let it ride; and if the LLC has an operating agreement, the member is likely bound by the agreement made among the members. The stakes can be high for both the withdrawing member and the ongoing LLC business, and the parties’ rights are not always clear.
Wisconsin’s New and Old LLC Laws- the Basics
Wisconsin’s limited liability laws, located in Chapter 183 of the Wisconsin Statutes, were initially created in 1993 and remained relatively unchanged until 2023 (the “Old Law”). On April 15, 2022, Gov. Evers signed Senate Bill 566/Act 258, repealing the Old Law and recreating Chapter 183 (the Wisconsin Uniform Limited Liability Company Law, the“New Law”) effective as of January 1, 2023. The New Law is similar to the Revised Uniform Limited Liability Company Act, adopted by over 20 states. Pro tip: Be careful when researching Chapter 183 on the internet- it can be hard to tell whether you’re viewing the New Law or the Old Law. See our prior articles on the New Law, here.
Both the Old Law and New Law include mandatory and “default” provisions. Mandatory provisions govern all LLCs, while default provisions apply to an LLC only if the LLC does not have an operating agreement that addresses the issue.
Which Law Applies? Hint: it may NOT be the New Law
LLCs formed in or before 2022 were given an opportunity to “opt-out” of the New Law between April and December, 2022. LLCs that timely filed a Statement of Nonapplicability with the Wisconsin Department of Financial Institutions (“DFI”) will continue to be governed by the Old Law unless and until they formally file an “opt-in” statement with DFI or until a future change in the law.
As of January 1, 2023, the New Law governs all LLCs that did not file the Statement of Nonapplicability with DFI. The New Law also applies to any LLCs formed after that date.
Whether an LLC is governed by the Old Law or New Law, the provisions of the LLC’s operating agreement may override the default provisions of Chapter 183. Therefore, it is possible that the LLC’s operating agreement will govern a member’s right to payment for that member’s LLC ownership interest after withdrawing from the LLC. Under the New Law, and contrary to practice under the Old Law, an operating agreement does not need to be in writing or signed by the members; it can instead be created by the members’ oral agreements or course of conduct. This change may add significant uncertainty to LLC governance, particularly when members disagree whether an unwritten operating agreement overrides the Chapter 183 defaults.
When Members Leave: Default Under the Old Law
Under the Old Law default, with notable exceptions, members could voluntarily withdraw from their LLC and reasonably demand a full cash out payment from the LLC. Wis. Stat. §183.0604 (1993 – 2022) required an LLC (if not dissolving as a result of the withdrawal) to pay the withdrawing member “a distribution in complete redemption of the fair value of the member’s interest” within a reasonable time of the member’s dissociation, unless otherwise provided in the LLC’s operating agreement. Thus, if a member withdrew, the member could trade its ownership interest for a full redemption payment.
Old Law Examples
An Old Law Example: ABC, LLC opted out of the New Law and remains governed by the Old Law. ABC has no written operating agreement, so the default rule in the Old Law likely governs the member’s rights after withdrawal. Therefore, if Member X owns a 50% interest in ABC, and if ABC has a “fair value” of $1 Million at the time of Member X’s withdrawal, ABC must pay Member X a $500,000 redemption payment within a “reasonable time” of Member X’s withdrawal, unless the LLC and Member X agree to something different.
A Problematic Old Law Scenario: Many operating LLCs run on tight cash margins, with most of the company’s “fair value” coming from real estate or equipment. A cash out redemption payment (often a very large payment) can be a high hurdle for an LLC that has few liquid assets. Indeed, if a withdrawing member demands payment in full, and the LLC cannot locate adequate cash to pay the redemption in a reasonable time, the withdrawing member could potentially force the LLC to liquidate its assets and dissolve, putting an end to an otherwise viable business. This Old Law default rule can be used by individual LLC members as a powerful tool to do harm to the LLC.
When Members Leave: Default Under the New Law
Under the New Law, if the (potentially unwritten) operating agreement doesn’t otherwise direct, a withdrawing member cannot force a cash out payment in exchange for its ownership interest, but essentially has to let it ride. Specifically, under current Wis. Stat. §183.0404, a member’s withdrawal from the LLC “does not entitle the person to a distribution” in redemption of the membership interest. Instead, after the member’s withdrawal, the LLC is required to make all LLC distributions “proportionally among members and dissociated members” until the LLC dissolves and winds up its business.
New Law Examples
A New Law Example: XYZ LLC was created in 2015 and did not opt-out, so it is now governed by the New Law. XYZ has a signed operating agreement from 2015, but it does not address a member’s right to payment after withdrawal from the LLC, so the New Law’s default payment rule likely applies. Member A is only entitled to the same distributions (in proportion to Member A’s ownership percentage) that the LLC pays to other current and dissociated LLC members, until the LLC dissolves and liquidates its assets.
A Problematic New Law Scenario: Under the above scenario, the members of XYZ LLC signed their operating agreement when the Old Law governed the LLC. If Member A owned 50% of XYZ LLC upon withdrawal, and XYZ was worth $1 Million, Member A could have a reasonable expectation of receiving a $500,000 cash out payment for the ownership interest after withdrawal. However, Member A’s rights are vastly different now than when the operating agreement was signed under the Old Law. Because the XYZ LLC operating agreement didn’t specifically address the issue, XYZ could argue that the New Law’s default now applies, and the LLC is not required to pay Member A any redemption payment after dissociation. Further, if XYZ chooses to reinvest all its earnings back into the business, XYZ LLC may never make any distributions to its members and dissociated members.
Member A could potentially make an argument under the New Law that the members’ course of conduct or oral agreements modified XYZ’s 2015 operating agreement in a manner that requires the LLC to make a full cash out payment. If this argument fails, however, Member A may have little recourse against XYZ.
The recent changes to Wisconsin’s LLC laws have far-reaching consequences that business owners may not have anticipated, particularly if the New Law now applies to their LLC and no operating agreement provisions override the defaults. We encourage LLC members and managers to review their operating agreements through the lens of the LLC laws that currently apply to the LLC. The attorneys at Boardman Clark can help with this complicated review. If the LLC’s operating agreement leaves too much to chance, our attorneys can help determine the best course of action, whether that is opting in to the New Law (for an LLC that initially opted out) or amending the operating agreement to require equitable outcomes for both the LLC and its members. We’re here to help businesses beat the odds.
DISCLAIMER: The information provided is for general informational purposes only. This post is not updated to account for changes in the law and should not be considered tax or legal advice. This article is not intended to create an attorney-client relationship. You should consult with legal and/or financial advisors for legal and tax advice tailored to your specific circumstances.