Expelling a member from an LLC: when the court will back you

A shareholder dispute rarely reaches a lawyer's office at an early stage. By the time it does, the company has usually gone six months without holding a meeting, one member has taken the customer database, the other has frozen the current account, and both are asking how to get rid of each other. Here is what a court can do in that situation and what it cannot.

There is only one ground for expulsion

Article 10 of the LLC Act: a member may be expelled if they grossly breach their duties or if, by their acts or omissions, they make the company's activity impossible or significantly impede it.

The Supreme Court, in Plenum Ruling No. 27 and in its reviews of practice, has made the point clearer: expulsion is a measure of last resort, applied in cases of plain abuse. Mutual grievances, differing views on strategy and personal dislike are not grounds. What is more, where two members holding 50/50 are locked in an equal, mutual conflict, the court more often refuses both of them and points to withdrawal or liquidation.

What the courts treat as a gross breach

The case law has settled around several recurring scenarios.

Systematic failure to take part in meetings, as a result of which the company cannot adopt decisions requiring a qualified majority: approving a major transaction, replacing the director, approving the accounts. The key word is systematic, and it has to be proved with notices and minutes.

Acts harmful to the company. A member who is also the director enters into transactions at non-market prices with companies he controls, strips out assets, and sells property below value.

Competing with your own company. Setting up a parallel legal entity with the same type of activity, moving customers and staff across, and using the database and the brand.

Falsifying documents and attempts to seize control. Forging minutes recording a change of director, entering changes in the state register on the basis of false information.

Spreading information that causes harm. Telling counterparties that the company will not perform its obligations, approaching the bank to demand that the account be frozen.

What to gather before filing the claim

A claim for expulsion is won on documents gathered before the conflict or at its very start.

Notices convening meetings, sent to the address shown in the state register, with an inventory and postal receipts. Minutes recording non-attendance. Correspondence in which the member refuses to vote. Valuation reports on the assets involved in the transactions that stripped the company. Register extracts showing the incorporation of a competing company with the same activity code. Evidence of staff moving across. Claims from counterparties caused by the member's conduct.

Separately, evidence that the harm was caused to the company and not personally to the other member. This is the point at which most claims fall apart: the claimant describes a personal grievance while the court is looking for loss to the company.

How expulsion differs from withdrawal and from a sale of the share

Withdrawal is a voluntary act by the member, where the articles allow it. The company pays out the actual value of the share according to the most recent accounts.

Expulsion is compulsory, by order of the court, with the same payment of actual value. In other words, the expelled member receives money: this is not a financial punishment but a way of separating people.

A sale of the share to a third party is possible where the articles do not require the other members' consent. That is often precisely why the articles contain a pre-emption right and a ban on disposal without consent — otherwise a stranger turns up one day in your partner's place.

How the payment is calculated

The actual value of a share is the portion of net assets proportionate to the size of the share. It is calculated from the accounting records for the last reporting period before the relevant event.

This is where the second dispute arises: the book value of assets is often far from the market value, particularly where the balance sheet carries real estate at an old valuation. The courts allow expert evidence and the determination of value taking the market price of the assets into account. That is why an expert report is ordered in almost every expulsion case, and the amount depends on its conclusions.

The payment period is three months from the day the obligation arises, unless the articles provide otherwise.

What to do when there are no grounds for expulsion

This is the answer I most often give at a first meeting: there are no grounds for expulsion, there is a deadlock in management.

The workable options in that situation are: a sale of the share to one of the partners with instalments and security, a split of the business by business line with contracts transferred across, a shareholders' agreement with a deadlock-breaking mechanism, or liquidation with distribution of the assets.

None of them is quick, but all of them end in certainty. Years of claims and counterclaims end in the same place, only with the company lost along the way.

This material is for information only and is not a substitute for advice on a specific matter.

If a shareholder dispute has reached deadlock, write to us — the first consultation is free when an engagement is signed.

Vladimir Kovalev — lawyer, founder and managing partner of Kovalev & Partners LLC