NYREJ Publishes Article by Thomas Kearns on Protecting Co-Investors in LLC Agreements

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New York Real Estate Journal recently published an article written by Olshan Real Estate partner Thomas Kearns entitled “LLC Agreement Issues for Co-Investors” (subscription required). (The article is also available on our blog.) The article examines the problems that co-investors face when entering an LLC agreement with an operating partner (or “member”) and a large institutional investor. “When the invitation to a smaller investor arrives,” Mr. Kearns explains, “it can be accompanied by a ‘we’re in a hurry’ message with the clear implication that the co-investor won’t be able to negotiate the terms of the agreement governing the LLC,” and as such, it is imperative that these smaller investors and their lawyers carefully review the draft LLC agreement. The foremost concern for small investors is “whether the operating member has disclaimed fiduciary duty.” New York LLCs do not permit a broad disclaimer, but in Delaware LLC agreements, Mr. Kearns warns that “an operating member should think twice before including a broad disclaimer in the proposed Delaware LLC agreement given to investors because of the negative impression it will give small investors. With a fiduciary duty standard, the investor can at least feel that he or she will be treated fairly. Without it, all bets are off.” Moreover, the operating member could choose to transfer its interest in the LLC to a third party, meaning that “the small investors could be stuck with an illiquid investment in an entity managed by a stranger. The easy solution,” he proposes, “is a ‘tag-along’ clause which lets the small investor sell its interest to the same third party at the same price.” Lastly, a key protection for small investors is the right to transfer their interest in the LLC for estate planning purposes and on death or disability. Neglecting to include such anticipatory language in the agreement could prove costly: “Failure to include commonly used permitted transfer provisions could lead to a default, a heavily discounted forced sale, or even forfeiture of the interest depending on the terms of the LLC agreement.”

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