Can an LLC Require a Member to Sign a Release?

Limited liability companies (LLCs) are some of the most flexible business entities you can form. Unlike corporations, LLCs are not required to follow a rigid management structure.

Instead, LLC members can manage business activities themselves or appoint designated managers to oversee operations. Whichever structure they choose, they must establish well-defined agreements to protect their and the company’s interests.

One safeguard LLCs typically use is release agreements, which waive a member’s right to file claims against the company under specific conditions.

While release agreements are useful tools for preventing member disputes, their enforceability depends on several legal and contractual factors.

In today’s blog, we’ll discuss how release agreements work and explore whether LLCs can require their members to sign one.

What is a Release Agreement?

Before anything else, let’s discuss release agreements and how they work.

Release agreements are legal documents in which one party formally agrees to waive their right to pursue any legal claims against another party in exchange for consideration, such as monetary compensation or dispute resolution.

This means that if you sign a release agreement, you’re relieving the other party of liability for any lawsuit you otherwise would have had the right to file.

Releases are typically used in business transactions and settlements, but entrepreneurs also use them in the context of an LLC.

Can LLCs Require Members to Sign a Release?

Technically, yes. If their operating agreements indicate this, LLCs can require members to sign a release.

Operating agreements are crucial business formation documents for LLCs. They outline the rules and regulations that govern an LLC, including procedures for member departures, buyouts, and other internal functions.

If your LLC’s operating agreement explicitly states that members must sign a release under certain scenarios, then it’s an enforceable requirement. Examples of these scenarios include:

Member Departures

Release agreements prevent departing LLC members from filing legal claims against the company or its remaining members. They’re particularly useful when the member voluntarily leaves the company or is removed due to a breach of contract.

Buyout

Release agreements can also be used to prevent departing members from challenging buyouts.

If a departing member is bought out of their ownership interest in the LLC, a release agreement ensures they can’t challenge the transaction’s validity after the fact.

This provision is important since factors like valuation methods and payment terms often become points of contention among members.

Dissolution

If an LLC is being dissolved, its members must sign a release agreement confirming they’ve collectively agreed to close the company and will not pursue legal action against one another. This step ensures that members’ outstanding obligations and claims are settled amicably.

Internal Disputes

Lastly, release agreements can resolve internal disputes. A release contract can be included in a negotiated resolution to prevent disputes from escalating to litigation.

For example, if two members disagree over profit distribution, you could suggest a mutually beneficial settlement that includes signing a release. The release will prevent both parties from pursuing further legal action related to the dispute.

Legal Considerations for Requiring Releases

While LLCs are generally allowed to include release clauses in their operating agreements, there are legal considerations to be made before you can enforce them, such as:

State Laws

LLC laws differ in each state, with some jurisdictions imposing specific restrictions on the scope and validity of release agreements.

For instance, Delaware’s law requires release contracts to be explicit in terms and circumstances. Otherwise, courts may disregard their validity.

Conversely, Nevada’s law states that an LLC’s release agreement cannot waive a member’s right to file claims related to intentional misconduct, fraud, and other statutory violations.

We recommend you review your state’s LLC laws before including any release clauses in your operating agreements.

Voluntariness & Fairness

For your LLC’s release clause to be valid, all members must agree to it voluntarily and knowingly and clearly understand the terms they agree to.

In addition, the clause must be mutually fair. It cannot favor the company or any other member. Any release agreement that heavily benefits an LLC or a certain member is considered unconscionable and will likely be challenged in court.

Valid Consideration

Any party that agrees or signs a release must receive something of value or consideration in return. This could be a financial payment, a mutual release of liability, or any other similar benefit.

Any release agreement will be ruled unenforceable if it does not have valid consideration.

These factors will determine the validity of your LLC’s releases, so you must carefully draft these clauses in your operating agreements.

What to Include in Your LLC’s Release Agreement

If you’re having trouble drafting your LLC’s release contract, here are some basic sections to start with:

• Names of the parties involved: The document should include your LLC’s information and the releasor’s.
• Acknowledgment and assumption of risk: States that the releasor fully understands the terms of your LLC’s agreement and is knowingly waiving their right to file claims against the business.
• No duress: Affirms that the releasor is signing the document voluntarily and without coercion.
• Acceptance and liability release: States that the releasor knowingly agrees to release the LLC and its remaining members from any specific claims they may have the right to pursue
• Release of specific rights: Outlines the rights that the releasor is waiving.
• Consideration: Enumerates the value or benefit the releasor will receive in exchange for signing the agreement.

Avoid Costly Disputes with A Comprehensive Operating Agreement

Including a well-written release clause in your LLC’s operating agreement can help you safeguard your business’s future from costly legal disputes. However, drafting a legally sound and enforceable clause can be challenging, especially if you’re unfamiliar with your state’s LLC laws.

Fortunately, NCH is here to help. Our business formation specialists will guide you through creating a comprehensive operating agreement. We’ll ensure it has provisions that will protect your business from litigious parties, including disgruntled members.

Don’t leave your LLC’s future to chance. Contact NCH today and let us help you create a legally sound operating agreement.

To learn more about our formation services, visit our website here or call us at 1-800-508-1729 to schedule a free consultation.

DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.