The Morals Clause and the Limited Liability Company Operating Agreement
A morals clause is a provision in a contract that forbids certain behavior in a person’s private life. A morals clause is useful in a situation where one of the limited liability company (“LLC”) members or partners of a business is known to act with disregard to others around them. Such clauses are commonly used in contracts with actors and/or athletes, but can also be drafted into business documents such as limited liability company operating agreement between members.
As a general rule, members usually have a fiduciary duty to the company to act in good faith and in the best interests of the LLC and/or the other members. For instance, a fiduciary duty can be breached by a member via their act of stealing from the LLC. However, the Operating Agreement can go one step further and have a morals clause drafted into the agreement. The morals clause can become a valuable addition to the LLC Operating Agreement in many circumstances. The morals clause can provide that in the event of a certain action taken by a member who is subject to the provision, an automatic purchase of that person’s membership interest shall occur. A right of first refusal by the LLC can be drafted into such provision. The other members will often have the ability to purchase the person’s business interests in the event the LLC declines to exercise its right of first refusal. Certain triggers can include felony convictions, alcohol abuse and/or drug abuse. Each business should draft their morals clause customized to their particular needs and potential issues with members owning membership interests. A member typically subjects himself or herself to this clause by signing the Operating Agreement. Further, the purchase price is usually the appraisal value of the membership interests as of the date of the sale (or redemption); however, other valuation methods may be used if negotiated between the parties.
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