In the July issue of BLT I described briefly the consequences of the application of RULLCA’s default rule to members of a limited liability company (LLC) who fail to provide for member death. Readers suggested a follow-up piece that would provide suggestions to avoid those consequences.
The issue arises because, unlike the shares of a corporate shareholder all of whose rights, unless otherwise provided in a shareholders agreement, pass to his or her estate, when an LLC member dies, unless something is provided to the contrary, his or her interest divides, with only economic rights passing to the estate.[1] The management rights devolve upon the remaining members. In a multi-member LLC (MMLLC), where the pick-your-partner principle of partnership law applies, this result is clearly appropriate. In a single member LLC (SMLLC) pick-your-partner protection is oxymoronic.
The consequences for the decedent’s heirs are different in the MMLLC from those in the SMLLC. In the former, the estate is treated as an assignee or transferee of the economic rights.[2] The now former member, dissociated at death, has provided his or her heirs with little or no authority to enforce their inherited economic rights. They are at the mercy of the remaining LLC members who may choose not to make distributions. They have no right to participate in the direction, whether wise or foolhardy, in which the surviving members may take the LLC. [3] Recovery of the decedent’s capital account will not be realized until the LLC dissolves if that event should ever occur. The estate has no right to compel the LLC’s dissolution[4] or even, perhaps, to acquire information as to the LLC’s ability to make distributions.[5]
In the SMLLC, where the economic rights also pass to the estate, the problem is that if the estate does not act within a short statutory period to name a successor member who accepts the role, the memberless LLC dissolves with whatever unintended consequences flow from that event.[6]
Knowledgeable business lawyers will protect against these consequences. When a multi-member LLC is formed, and all the members are on the same side of the table and don’t know who will be the first to die, the lawyers will offer suggestions as to how the members may wish to provide for death in their operating agreement. If admission to membership of one or more successors to a deceased member is not desired, perhaps a buy-out on death can be negotiated, or provision made for the heirs to have certain rights short of participation in management.
In the SMLLC provision should also be made in the operating agreement for the one future event that is certain to occur. Here are a few suggestions.
1. Treat the member’s interest similar to that of a sole shareholder in a corporation. The operating agreement might provide that:
Upon the death of the member (or last surviving member in a multi-member LLC), the member’s estate is admitted to membership in the LLC on the member’s date of death with both economic rights and full management authority.
The time gap between the date of death and the appointment of an executor or administrator for the estate, during which business operations may not be able to be directed, might be addressed by naming an interim manager.
2. The operating agreement might name a successor member admitted to membership immediately upon the death of the member.[7]
3. If the governing statute permits, name a special member who has no capital account or percentage interest in the LLC and thus should not impair its disregarded status for income tax purposes.[8]
4. If the governing statute permits, the concept of a springing member might be utilized.
5. Instead of placing the membership interest in the individual, it may be placed in a revocable trust for the client (a) if a trust may be an LLC member and (b) if the client is willing to incur the complexity and cost of a trust agreement in addition to an operating agreement.
My attention has been called to The Uniform TOD Securities Registration Act, part of the Uniform Non-Probate Transfers on Death Act, promulgated in 1989 when LLCs were in their infancy. Its design is to provide the owner of securities an alternative to the process of probate. Although the statute’s definition of security is broad enough to encompass an interest in an LLC, the statute does not address the dichotomy between economic and management rights. It is doubtful that, in a multi-member LLC, authorization for non-probate transfer overrides the pick-your-partner principle. The statute’s usefulness to a SMLLC, limited by the definition of Registering Entity, may present practical difficulties.
[1] Ott v. Monroe, 2011 WL 5325470 (Va. 2011): An LLC interest, like a partnership interest, is comprised of two separate components. The first is the management right to control or participate in administration. The second is the economic or financial right to participate in the sharing of profits and losses and receipt of distributions. The only interest alienable is the economic interest
[2] Faienza v. T-N-B Marble-N-Granite, LLC, 2018 WL 1882586 (Conn. Sup. Ct. 2018): The deceased member’s estate has only the rights of a transferee, not a member, and cannot sue for dissolution. To the same effect: Estate of Calderwood v. ACE Grp., Int’l, LLC, 61 N.Y.S. 3d 589 (App. Div. 2017); SDC University Circle Developer, L.L.C. v. Estate of Patrick Whitlow, M.D., 2019 WL 92791 (Ct. App. Ohio 2019).
[3] See, Gebroe-Hammer v. West Green Gables, LLC, 2019 WL 3428499 (App. Div. N.J. 2019). Act of sole surviving member bound, LLC.
[4] Faienza v. T-N-B Marble-N-Granite, LLC, 2018 WL 1882586 (Conn. Sup. Ct. 2018).
[5] Succession of McCalmont, 261 So.3d 903 (La. App. 2018): As a mere assignee the deceased member’s estate as could not access the LLC’s books and records to determine if it was getting its fair share of distributions.
[6] Felt v. Felt, 928 N.W. 2d 882, 2019 WL 2372321 (Ct. App. Iowa 2019).
[7] Blechman v. Estate of Blechman, 160 So. 3d 152 (Fla. App. 2015): Where supported by adequate consideration, contracts transferring a property interest upon death are neither testamentary nor subject to the Statute of Wills, but are instead evaluated under contract law. See also, in the corporate context, Jimenez v. Carr, 764 S.E.2d 115 (Va. 2014)
[8] Support for this proposition is Historic Boardwalk Hall, LLC v. C.I.R., 694 F.3d 425 (3rd Cir. 2012), where the entity involved was not recognized as a partnership for tax purposes because the purported partner had no meaningful stake in its success or failure.
