Month: July 2019

Transferring LLC Membership Interests Part 3—Involuntary Transfers – Intrepid Law

An involuntary transfer of an LLC membership interest is just that—a transfer prompted by a creditor action or the occurrence of a triggering event outside of the member’s control. An individual or entity obtaining a membership interest as a result of an involuntary transfer usually cannot fully step into the shoes of the transferring member.

This statutory protection—often called a pick your partner provision—acts as a safeguard that provides LLC members with a certain amount of personal asset protection. For example, whereas the creditor of a corporate shareholder could reach and exercise shareholder rights to their full extent, the creditor of an LLC member can reach and exercise only the economic rights associated with membership interests—not the voting or management rights. The recipient of this type of membership interest is called an assignee.

Statutory Provisions – Creditor Action

If an LLC does not specify any transfer provisions, creditor actions are subject to state LLC laws. Each state, in its LLC statute, has provisions limiting what actions a creditor can take against an LLC member for personal debt. Depending on the state, the statutory remedies available to an LLC member’s personal creditors may include:

  • A charging order, which is a court order requiring the LLC to pay all the distributions due to the member-debtor from the LLC to the creditor.
  • A foreclosure on the member-debtor’s LLC ownership interest.
  • A court order to dissolve the LLC.

These remedies protect the other LLC members from the risk of having the creditor of a debtor-member step into the debtor-member’s place and share in the control of the LLC. To a varying degree, they also address the creditor’s right to satisfaction of the debt.

Transfer Provisions – Other Triggering Events

Transfer provisions are typically specified in the LLC’s operating agreement or in a separate buy-sell agreement. There may be some overlap with creditor actions, as these are often included as triggering events in the transfer provisions.

Examples of triggering events that can be specified in an LLC’s transfer provisions include the following:

  • A deceased member’s membership interest passes to a prohibited individual or entity
  • A member’s bankruptcy or other involuntary transfer of a membership interest to the member’s creditors
  • A member’s separation or divorce, or the transfer to a member’s spouse under property division or under a divorce or separation decree
  • A member’s membership interest becomes subject to a valid court order, levy, or other transfer that the LLC is required by law to recognize
  • A member’s breach of the LLC’s confidentiality
  • A member’s failure to comply with any mandatory provision of the operating agreement
  • A member’s failure to maintain a license or other qualification that disqualifies the member from engaging in the LLC’s primary business

If a triggering event occurs, the transfer provisions may prompt a mandatory redemption of the member’s membership interest or a right of first refusal to the LLC or to the other members. If an involuntary transfer does occur, the recipient of the membership interest—the assignee—typically receives only an economic interest in the LLC with no management or voting rights.

Transferring LLC Membership Interests Part 2—Voluntary Transfers – Intrepid Law

An LLC affords its members a certain amount of personal asset protection. Part of this protection hinges on the restricted transferability of LLC membership interests.  Restricted transferability protects the non-transferring members from creditors and unwelcome new members, which upholds the integrity and value of the non-transferring members’ membership interests.

  • Most (but not all) LLCs impose requirements or restrictions on the transfer of a member’s interest.
  • If the LLC’s operating agreement is silent on the transferability of interests, you must look to state law to be sure there are no default provisions restricting transferability.

This article, part 2 in a 3-part series, focuses on voluntary membership interest transfers done with the intent to grant full membership rights to the recipient.

Step 1 – Determine the Transfer Process

The LLC’s operating agreement should specify the process for transferring a membership interest. If the LLC has a buy-sell agreement in place, that must also be consulted.

  • Find the provisions that detail allowable transfers, the steps to complete them, and the method for calculating the value of the membership interest, if any.
  • The membership interests may be freely transferable but are likely subject to restrictions set forth in the operating agreement, the buy-sell agreement, or by state law.
  • Some transfers may be permitted without prior approval of the other members, such as transfers to a member’s immediate family or to a trust for the benefit of a member or a member’s immediate family.
  • The LLC or the other members may have a right of first refusal before a transfer can be made.

If the operating agreement or buy-sell agreement doesn’t specify the process for transferring a membership interest, you will have to look to state law. Once you determine the authority governing the transfer process—the operating agreement and buy-sell agreement or state law—be sure to note all requirements and restrictions.

Step 2 – Determine the Value

Calculate the value of your membership interest. If the operating agreement or a separate buy-sell agreement doesn’t address this, you will have to work with the other LLC members to determine and agree upon the value of the membership interest.

Step 3 – Follow Transfer Process

Complete the LLC transfer process as determined in Step 1. Make sure you follow all requirements. For example, if the operating agreement requires the unanimous written consent of all LLC members (a common requirement), meet with all of the LLC members to obtain their written consent.

Step 4 – Obtain or Draft the Transfer Document

If the LLC does not have a standard transfer document, you will need to draft a transfer document.

  • Check the operating agreement or state law to determine what the transfer document must include.
  • Typically, it must include the transferor’s name, the LLC’s name, the recipient’s name, and the percentage of the membership interest being transferred.
  • If a form is not provided by the LLC, note that the form of the transfer document is usually subject to the LLC’s approval; make sure to obtain this approval if necessary.

Step 5 – Execute the Transfer Document; Other Documents

Sign and date the transfer document. Make a copy for your records, for the recipient, and for the LLC.

  • The recipient typically receives the original transfer document.
  • The LLC may have additional documents that the recipient must sign in order to be admitted as a member.
  • State law may require the operating agreement and certificate of formation to be updated with the new member information.
  • The LLC may pass the costs associated with the transfer to the new member.

Conclusion

Making a proper transfer of membership interests requires the transferor to jump through a lot of hoops. The first step in the process is determining which hoops are required. Taking the time to properly transfer membership interests ensures that the recipient obtains full membership rights and protection.

We offer proactive business planning strategies. We help businesses draft thorough operating agreements that provide clear directions to the LLC members—to exercise membership interest transfers and other important member rights. We also assist existing LLC members who want to properly transfer their membership interests in the absence of a thorough operating agreement.  Contact us today to learn more about our business services.

Transferring LLC Membership Interests Part 1—An Overview – Intrepid Law

Say you are a member of an LLC. You own membership interests in the LLC. But what if you want to leave the LLC? What if you get a divorce? What if you have creditors seeking immediate repayment? What can you do with your membership interests? The answer depends on how transferable those membership interests are.

A transfer of LLC membership interests can mean selling, donating, assigning, or gifting—basically one LLC member turning over his or her membership interests to another individual or entity. The transfer can be voluntary or involuntary.

  • Examples of voluntary transfers include selling membership interests to a third party or to the remaining members, donating membership interests to a charity, or leaving membership interests to a trust upon death.
  • Examples of involuntary transfers include those prompted by divorce, bankruptcy, and termination of employment.

The transferability of LLC membership interests is subject to competing interests.  On the one hand, freely transferable membership interests can be more attractive to members because they are easier to dispose of or cash out of—in other words, the membership interests are more liquid and marketable.

On the other hand, LLC members usually want to maintain the right to “pick their partners.” If membership interests are freely transferable, the remaining members have no control over who comes in as a business partner when a member decides to transfer membership interests. Restricted transferability places limits on transfers and the status of the recipient.

Are Membership Interests Freely Transferable or Restricted?

The members decide. The good news about forming an LLC is how flexible the structure is. At the outset, the founding members can adopt transferability provisions— either in the operating agreement or in a separate buy-sell agreement.

  • If neither document addresses transferability, the default provisions of state law prevail.

In other words, if the founding members fail to address transferability in the operating agreement or in a buy-sell agreement, they’ve relinquished control and subjected the members and the LLC to the state law default provisions.

  • Although planning for a member’s departure from the LLC when you’re just forming it may be difficult, thinking through all the possible exit scenarios—and planning for them—is essential.

If your LLC is already up and running and you don’t have transferability provisions in place, the members can amend the operating agreement or adopt a buy-sell agreement. Look to the operating agreement for directions on how to amend the LLC’s terms.

How are Membership Interest Transfers Restricted?

While membership interests are freely transferable in the sense that any member generally can transfer his or her economic rights in the LLC (subject to the operating agreement, a stand-alone buy-sell agreement, and state law), the management or voting rights in the LLC are usually what are restricted—otherwise, other members would be forced to become “partners” with someone not of their choosing.  Typically, a recipient of restricted membership interests can receive economic and management rights—a full membership interest—only with unanimous member consent.

In the next two articles in this series, we’ll look at voluntary and involuntary transfers of LLC interests.

Series LLCs: What You Need to Know – Intrepid Law

A series LLC, a relatively recently authorized form of LLC, is composed of a master LLC which houses a series of LLCs. Each series within the series LLC typically has separate owners, assets, and liabilities. Similar to a corporate/subsidiaries business model, series LLCs may potentially offer asset-protection benefits, but they avoid the complexities of corporate taxes, structure, and other required formalities.

This type of entity is well suited for certain businesses that may benefit from its relative simplicity, reduced costs, and increased asset protection. But especially because of its newness, there are also some uncertainties associated with the series LLC.

Potential Benefits of the Series LLC:

  1. Simplicity
  • Reduced Administration

Although each series must be administered separately, series LLCs have the potential to save time and administration costs.

  1. Reduced Costs
  • One Registration

Each of the individual series is formed and governed by the master LLC’s operating agreement.  In most states, only the master LLC must be registered with the state, which means reduced fees.

  • Potential Sales Tax Savings

Some states may not require sales tax to be paid on rent that one series pays to another series.

  1. Asset Protection
  • Mixed Signals

Under most series LLC statutes, each series is protected from judgments against assets in other series under the master LLC.  But it’s not clear that this protection will be respected in bankruptcy proceedings or in states that don’t recognize series LLCs.

Potential Downsides of the Series LLC:

  1. Some Additional Costs
  • Registered Agent

Many states require a separate registered agent for each series in the series LLC, which may mean additional expenses.

  • Formation Cost

The up-front registration fee for a series LLC may be higher than the registration fee of a regular LLC.  In some cases, it may be less expensive to register multiple single-member LLCs rather than a series LLC with multiple series.

  1. Governance Issues
  • Overlap Jeopardy

The operations may not be as streamlined as anticipated. The records of each series must be maintained separately, and each series must have its own separate bank accounts.  Can administrative functions among the series overlap without jeopardizing the limited liability? Can the ownership or management overlap? Does inadequate capitalization of one series impact the other series in the series LLC? At this point, these types of questions remain unanswered.

3. Liability Questions

  • Bankruptcy Issues

Federal bankruptcy laws do not yet address series LLC issues.  Can an individual series within a series LLC file for bankruptcy? Are the assets of the non-filing series and the master LLC protected from the filing series?  At this time, there are no clear answers to these and other bankruptcy-related questions.

  • Choice-of-Law Issues

If a series LLC gets sued by a third party in a state that doesn’t authorize series LLCs, the assets of each series and the master LLC may be at risk. For LLCs that operate in states with and without series LLC statutes, this may make a series LLCs much less attractive.

The series LLC is potentially a star on the rise and is definitely worth watching.  If your business is particularly well suited to this compartmentalized approach and you live in one of the states that currently authorizes series LLCs, you may want to talk with your business planning team about this type of business entity.

We work with business owners to ensure they’re up to date with the latest business planning and operations strategies.  Contact our office today so we can evaluate your current and future business asset protection needs.

Stay in Control: Good LLC Governance – Intrepid Law

The LLC is a popular way to structure a business because it provides personal liability protection to the members– like a corporation does to its shareholders–but without as many administrative formalities. But if you’re an LLC member, don’t let this lull you into complacency.

As a business owner, you’re responsible for the proper governance of the LLC.  If a conflict arises—either among LLC members or between the LLC and a third party—the governing documents and methods through which the owners govern the LLC may help prevent a conflict from escalating into litigation. Even if a dispute reaches court and you are unable to control the outcome, you can ensure that the LLC presents clear evidence of its intent and purpose by practicing good governance.

Good LLC governance hinges on four key practices:

  1. Practice good record keeping.
    • Document key business decisions.
    • Store records in a secure and fireproof location.
    • Provide members with access to records as required by the LLC’s operating agreement.
    • Keep the list of members and their ownership interests current.
    • Keep the LLC records organized.

  2. Don’t commingle LLC and member assets.
    • Keep all member and LLC assets completely separate. The initial contributions that members make to the LLC and any later contributions made after a capital call should be clearly documented as such.
    • Make sure any loans to the LLC—and the repayment terms—are clearly documented.
    • All distributions and any advancements to members should be documented as such.
    • Members who are also employees of the LLC should receive a paycheck from the LLC payroll account like any other employee would.
  1. Follow the operating agreement.
    • Do what you say you’re going to do. Your LLC should have an operating agreement even if your state’s LLC statutes don’t require one.  A well-drafted operating agreement provides a written record of owner expectations in terms of LLC structure and ownership, as well as business, operations.  The agreement is an essential tool for keeping the peace among LLC owners and restoring the peace if a disagreement arises.  And, if a dispute arises between the LLC and a third party, the operating agreement may become evidence the fact finder considers to resolve the dispute.
  1. Amend the operating agreement if the LLC is acting inconsistently with it.
    • If the LLC ends up in court and the intent of the LLC or its members is at issue, the fact finder will look at three main factors to make a determination: the LLC documents (the articles of formation filed with the state, the buy-sell agreement, if any, and the operating agreement), and the actions of the LLC and its members.
    • When the actions of the members and of the LLC are in sync with the governing documents, a court is more likely to find an intent that corresponds to the original intent of the members when they formed the LLC.  But when the operating agreement says one thing and the LLC or its members behave differently, intent is wide open for interpretation.  If that happens, a court may place greater weight on the actions of the members or LLC and make findings of fact vastly different from what is found in the LLC documents, resulting in a potentially disastrous outcome.

Practicing good governance of the LLC helps make the intent and purpose of the LLC clear to its members and to outside parties.  And, if a conflict goes to court, good governance provides the judge or jury with a clear picture of what the members intended for the LLC.

We work closely with business owners to create and implement forward-thinking business-planning strategies.  We anticipate what can go wrong and counsel our clients on how to best maintain their businesses so that they are well prepared to weather any storm.