The LLC Transferability Trap

As part of your estate planning, your will leaves all your interest in your company to your son. When you die, who gets control of your company? As any lawyer will tell you, “It depends…”

Suppose you own 80% of your LLC because some time ago you conferred 2% membership to each of your 10 key employees as a means of motivating them. Then on your death, your employees will probably take control of your company! And this would be the result even if you had modified your LLC’s operating agreement to permit such a transfer before you gave your employees their membership rights! Here’s why…

There of two components to LLC membership interests: A financial interest (right to distribution of accumulated profits) and a control interest (right to manage the company). By the Uniform Limited Liability Company Act, upon which most states’ LLC act is modeled, only the financial interest is transferable; control interest is not transferable. Although your son received your financial interest through your will, not even a well crafted operating agreement can overcome a state statute that limits your right to convey your control interest. If there are other members, such as your employees in the scenario I posed above, a majority of them must agree to make your son a member and thereby convey control rights to him. Until they do so, your son could not exercise any of the rights of a member (voting, access to financial statements, etc.) except to receive his share of profits.

The Virginia Supreme Court recently affirmed this in a ruling on similar facts. Implicit in the ruling is an extension to prohibit any attempt to assign your control interest. That means, for example, you cannot sell your control interest either. The ruling makes sense, since the LLC is a mixture of partnership and corporation. If you held such an interest in a partnership, the remaining partners shouldn’t be forced (and cannot be) to deal with just anyone you want to sell you management interest to.

If you find yourself in this situation, your company’s lawyer cannot help you because his client is the company as a whole, and your interests conflict with his client. So you need personal legal counsel.

Please read, use, and comment on what you find here, but remember this: Random advice, even the advice you find at Argent Place, cannot supplant the personal legal advice you receive from your own legal counsel.

If you agree that Personal Legal Counsel could help you create more wealth, please contact Argent Place Advisors to have an exploratory conversation.

© 2011 Argent Place Advisors, LLC

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