Posted on April 11, 2012 in Business Law
We have written about the importance of operating agreements to help succession planning for your limited liability company (“LLC”). Operating agreements can help the company with procedures to remove a member, or with procedures to permit a member to leave the LLC on his own accord. This blog post reviews a recent Virginia Supreme Court case that shows the importance of using your LLC operating agreement to set forth succession planning of a member’s interest when that member dies.
In the case of Ott v. Monroe, there were 2 members of an LLC, a husband and wife. The husband (“Dewey”) owned an 80% membership interest, and his wife (“Lou Ann”) owned the remaining 20% and was the managing member. When Dewey passed away, his Will showed that he bequeathed his entire estate to his daughter, Janet. Janet proclaimed that because her father’s estate included the LLC membership interest, she became the majority member of the LLC. Janet immediately removed Lou Ann as the managing member and took control of the LLC herself.
The LLC had an operating agreement, but the agreement did not contain a clause requiring the company or the remaining member to purchase Dewey’s membership interests. Such a clause would have negated this entire case and saved the parties tens of thousands of dollars in attorneys’ fees and other transaction costs. Consequently, the issue in the case was “What rights did Janet have in the company by succeeding to her father’s membership interests?”
The Virginia Supreme Court noted that a membership interest in an LLC is composed of two components: a control interest, which permits the member to participate in the administration of the LLC’s affairs, and a financial interest, which allows the member to share in the company’s profits and losses, and to receive distributions from the business’ income and assets. The Court looked to the Virginia statutes that permit an LLC member to unilaterally assign hisfinancial interest in the company, but to obtain the control interest, the member must obtain the “consent of a majority of those members exercising the direct management of the company.”
The company’s operating agreement did not provide for a procedure to transfer membership interests upon the death of a member. Consequently, because Janet received her father’s membership interests by a unilateral assignment through her father’s Will, and because the only remaining member, Lou Ann, did not consent to Janet’s membership in the LLC, the Virginia Supreme Court ruled that Dewey’s Will could not make her a member of the company upon his death. Therefore, Janet “inherited only Dewey’s financial interest in the Company – the right to share in profits and losses and to receive distributions.”
Does your limited liability company’s operating agreement set forth procedures for dealing with the membership interests of a member upon death? As shown in this case, the remaining members of your company could be in a state of flux jeopardizing the LLC’s survival. You may not have reviewed your operating agreement since your company was formed. When in doubt, contact your experienced business lawyer to review your operating agreement for peace of mind.