If your LLC operating agreement — not your will — does not provide for death, the “default” rules of LLC law could leave your loved ones in an untenable legal position with no meaningful benefit without a fight.
Here’s why. LLC membership rights do not pass like corporate shares. Only your economic rights pass to your estate and eventually to your heirs. The rights you enjoy as a member, to vote and participate in the management of the business, pass not to your estate, but go pro rata to the remaining LLC members.
This protects the surviving members from having someone not admitted to membership being thrust upon them as a “partner,” but it severely limits the ability of your family to enforce their economic rights. While your heirs receive the right to your share of distributions from the LLC, they cannot force distributions to be made. Their ability to obtain information about the LLC’s finances is limited. Your capital account is locked in the LLC until it dissolves, and the estate has no power to force dissolution.
A recent case is illustrative. Jack and Jill each held a 50% interest in an LLC owning real estate. When Jill died, her economic interest passed to her estate, but her management rights passed to the surviving member, Jack. Jack signed an exclusive brokerage agreement with which Jill’s executor was not happy. The broker sued after producing a willing buyer and not being paid its commission. After a costly legal battle, the court ruled the contract enforceable because, after Jill’s death, Jack had sole authority to manage and bind the LLC. This resulted in the LLC, in which Jill’s children held a 50% economic interest, suffering a substantial liability — to their detriment.
Other default rules apply to the single-member LLC. With no provision in an operating agreement, unless an estate acts within 30 days to name a successor, the LLC dissolves, resulting in consequences the member had not intended.
These results are avoidable if addressed either when the LLC is formed or later, but before anyone dies. For an LLC with two or more members, the operating agreement might provide for a death buyout or, alternatively, admission to full membership of a deceased member’s estate.
A single-member LLC’s operating agreement can name a successor admitted to membership immediately upon the member’s death. It might also provide for a special member. Another possibility is to place the membership interest in a revocable trust as part of an estate plan.
There is no need to leave one’s family with the risks, burdens and uncertainties that follow when LLC default rules are applied.
Stuart L. Pachman is a member of Brach Eichler LLC and is a recognized authority on corporate law who has written extensively on business law issues. He can be reached at email@example.com or 973-403-3133.