The single member limited liability company (SMLLC) is highly useful but hardly simple. State law and tax treatment render it sometimes “regarded” (but not always) and sometimes disregarded (but not always), all of which lead to some unusual results.
When first authorized about 30 years ago, LLCs, like partnerships, were designed to have two or more members. The “pick your partner” principle of partnership law became part of an LLC’s DNA. This prevents a member, either during lifetime or at death, from forcing an unadmitted and perhaps undesirable member on those who remain or survive. When state statutes were subsequently amended to authorize SMLLCs, followed by the “check the box” regulations, the “pick-your-partner” principle adhered. As noted in the dissent in Olmsted v. FTC, a case involving the rights of a creditor of a sole member, when legislatures amended their LLC statutes to permit SMLLCs, they did not contemplate issues that would arise from application to SMLLCs of statutory sections designed for those with more than one member. The default rule when a sole member dies without providing for that inevitable event is another place where “pick-your-partner” protection is inappropriate.
In both a multimember and SMLLC, when a (or the) member dies, the deceased is dissociated. Without provision in an operating agreement addressing death, the decedent’s interest divides. In a multimember LLC, the economic rights pass to the decedent’s estate, but the decedent’s management rights devolve on the surviving members who are thereby protected from unadmitted heirs participating in management.
Absent provision in an operating agreement, when a sole (or last surviving) member dies, the membership rights also divide with the economic rights passing to the decedent’s estate. Although there are no surviving members to protect, the authority to manage goes into what might be described as a “suspended state.” Uncertainty ensues. The governing statute may provide for a 90 day or other period within which the decedent’s estate may designate a successor member who must then agree to assume that role. If no designation is made and the statutory period expires, the LLC “automatically” dissolves, which may not be a desirable outcome. Meanwhile, the business is like a rudderless ship. Who has the authority to collect the receivables, carry out the LLCs contracts, and deal with employee issues?