In the SMLLC, where the economic rights also pass to the estate, the problem is that if the estate does not act within a short statutory period to name a successor member who accepts the role, the memberless LLC dissolves with whatever unintended consequences flow from that event.
Knowledgeable business lawyers will protect against these consequences. When a multi-member LLC is formed, and all the members are on the same side of the table and don’t know who will be the first to die, the lawyers will offer suggestions as to how the members may wish to provide for death in their operating agreement. If admission to membership of one or more successors to a deceased member is not desired, perhaps a buy-out on death can be negotiated, or provision made for the heirs to have certain rights short of participation in management.
In the SMLLC provision should also be made in the operating agreement for the one future event that is certain to occur. Here are a few suggestions.
- Treat the member's interest similar to that of a sole shareholder in a corporation. The operating agreement might provide that:
Upon the death of the member (or last surviving member in a multi-member LLC), the member's estate is admitted to membership in the LLC on the member’s date of death with both economic rights and full management authority.
The time gap between the date of death and the appointment of an executor or administrator for the estate, during which business operations may not be able to be directed, might be addressed by naming an interim manager.
- The operating agreement might name a successor member admitted to membership immediately upon the death of the member.
- If the governing statute permits, name a special member who has no capital account or percentage interest in the LLC and thus should not impair its disregarded status for income tax purposes.
- If the governing statute permits, the concept of a springing member might be utilized.
- Instead of placing the membership interest in the individual, it may be placed in a revocable trust for the client (a) if a trust may be an LLC member and (b) if the client is willing to incur the complexity and cost of a trust agreement in addition to an operating agreement.
My attention has been called to The Uniform TOD Securities Registration Act, part of the Uniform Non-Probate Transfers on Death Act, promulgated in 1989 when LLCs were in their infancy. Its design is to provide the owner of securities an alternative to the process of probate. Although the statute’s definition of security is broad enough to encompass an interest in an LLC, the statute does not address the dichotomy between economic and management rights. It is doubtful that, in a multi-member LLC, authorization for non-probate transfer overrides the pick-your-partner principle. The statute’s usefulness to a SMLLC, limited by the definition of Registering Entity, may present practical difficulties.