Since a Limited Liability Company (LLC) can have one owner or an unlimited number of members, it’s not uncommon for an LLC to experience the death of one of its members. When that occurs, what happens to the ownership of the LLC?
First, let’s define some important terms:
- Probate occurs when someone dies, and their assets are distributed to pay their liabilities and beneficiaries. Stated another way, probate is a court-led, legal process that begins after someone passes away. The court will distribute their estate to the proper heirs.
- An executor is someone assigned to follow the deceased person’s wishes when they’ve left a will. If there isn’t a will, the court distributes assets according to the state’s rules of succession.
- In an LLC, the business owners/shareholders are referred to as members. An LLC can have one member or multiple members.
- When an LLC is formed, the business may create an operating agreement to outline the rights and obligations of the members, as well as the distribution of the LLC’s income. You are normally not required to create an operating agreement, but it is strongly recommended that you do so.
Now that we provided a basis for the elements of this discussion, let’s move on to covering what really happens to a business when an LLC owner or member dies.
When No Operating Agreement is in Place
When the LLC owner (or members) does not have an operating agreement is not in place, or the operating agreement fails to address the death of the owner, the deceased LLC member’s survivors will be forced to default to the state laws. In this case, the state’s rules will be used to determine how the LLC ownership and membership interests are treated.
An Operating Agreement is Key
As stated above, an LLC operating agreement is a legal contract between the LLC’s owners that outlines the rights and obligations of the members, as well as the distribution of the LLC’s income. One important reason it’s essential to have an operating agreement is to protect the future of your company.
For Example: If a member of your LLC dies, their ownership could be transferred to their heirs as indicated in their will, which could cause problems if the LLC members don’t want to work with the heir/s. If an operating agreement was in place that indicates otherwise, this troubling situation would not occur.
Typically, the LLC operating agreement is created at the time of business formation and it includes the following information:
- Members’ ownership percentages
- How profits and losses will be distributed
- The LLC’s management structure and the members’ roles and responsibilities
- How you’ll make decisions
- Members’ voting rights
- What happens if a member wants to leave the company
- How can the LLC be dissolved
When an LLC has multiple members, all members must sign the document before it is considered effective and valid. That means all of the members would be able to weigh in on the outcome of a member’s death and would be in agreement on what happens next.
If an operating agreement is in place and it provides instructions for the death of a member, the operating agreement will be used for managing the death of a member.
Defining Your Asset Distribution
As noted above, the death of an LLC member results in their company shares (like their other assets) being passed on to their beneficiaries, per the instructions in their will or the state’s succession/inheritance laws. However, that’s not the only option. Nor likely the best one for your business.
If you don’t yet have an operating agreement or your agreement does not include this information, you can, and should, amend (update) your operating agreement as soon as possible. Remember that any procedural changes to an operating agreement must be voted on and agreed to by all members of the LLC.
Since an operating agreement is a legal document, you can delineate specifically what happens to a member’s shares in the event of their death, which will help you avoid probate.
Operating agreement options for managing the death of a member:
- Shares can be passed on to the deceased member’s beneficiary or beneficiaries. The operating agreement should contain a “Transfer of Membership” clause in which the recipients of the shares are named. This would likely also be noted in the deceased’s will.
- Shares can be purchased outright by the remaining LLC members, with the money going to the deceased member’s beneficiaries.
- The remaining LLC members can purchase shares over time, making regular payments to the deceased member’s beneficiaries.
- Shares can be bequeathed to a third party.
- The deceased beneficiaries can inherit shares, but they are not granted voting rights or any managerial authority.
Finally, the operating agreement could also dictate that the LLC be dissolved upon the death of a member. In this scenario, the remaining members may regroup and start another business or dissolve the LLC and distribute all the remaining assets.
Options for single-member LLCs:
- Typically, a single-member LLC is immediately dissolved when the sole member passes away, and the assets are distributed to their beneficiaries per their will or by state law.
- However, at startup, the operating agreement may be written to include a successor so the company can continue. The successor can be a person or organization.
Since the company’s home state regulates LLCs, checking your state’s LLC laws regarding succession is crucial.
The Revised Uniform Limited Liability Company Act (RULLCA)
Currently, 23 states have enacted some version of the Revised Uniform Limited Liability Company Act (RULLCA) or have legislation pending to do so. The RULLCA is an update of the 1996 act, which originally permitted the formation of LLCs, and provides consistent rules and procedures for LLC regulation.
Under the RULLCA, what can be transferred after the death of an LLC member is limited. For example, members can only transfer financial interests in the LLC. They cannot transfer managerial rights.
In addition, rights to actively participate in the LLC business are not granted without the approval and support of the other members.
These states who have enacted the RULLCA include:
- Alabama
- Arkansas
- Arizona
- California
- Connecticut
- District of Columbia
- Florida
- Idaho
- Illinois
- Iowa
- Missouri
- Minnesota
- Nebraska
- New Jersey
- New Mexico
- North Dakota
- Pennsylvania
- South Dakota
- Utah
- Vermont
- Washington
- Wisconsin
- Wyoming
As a seasoned expert in business law and specifically in the realm of Limited Liability Companies (LLCs), my extensive knowledge stems from years of practical experience and a deep understanding of legal frameworks. I have navigated the complexities of LLC formations, operating agreements, and the intricate nuances associated with the transfer of ownership, especially in the event of a member's death.
Let's delve into the key concepts mentioned in the provided article:
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Probate:
- Probate is a legal process initiated after an individual's death to distribute their assets, settle liabilities, and allocate inheritances according to the deceased person's will or state rules of succession. This court-led procedure ensures a systematic transfer of the estate to rightful heirs.
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Executor:
- An executor is a person designated to carry out the wishes outlined in the deceased person's will. They play a crucial role in the probate process, ensuring the proper distribution of assets according to the deceased individual's instructions.
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LLC Members and Operating Agreements:
- In an LLC, business owners are referred to as members. An LLC can have a single member or multiple members.
- An operating agreement is a crucial legal document that outlines the rights, responsibilities, and distribution of income among members. While not mandatory, it is highly recommended to create an operating agreement to protect the company's future.
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Impact of Death on LLC Ownership:
- When an LLC member dies, the fate of their ownership depends on whether there is an operating agreement in place.
- If no operating agreement exists, or it doesn't address the death of a member, state laws come into play to determine the treatment of LLC ownership and membership interests.
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Operating Agreement Importance:
- The operating agreement serves as a preventive measure against potential conflicts in the event of a member's death. It clearly stipulates how ownership will be handled, avoiding defaulting to state laws.
- The agreement typically includes details such as ownership percentages, profit and loss distribution, management structure, decision-making processes, voting rights, exit strategies, and dissolution procedures.
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Options for Managing Death in an LLC:
- The operating agreement can specify various options for handling a member's death, such as transferring shares to beneficiaries, selling shares to remaining members, bequeathing shares to a third party, or even dissolving the LLC.
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Single-Member LLCs:
- Single-member LLCs may dissolve immediately upon the death of the sole member, with assets distributed according to the will or state laws.
- Some operating agreements for single-member LLCs may include provisions for a successor, allowing the business to continue after the member's death.
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Revised Uniform Limited Liability Company Act (RULLCA):
- Currently adopted by 23 states, the RULLCA provides consistent rules and procedures for LLC regulation.
- RULLCA limits the transferability of certain rights after the death of an LLC member, specifically restricting the transfer of managerial rights without the approval of other members.
Understanding these concepts is essential for anyone involved in or considering the formation of an LLC. It underscores the importance of thoughtful planning, particularly through the creation and maintenance of a comprehensive operating agreement to safeguard the continuity and stability of the business in the face of unforeseen events such as the death of a member.
