Private Client Services Update – What Really is Inherited with a Limited Liability Company Interest?

    By Sarah E. Messersmith, Estate, Trust & Wealth Transfer

    Limited liability companies (LLCs) quickly have become one of the most effective and frequently utilized ownership vehicles for small business. LLCs are extremely easy and inexpensive to create. Whenever there is more than one member of an LLC, it is vitally important that the parties have a meaningful Operating Agreement in place. Unfortunately, in many instances, there is either no Operating Agreement at all, or there is a “form” Operating Agreement which does not accurately reflect the parties’ wishes or intentions at the time they formed the entity together.

    The existence of a substantive and meaningful Operating Agreement is especially important in light of the 2013 amendment to Virginia Code Section 13.1-1039. Prior to the 2013 amendment, the law was represented by the holding in Ott v. Monroe, 282 Va. 403, 719 S.E.2d 309 (Va. 2011). In Ott, the Virginia Supreme Court held that when a member of an LLC dies, regardless of the language in the Operating Agreement, the beneficiary of such LLC interest (whether by Will or other means) inherits only the right to share in the profits and losses of the company. Additionally, regardless of the language in the Operating Agreement, such beneficiary does not become a member of the LLC in the place and stead of the decedent. The beneficiary only may become a member of the LLC after an affirmative vote of the majority of the members taken after the death of the original owner.

    In response to Ott, the Virginia legislature amended Virginia Code Section 13.1-1039 to state that as long as it is provided in the Operating Agreement or the Articles of Organization, the assignee of an LLC interest may become a participating member in the company, in addition to inheriting the right to share in the profits and losses.

    It is crucial that owners of an LLC have in place an Operating Agreement that sufficiently addresses what will happen when an owner dies and his or her shares are inherited by someone else. For example, the owners may wish to provide that the company have the right to purchase the ownership interests back from the estate of the deceased owner, and they may or may not wish to establish the purchase price, or a formula for calculating it, in the Operating Agreement. Alternatively, the owners may desire to pass their shares to family members or others through a Will or Trust. In such event, the original owners will need to decide whether the inheritors automatically will become members of the LLC, or whether the beneficiaries only will share in the profits and losses of the LLC.

    For example, imagine a situation where two brothers, Adam and Billy, form an LLC together as equal owners. While they both are living, the brothers work together well and easily are able to manage the business. Imagine that Adam dies and his fifty percent ownership interest passes under his Will to his wife Amy. If the Operating Agreement gives Amy the automatic right to become a Member, she will have an equal voice in the operation of the company. If the Operating Agreement requires Billy to agree before Amy becomes a Member of the company, Billy may not do so and Amy then only would be entitled to profits and losses. Depending on the relationship between Amy and Billy, one alternative might be a much better choice than the other. At the time they formed their LLC, or in any event, while Adam was still living, it would have been preferable for the brothers to have developed a plan for the company in the event that one of them passed away.

    As members of the Private Client Services group at Kaufman & Canoles, we work with our clients to ensure that all aspects of their estate and business succession plans are addressed in a complete and thorough manner. We help our clients plan for the future of the businesses that they have worked so hard to create.

    Sarah E. Messersmith is an associate attorney in the Hampton and Newport News offices. Her estate planning and administration work with clients ranges from the initial structuring and implementation of their estate plans to the resulting estate and trust administration. Sarah helps clients create wills, revocable and irrevocable trusts, powers of attorney and advance medical directives and assists clients with tax planning and succession planning issues. She also represents clients who are administering an estate or trust after a family member has died, providing assistance through the trust implementation or probate process. Sarah is CRESPA certified and her real estate practice consists of representation of buyers, sellers and lenders in all aspects of residential and commercial real estate purchase and sale transactions and the associated financing. She represents clients engaging in residential and commercial leasing as well as land use and rezoning. Sarah’s practice also includes creation of new business entities and working with owners of existing closely held businesses. Sarah serves on the Board of Directors for the Peninsula SPCA, the Board of Trustees for the Sarah Bonwell Hudgins Foundation and is an active member of the Junior League of Hampton Roads.

    The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2024.