Say you are a member of an LLC. You own membership interests in the LLC. But what if you want to leave the LLC? What if you get a divorce? What if you have creditors seeking immediate repayment? What can you do with your membership interests? The answer depends on how transferable those membership interests are.
A transfer of LLC membership interests can mean selling, donating, assigning, or gifting—basically one LLC member turning over his or her membership interests to another individual or entity. The transfer can be voluntary or involuntary.
● Examples of voluntary transfers include selling membership interests to a third party or to the remaining members, donating membership interests to a charity, or leaving membership interests to a trust upon death.
● Examples of involuntary transfers include those prompted by divorce, bankruptcy, and termination of employment.
The transferability of LLC membership interests is subject to competing interests. On the one hand, freely transferable membership interests can be more attractive to members because they are easier to dispose of or cash out of—in other words, the membership interests are more liquid and marketable.
On the other hand, LLC members usually want to maintain the right to "pick their partners.” If membership interests are freely transferable, the remaining members have no control over who comes in as a business partner when a member decides to transfer membership interests. Restricted transferability places limits on transfers and the status of the recipient.
Are Membership Interests Freely Transferable or Restricted?
The members decide. The good news about forming an LLC is how flexible the structure is. At the outset, the founding members can adopt transferability provisions— either in the operating agreement or in a separate buy-sell agreement.
● If neither document addresses transferability, the default provisions of state law prevail.
In other words, if the founding members fail to address transferability in the operating agreement or in a buy-sell agreement, they've relinquished control and subjected the members and the LLC to the state law default provisions.
● Although planning for a member's departure from the LLC when you're just forming it may be difficult, thinking through all the possible exit scenarios—and planning for them—is essential.
If your LLC is already up and running and you don't have transferability provisions in place, the members can amend the operating agreement or adopt a buy-sell agreement. Look to the operating agreement for directions on how to amend the LLC's terms.
How are Membership Interest Transfers Restricted?
While membership interests are freely transferable in the sense that any member generally can transfer his or her economic rights in the LLC (subject to the operating agreement, a stand-alone buy-sell agreement, and state law), the management or voting rights in the LLC are usually what are restricted—otherwise, other members would be forced to become "partners" with someone not of their choosing. Typically, a recipient of restricted membership interests can receive economic and management rights—a full membership interest—only with unanimous member consent.
In the next two articles in this series, we'll look at voluntary and involuntary transfers of LLC interests.
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