Your LLC Up and Running in 6 Steps

One of the first decisions to make when starting a business is what type of business entity to form. The limited liability company (LLC) is one of the most popular business structures because it offers a level of flexibility and legal protection that is attractive to many people who are starting their own businesses. The following six steps will help you get started if you are interested in forming an LLC.

  1. Choose a name. To form an LLC, you must select a business name that complies with state regulations. The name you select cannot be the same as or even too similar to any other LLC’s name; it must be unique to avoid consumer confusion. Next, states often require that the name of your LLC include one of the following at the end: “limited liability company,” “LLC,” or “Limited.” This requirement gives the public notice of your business structure. As simplistic as this step may seem, it is critical to successfully establishing an LLC and being able to take advantage of the legal protections this business structure provides.
  2. Select a registered agent. In addition to selecting an appropriate name, you must select a registered agent. A registered agent, also known as a statutory agent, is the party appointed to receive service of process and communication from your state’s secretary of state. If you live in the state where you form your LLC, you may be your own registered agent. Registered agents must provide an address where important correspondence can be sent. Typically, post office boxes are not acceptable places for a registered agent to receive these communications—rather, a physical address is usually required so the agent can receive service of process. When deciding who should serve as the registered agent, keep in mind that the registered agent will typically be the first person to whom the state reaches out if any issues arise with your LLC. As a result, it is important to ensure that your registered agent consistently checks incoming correspondence and relays that information to you as the business owner. If you are not interested in being your own registered agent, consider using one or more commercial registered agents in your state to do the job. Generally, they perform their services fairly inexpensively.
  3. File documents. Perhaps the most important step in creating your LLC is filing the required documents. The articles of organization (referred to in some states as the certificate of formation or certificate of organization) are usually filed with the secretary of state and include such information as the company’s name, the registered agent’s name and address, and the business’s purpose. This information becomes public record, so be mindful of what information you are comfortable sharing with the world. Keep in mind that there is a fee to file these documents; however, any start-up costs and filing fees you incur are tax-deductible. 
  4. Get a tax identification number. Another essential step in starting an LLC is obtaining a Tax Identification Number. Your LLC’s Tax Identification Number, also known as an Employer Identification Number or EIN, is provided by the Internal Revenue Service (IRS). After completing a successful application, the IRS assigns a unique number that links the identity of the responsible party to the business for income tax purposes. 
  5. Open a business bank account. After you have filed your LLC’s formation documents with the state and obtained a Tax Identification Number, you will be ready to open a business checking account. This step must not be overlooked in order to enjoy the benefits of an LLC. Maintaining this separate business checking account prevents you from commingling your personal funds with the business’s funds. Failure to maintain this separate business account could result in losing the business’s limited liability status because of a legal concept called “piercing the veil.” If this happens, you could be held personally liable for the LLC’s debts and liabilities.
  6. Draft an operating agreement. Finally, to form an LLC, you must create an operating agreement. This document outlines the rules and regulations governing the LLC. Think of it as a contract or agreement between you and the other members of the LLC or between you and the LLC if you form a single-member LLC. In some states, business owners are required to file this document with the articles of organization. 

Once your LLC is formed, it is critical to remember and adhere to the compliance requirements to keep your LLC in good standing. These requirements vary by state but often involve some form of annual reporting. In most states, for example, Utah and Wyoming, you may also be required to pay an annual fee. Failure to comply with these requirements will result in the suspension of your LLC and put your personal assets at risk.

The Impact of Transferring a Property in or out of an LLC on the Underlying Mortgage

The purpose of the Garn-St. Germaine Depository Institutions Act of 1982 is the “permanent preemption of state prohibitions on the exercise of due-on-sale clauses by all lenders, whether federally or state-chartered, [and] to reaffirm the authority of Federal savings associations to enforce due-on-sale clauses, and to confer on other lenders generally comparable authority with respect to the exercise of such clauses.”

That said, the Act contains some limitations on that authority:

§ 591.5  Limitation on exercise of due-on-sale clauses.

(a)  General.  Except as provided in § 591.4(c) and (d)(4) of this part, due-on-sale practices of Federal savings associations and other lenders shall be governed exclusively by the Office’s regulations, in preemption of and without regard to any limitations imposed by state law on either their inclusion or exercise including, without limitation, state law prohibitions against restraints on alienation, prohibitions against penalties and forfeitures, equitable restrictions and state law dealing with equitable transfers.

(b)  Specific limitations.  With respect to any loan on the security of a home occupied or to be occupied by the borrower,

(1)  A lender shall not (except with regard to a reverse mortgage) exercise its option pursuant to a due-on-sale clause upon:

(i)  The creation of a lien or other encumbrance subordinate to the lender’s security instrument which does not relate to a transfer of rights of occupancy in the property: Provided, That such lien or encumbrance is not created pursuant to a contract for deed;

(ii)  The creation of a purchase-money security interest for household appliances;

(iii)  A transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety;

(iv)  The granting of a leasehold interest which has a term of three years or less and which does not contain an option to purchase (that is, either a lease of more than three years or a lease with an option to purchase will allow the exercise of a due-on-sale clause);

(v)  A transfer, in which the transferee is a person who occupies or will occupy the property, which is:

(A)  A transfer to a relative resulting from the death of the borrower;

(B)  A transfer where the spouse or child(ren) becomes an owner of the property; or

(C)  A transfer resulting from a decree of dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement by which the spouse becomes an owner of the property; or

(vi)  A transfer into an inter vivos trust in which the borrower is and remains the beneficiary and occupant of the property, unless, as a condition precedent to such transfer, the borrower refuses to provide the lender with reasonable means acceptable to the lender by which the lender will be assured of timely notice of any subsequent transfer of the beneficial interest or change in occupancy. (Emphasis supplied)

A cursory reading of this statute will demonstrate that though transfers to inter vivos trusts are exempted from the due-on-sale provisions of Garn-St. Germain, for example, transfers to LLCs are not. Thus, if your clients deeds her personally own, mortgage-encumbered rental property into her single-member LLC (SMLLC) of which she is the sole member, she risks her mortgage lender calling the loan—that is, the loan being immediately due and payable.

What to do? Interestingly, different attorneys give different advice. Some will say that the safest path is to call the mortgage lender and let them know what is going on—essentially ask permission. They’ll then say, “but why bother? The lender will never find out anyway.” Actually, it may be true that lenders don’t spend much time policing property records in an effort to catch borrowers transferring real estate into their LLCs—I’ve heard this a lot, but who knows if it’s true? However, the safest path is also the best path, and in most cases, it will be a relatively easy one. But when you make that call, make sure you keep talking until you talk to a person who knows what they’re doing.

The due-on-sale concern will arise in two situations: 1. In a new purchase where the lender says the purchaser/borrower must buy the property in her own name, and the purchaser/borrower intends to transfer it into an LLC post purchase; and 2. Where the purchaser/borrower has owned the property in his own name for a while and decides he wants to transfer it into an LLC—the old purchase.

New Purchases. In this situation, it’s simply a matter of being up front with the lender from the beginning. The borrower should explain their intentions and get the lender’s approval in writing prior to signing the loan, when she has leverage. Lenders see these situations all the time, and most will agree and even facilitate the transaction. Some may require guarantees by the LLC, signed by its members or managers accompanied by a resolution or other statement of authority evidencing their authority to sign.

Old Purchases. This situation is more problematic. The lender has the leverage, and if rates are up, it’s in the lender’s interest to call the loan. In such an environment, it may be worth the risk to transfer to the LLC and ask forgiveness later—if ever. Chances are, the lender will never know. But if the lender discovers that your client transferred the property and if rates are up and the client’s financial situation has deteriorated, trouble may ensue. If rates haven’t changed much and if the client is able to refinance if necessary, the existing lender may be more willing to allow the transfer without calling the loan.

It’s virtually always best to talk to your lender before you make a transfer; otherwise, you risk the lender calling your loan. And besides, do you want a good or a bad relationship with your lender. Yeah, I thought so.

More than Just the Tetons: A New Chancery Court Makes Wyoming Well Worth Discovering

Geyser Basin, Yellowstone Park, Wyoming (like the title says, more than the Tetons)

But for the missing photo of the magnificent Tetons, volume 11, number 1 of the 2011 Wyoming Law Review might be mistaken for a sales piece published by the Wyoming Business Council—the state’s economic development agency. Two articles in the journal tout Wyoming’s business and trust friendly laws. “The Undiscovered Country: Wyoming’s Emergence as a Leading Trust Situs Jurisdiction,”[1] Christopher Reimer argues that the state’s laws on directed trusts, trust protectors, self-settled trusts, and private trust companies, among other tools justify that claim. A few pages earlier, Dale Cottam and four others make similar claims with regard to limited liability companies. Not only did the new 2010 Limited Liability Company Act (“LLC Act”) replace Wyoming’s original—and first-in-the-nation—act, they point out, it included some “home cooking” that makes the Cowboy State the place to be . . . organized.[2] Come for the Tetons; stay for the business and trust friendly laws and the lack of a state income tax.

Seven years later, Amy Staehr revisited that theme in her piece “The Discovered Country: Wyoming’s Primacy as a Trust Situs Jurisdiction.”[3] In it, she updates what Wyoming’s part-time legislature had been up to in the intervening years. Among other things, new legislation provided more privacy protection to trusts and better asset protection with a new Wyoming Qualified Spendthrift Trust. Likewise, limited liability companies could now have a more flexible management structure. The message was again clear: Yes, the vistas are expansive and the sunsets beautiful, but have you looked at our business and trust friendly laws lately? “I think it’s exciting what Wyoming’s trying to do with its laws,” says Michael Greear, a state representative and member of the state’s Chancery Court Committee. “Anything we do to get more business and still keep the population at 500,000 is all good.”

But there was a hitch: Wyoming’s court system. It had essentially two tiers: Nine District Courts of general jurisdiction and a Supreme Court, the state’s only appellate court. And only the Supreme Court reported its cases online. In 2019 it issued 151 opinions, just 3 of them involving trusts and businesses, down from the 159 it heard in 2018, again, only 3 of them dealing with trusts and businesses. In short, Wyoming had great new business and trust laws, but too few court opinions published online to help interested observers discern how Wyoming courts might interpret those laws, an essential ingredient to a stable climate for business entities and trusts.

It didn’t help that recently—and unfortunately—the Court’s 2014 GreenHunter Energy case put the fear of creditors into the hearts of businessmen and women. The case’s result was certainly just, but the rule of the case appeared to ignore new veil piercing provisions in the LLC Act. It’s worth noting that the Wyoming legislature did its part to provide stability. Almost immediately after the Court issued its opinion, the legislature amended the LLC Act to essentially reset the law clearly and unequivocally to pre-GreenHunter days.[4]

In its 2019 session, the Wyoming Legislature acted again, this time to increase the size and density of the paper trail created by Wyoming courts in hopes of becoming the Delaware of the West. Delaware has a Chancery court, its docket devoted to trusts and business; so should Wyoming. And voila! After a concerted effort by some forward-thinking legislators and a stroke of the Governor’s pen, Wyoming has a Chancery Court dedicated to hearing nothing but trust and business cases.  Senate File 0104, the bill that started it all, now sits ensconced as Chapter 13 of Title 5 of the Wyoming Code. Where the court will sit and when it will open is another matter. “Two things will dictate when the factory is up and running: the adoption of court rules and making sure we’ve got the IT—the caseload management system and e-filing—in place,” says Senate President Drew Perkins, sponsor of the bill.

The Act mandates $1,500,000.00 of initial funding for the court and contains a broad outline for how the court should operate, among other things. In April 2019, the Supreme Court issued an order establishing the Chancery Court Committee to fill in the details of that outline. Justice Kate Fox was appointed its chairperson. “She gets two thumbs up,” Greear says. “She put together a great committee.”

The Committee did its job, particularly in developing court rules. Finally on January 7, 2020, an email went out to the Wyoming Bar, asking for comments on the proposed rules. The comment period ends on May 15, 2020, and final rules will go into effect six months later on November 15, 2020. That date makes sense because there is still a lot to work through, according to Justice Fox. That includes the rules, but also who the judges will be and where their court will sit. “The plan is to appoint judges with expertise in the statutory areas, much like in Delaware. Wyoming Chancery Court judges must be experienced or knowledgeable in the subject matter jurisdiction of the court,” she explains.

The court’s jurisdiction includes everything from breach of contract to fraud and misrepresentation, from statutory violations of laws governing asset sales and protecting trade secrets to transactions involving the Uniform Commercial Code and the Uniform Trust Code. Disputes concerning employment agreements, insurance coverage, and dissolution of corporations, LLCs, and other entities can all be heard by the Chancery Court. The statute says the Court “shall employ “alternative nonjury trials, dispute resolution methods and limited motion practice and shall have broad authority to shape and expedite discovery,” [5] a good idea, given that the new law requires “effective and expeditious resolution of disputes,” a term of art that means a majority of the actions filed in the court must be resolved with 150 days of filing. “The sponsors of the bill view the Chancery Court as kind of a business draw,” Fox says. “A speedier court with more particular [business and trust] expertise should be attractive to businesses who are considering incorporating in or coming to Wyoming.”

As for where the court will sit, “it will likely be in Casper or Cheyenne, just because they are bigger,” she continues. “But it’s also possible, depending on the case and where the parties are, that the judges could be mobile and hear cases in places like Jackson.”

The smart money is on Casper. It’s centrally located, new money was recently appropriated for a new state office building there, and it has good air service. “Last week I had meetings in New York with our investment bankers,” says Greear, who lives in Worland, Wyoming, where he’s the CEO of Wyoming Sugar Company. “I flew out of Casper, had a nice dinner in New York, met with my bankers and was home the next day. United and Delta service Casper really well.”

Perkins, who lives and works in Casper, hopes there will eventually be one or more courts outside of his hometown, maybe one in Cody or Sheridan and one in Cheyenne, for example. “That’s my vision for it, anyway. The idea is not about having the court in Casper; it’s about having the court available for quick resolution.”

As they say, time will tell. The job now is to get the first court up and running with a judge knowledgeable about business and trust law expeditiously issuing opinions. The hope is that, when published, those opinions will consistently and clearly demonstrate how things are done in the Wyoming. And done right, it’s all good—for the Equality State and the businesses that locate there.

[UPDATE] After this story went to press at the ABA, the Wyoming legislature failed to fund a variety of construction projects during the recent legislative session, including the construction of the Chancery Court in Casper. With the COVID-19 pandemic and the drop in oil prices, even Drew Perkins, a sponsor of the Chancery Court, thought it good to wait and watch.


[1] Pg. 165 (2011).

[2] “The 2010 Wyoming Limited Liability Company Act: A Uniform Recipe with Wyoming ‘Home Cooking,” pg. 49 (2011).

[3] Wyoming Law Review, Volume 18, Number 2, pg. 283.

[4] See “Wyoming Supreme Court Upholds Decision to Pierce the Veil of Single-Member LLC,” Rutledge, Thomas; November 13, 2014, https://kentuckybusinessentitylaw.blogspot.com/2014/11/wyoming-supreme-court-upholds-decision.html (accessed 2/26/2020); and “Wyoming Cleans up Veil Piercing in LLC Act,” Fershee, Joshua; March 29, 2016, https://lawprofessors.typepad.com/business_law/2016/03/wyoming-cleans-up-veil-piercing-in-llc-act.html (accessed 2/26/2020).

[5] Wyo. Stat. § 5-13-111

I wrote the piece above for the April, 2020 issue of The LLC & Partnership Reporter, a publication of the ABA.

DIY Investment Management of Retirement Assets: Is There an LLC in Your Self-Directed IRA’s Future?

An idea worth considering.

As baby boomers begin to retire, the burden of making management decisions regarding their retirement assets may seem daunting. This is especially true for those who choose to forego using professional investment advisors and instead manage their assets by themselves. If DIY appeals to you, just know there are many pros and probably as many cons.

 First, the pros of choosing to manage your own retirement funds, particularly if you are a business owner with expertise in the area in which you invest. By doing it yourself, you can:

  • Exercise greater control over investment choices,
  • Enjoy greater flexibility in allocating and diversifying these investments, and
  • Avoid high fees associated with having a financial advisor.

If you choose to pursue the DIY method, a reasonable option for you to explore is the self-directed Individual Retirement Account (IRA). A self-directed IRA is like other retirement accounts that allow individuals to save for retirement. A self-directed IRA can take the form of any of the more common ROTH, SEP, and traditional IRAs, allowing your investments to enjoy benefits like tax-free growth or specified tax-deferment. The self-directed IRA’s unique attribute relates to the types of investments that are permitted. Unlike standard IRAs, a self-directed IRA extends beyond mutual funds and stocks. With a self-directed IRA, a custodian can also invest in real estate, private company stock, precious metals, and all other investments available by law.

(Some investors have taken the self-directed IRA a step further and set up what is referred to an “IRA/LLC” or “checkbook control IRA,” an arrangement by which investors may directly manage their IRA investments through an LLC owned 100% by a self-directed IRA. This arrangement is beyond the scope of this short blog post, but since it’s an option worth considering, it’s one worth mentioning.)

Pros inevitably are accompanied by cons. Self-directed IRAs are no exception. In fact, there are considerable risks and other considerations, you should take into account:

  • Clarity of Goals. One significant limitation for individuals attempting to manage their own retirement accounts is that they haven’t given serious thought to their financial goals, let alone their retirement plans. To successfully manage retirement assets, you must understand exactly what you are trying to achieve and strategically align your investments with those goals. Failure to do so may result in inadequate savings or over-spending. Both mistakes can lead to complications once you retire.
  • Understanding of Financial Concepts. In addition to having a clear vision for your financial future, you must understand basic financial concepts associated with investing. For example, anyone interested in managing their retirement funds should be able to develop an asset allocation strategy that incorporates factors like tax rates, age of retirement, required income, and current assets. Without a solid understanding of how these various factors influence each other, you could under-save and outlive your retirement funds.
  • Compliance with complex investment rules. Understanding your goals and navigating complex financial concepts will not matter if you violate one of the many rules associated with investments. The federal government has a variety of regulations that govern the types of permitted transactions, who can be a party to such transactions, and the extent to which various taxes apply. For example, in a self-directed IRA, clearly defined rules prohibit certain transactions characterized as self-dealing. To that end, your self-directed IRA is not allowed to engage in transactions with certain people, including the account owner, family members, and business partners. What constitutes self-dealing is defined by the Internal Revenue Service and case law. Figuring out which transactions are allowed is tricky, and failure to comply with IRS rules can result in hefty fines.

In short, going DIY? Be careful out there. Better, don’t DIY in every aspect of managing your retirement funds. Be honest with yourself: Seek advice where you lack knowledge.

Series LLCs: (Some of) What You Need to Know

A series LLC, a relatively recently authorized form of LLC, is composed of a master LLC—the Mother Ship—which houses a series of LLCs. Each series, silo, or cell (the potential synonyms are almost endless) within the series LLC often has separate owners, and each must always maintain separate records, especially records that account only for the assets of that series—at least if the series LLC is formed in Utah or Wyoming and other ULLCA states that allow for series LLCs.

Series, Silos, or Cells: more protection at less cost?

Similar to a corporate/subsidiaries business model and like their more well-known parent LLCs, series LLCs offer asset-protection benefits, but they avoid the complexities of corporate taxes, structure, and other required formalities. 

This type of entity is well suited for certain businesses that may benefit from its relative simplicity, reduced costs, and increased asset protection. But especially because they are so new, there are also some uncertainties associated with the series LLC.

Potential Benefits of the Series LLC:

1. Simplicity

  • Reduced Administration

Although each series must be administered separately, series LLCs have the potential to save time and administration costs.

2. Reduced Costs

  • One Registration

Each of the individual series is formed and governed by the master LLC’s operating agreement.  In most states—Wyoming and Utah, included—only the master LLC must be registered with the state, which means reduced fees.

  • Potential Sales Tax Savings

Some states may not require sales tax to be paid on rent that one series pays to another series.

3. Asset Protection

  • Mixed Signals

Under most series LLC statutes, each series is protected from judgments against assets in other series under the master LLC.  But it’s not clear that this protection will be respected in bankruptcy proceedings or in states that don’t recognize series LLCs.

Potential Downsides of the Series LLC:

1.  Some Additional Costs

  • Registered Agent

Many states require a separate registered agent for each series in the series LLC, which may mean additional expenses.

  • Formation Cost

The up-front registration fee for a series LLC may be higher than the registration fee of a regular LLC.  In some states, it may be less expensive to register multiple single-member LLCs rather than a series LLC with multiple series. This is generally not the case in Wyoming and Utah.

2. Governance Issues

  • Overlap Jeopardy

The operations may not be as streamlined as anticipated. The records of each series must be maintained separately, and each series must have its own separate bank accounts.  Can administrative functions among the series overlap without jeopardizing the limited liability? Can the ownership or management overlap? Does inadequate capitalization of one series impact the other series in the series LLC? At this point, these types of questions remain unanswered.

3. Liability Questions

  • Bankruptcy Issues

Federal bankruptcy laws do not yet address series LLC issues.  Can an

individual series within a series LLC file for bankruptcy? Are the assets of the non-filing series and the master LLC protected from the filing series?  At this time, there are no clear answers to these and other bankruptcy-related questions.

  • Choice-of-Law Issues

If a series LLC gets sued by a third party in a state that doesn’t authorize series LLCs, the assets of each series and the master LLC may be at risk. For LLCs that operate in states with and without series LLC statutes, this may make a series LLCs much less attractive.

The series LLC is potentially a star on the rise and is definitely worth watching.  If your business is particularly well suited to this compartmentalized approach—real estate investing, for example—and you live in one of the states[1] that currently authorizes series LLCs, you may want to this novel entity.


[1] As of November 2019, Alabama, Delaware, DC, Illinois, Indiana, Iowa, Kansas, Missouri, Montana, Nevada, North Dakota, Oklahoma, Tennessee, Texas, Utah Wisconsin, Wyoming, and Puerto Rico provide for series LLCs in their statutues.

Transferring LLC Membership Interests Part 3—Involuntary Transfers

An involuntary transfer of an LLC membership interest is just that—a transfer prompted by a creditor action or the occurrence of a triggering event outside of the member’s control. An individual or entity obtaining a membership interest as a result of an involuntary transfer usually cannot fully step into the shoes of the transferring member.

This statutory protection—often called a pick your partner provision—acts as a safeguard that provides LLC members with a certain amount of personal asset protection. For example, whereas the creditor of a corporate shareholder could reach and exercise shareholder rights to their full extent, the creditor of an LLC member can reach and exercise only the economic rights associated with membership interests—not the voting or management rights. The recipient of this type of membership interest is called an assignee.

Statutory Provisions – Creditor Action

If an LLC does not specify any transfer provisions, creditor actions are subject to state LLC laws. Each state, in its LLC statute, has provisions limiting what actions a creditor can take against an LLC member for personal debt. Depending on the state, the statutory remedies available to an LLC member’s personal creditors may include:

  • A charging order, which is a court order requiring the LLC to pay all the distributions due to the member-debtor from the LLC to the creditor.
  • A foreclosure on the member-debtor’s LLC ownership interest.
  • A court order to dissolve the LLC.

These remedies protect the other LLC members from the risk of having the creditor of a debtor-member step into the debtor-member’s place and share in the control of the LLC. To a varying degree, they also address the creditor’s right to satisfaction of the debt.

Transfer Provisions – Other Triggering Events

Transfer provisions are typically specified in the LLC’s operating agreement or in a separate buy-sell agreement. There may be some overlap with creditor actions, as these are often included as triggering events in the transfer provisions.

Examples of triggering events that can be specified in an LLC’s transfer provisions include the following:

  • A deceased member’s membership interest passes to a prohibited individual or entity
  • A member’s bankruptcy or other involuntary transfer of a membership interest to the member’s creditors
  • A member’s separation or divorce, or the transfer to a member’s spouse under property division or under a divorce or separation decree
  • A member’s membership interest becomes subject to a valid court order, levy, or other transfer that the LLC is required by law to recognize
  • A member’s breach of the LLC’s confidentiality
  • A member’s failure to comply with any mandatory provision of the operating agreement
  • A member’s failure to maintain a license or other qualification that disqualifies the member from engaging in the LLC’s primary business

If a triggering event occurs, the transfer provisions may prompt a mandatory redemption of the member’s membership interest or a right of first refusal to the LLC or to the other members. If an involuntary transfer does occur, the recipient of the membership interest—the assignee—typically receives only an economic interest in the LLC with no management or voting rights.

Transferring LLC Membership Interests Part 2—Voluntary Transfers

An LLC affords its members a certain amount of personal asset protection. Part of this protection hinges on the restricted transferability of LLC membership interests.  Restricted transferability protects the non-transferring members from creditors and unwelcome new members, which upholds the integrity and value of the non-transferring members’ membership interests.

  • Most (but not all) LLCs impose requirements or restrictions on the transfer of a member’s interest.
  • If the LLC’s operating agreement is silent on the transferability of interests, you must look to state law to be sure there are no default provisions restricting transferability.

This article, part 2 in a 3-part series, focuses on voluntary membership interest transfers done with the intent to grant full membership rights to the recipient.

Step 1 – Determine the Transfer Process

The LLC’s operating agreement should specify the process for transferring a membership interest. If the LLC has a buy-sell agreement in place, that must also be consulted.

  • Find the provisions that detail allowable transfers, the steps to complete them, and the method for calculating the value of the membership interest, if any.
  • The membership interests may be freely transferable but are likely subject to restrictions set forth in the operating agreement, the buy-sell agreement, or by state law.
  • Some transfers may be permitted without prior approval of the other members, such as transfers to a member’s immediate family or to a trust for the benefit of a member or a member’s immediate family.
  • The LLC or the other members may have a right of first refusal before a transfer can be made.

If the operating agreement or buy-sell agreement doesn’t specify the process for transferring a membership interest, you will have to look to state law. Once you determine the authority governing the transfer process—the operating agreement and buy-sell agreement or state law—be sure to note all requirements and restrictions.

Step 2 – Determine the Value

Calculate the value of your membership interest. If the operating agreement or a separate buy-sell agreement doesn’t address this, you will have to work with the other LLC members to determine and agree upon the value of the membership interest.

Step 3 – Follow Transfer Process

Complete the LLC transfer process as determined in Step 1. Make sure you follow all requirements. For example, if the operating agreement requires the unanimous written consent of all LLC members (a common requirement), meet with all of the LLC members to obtain their written consent.

Step 4 – Obtain or Draft the Transfer Document

If the LLC does not have a standard transfer document, you will need to draft a transfer document.

  • Check the operating agreement or state law to determine what the transfer document must include.
  • Typically, it must include the transferor’s name, the LLC’s name, the recipient’s name, and the percentage of the membership interest being transferred.
  • If a form is not provided by the LLC, note that the form of the transfer document is usually subject to the LLC’s approval; make sure to obtain this approval if necessary.

Step 5 – Execute the Transfer Document; Other Documents

Sign and date the transfer document. Make a copy for your records, for the recipient, and for the LLC.

  • The recipient typically receives the original transfer document.
  • The LLC may have additional documents that the recipient must sign in order to be admitted as a member.
  • State law may require the operating agreement and certificate of formation to be updated with the new member information.
  • The LLC may pass the costs associated with the transfer to the new member.

Conclusion

Making a proper transfer of membership interests requires the transferor to jump through a lot of hoops. The first step in the process is determining which hoops are required. Taking the time to properly transfer membership interests ensures that the recipient obtains full membership rights and protection.

We offer proactive business planning strategies. We help businesses draft thorough operating agreements that provide clear directions to the LLC members—to exercise membership interest transfers and other important member rights. We also assist existing LLC members who want to properly transfer their membership interests in the absence of a thorough operating agreement.  Contact us today to learn more about our business services.

Transferring LLC Membership Interests Part 1—An Overview

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.

Limited Liability Companies in the News (I wrote)

So I haven’t been writing on my blog a lot lately. But I have been writing. Here are just three examples:

  1. The October 2018 issue of The LLC & Partnership Reporter, a publication of the ABA’s Business Law Section, sports an article I wrote titled, “Wyoming’s Series Limited Liability Company Act: (Virtually) All in the Operating Agreement.” You can find it on page 31. The piece makes clear that Wyoming’s new series act is straightforward and allows an LLC’s operating agreement to do most of the heavy lifting regarding how a particular LLC is managed and how members relate with one another and with third parties.
  2. Another article I wrote appears in the same issue, this one titled, “Utah’s ‘Benefit Limited Liability Company Act”: A Bridge Too Far?” My answer is Yes, the bridge isn’t even needed. You’ll have to read the piece to understand why. You can find it on page 42.
  3. My most recent article appears in the February 2019 issue of Wyoming Lawyer, a publication of the Wyoming Bar. Titled “2018 Case Law Review,” the story discusses a number of recent cases from around the country. I’m particularly interested in whether other states, including Wyoming and Utah, will follow the Fourth Circuit Court of Appeals’ holding in Sky Cable, LLC v. DIRECTV and recognize the creditor’s remedy of reverse veil piercing. What’s reverse veil piercing, you ask? Read my article in Wyoming Lawyer!

The Corporate (or LLC) Veil: “sufficient corporate formalities were followed”

An interesting article at Lexology, regarding the fact that, as the title says, “Creditors Find Piercing the Corporate Veil is Not So Easy.” The piece tells the story of three different cases involving disgruntled plaintiffs suing either a corporation (2 cases) or an LLC (1 case), under the so-called “piercing the veil” theory. That theory basically says that if someone is basically hiding behind the facade of a corporate business form (or an LLC) when, in fact, the business is really no more than an individual, with one foot inside the corporation and one foot out.

As the opening paragraph explains:

[V]eil piercing is an equitable remedy only rarely allowed by courts and is limited to situations in which the corporation’s principals (or parent company) (i) so dominated the corporation that they can be said to be the “alter-ego” of the corporation; and (ii) misused the corporate entity to perpetrate a fraud or crime or otherwise work an injustice. A number of factors have been found relevant to a veil piercing analysis, including whether the corporation is undercapitalized, whether the corporation failed to observe corporate formalities or failed to maintain corporate records; whether the debtor corporation was insolvent; whether the corporation’s funds were siphoned off by the dominant shareholder; and whether the corporation served merely as a façade for the operations of the dominant shareholder or shareholders. (Emphasis supplied)

Though veil piercing sounds good and reasonable in theory, the veil is more teflon than chiffon. Take the LLC case for example:

The court [in Ossa v. Kalyana Mitra LLC, a New Jersey case noted that “sufficient corporate formalities were followed.” Apparently, the record showed that at least some regular corporate practices had not been observed but the court did not find them troubling, given the “documentation of minutes of meetings, notes, and agendas, and tax and bank records indicating that company funds were not siphoned for personal use.” The documents, in fact, showed that Miller was using the money to repay her husband’s company, which was one of Kalyana Mitra’s creditors. (Emphasis supplied)

Sufficient is apparently sufficient, but my advice continues to be, make the letter (and spirit) of the corporate form your mantra; otherwise, that protective veil may disappear just when you need it most.

 

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