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.

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!
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