Virginia Limits the Assignability of LLC Member Control Rights
The transferability of an LLC member’s interest is determined by the terms of the LLC’s operating agreement and the requirements of the state’s LLC Act. State LLC statutes usually distinguish between transferability of a member’s economic interest and the member’s control rights, and generally make it easier to transfer the economic rights than the right to participate in management.
The Virginia Supreme Court recently analyzed the interplay between the transferability provisions of Virginia’s LLC Act and the LLC’s operating agreement in Ott v. Monroe, No. 101278, 2011 Va. LEXIS 214 (Va. Nov. 4, 2011). The court held that the death of an LLC member, and the transfer by will of his interest in the LLC, resulted in the transfer of the decedent’s economic rights but not his management rights.
Dewey Monroe, Jr. was an 80% member of L&J Holdings, LLC, a Virginia limited liability company. His wife Lou Ann was a 20% managing member. Dewey died in 2004, and his will bequeathed his LLC interest to his daughter Janet. Janet later called a meeting of the LLC and voted her 80% to remove Lou Ann and substitute herself as the managing member. Lou Ann objected that Janet had inherited only Dewey’s right to share in the LLC’s profits, losses, and distributions, and therefore had no right to vote as a member.
Janet then filed suit and asked for a declaration that she had inherited Dewey’s full membership in the LLC and that Lou Ann had been validly removed as a managing member. The trial court found that Janet had inherited only the economic rights and had no right to vote her interest or participate in the control of the LLC’s affairs, and that Janet therefore had no authority to remove Lou Ann from her position.
Virginia’s Supreme Court reviewed the history of Virginia’s LLC Act, and found the transferability of a member’s LLC interest to be analogous to the transferability of a partner’s interest in a partnership. Id. at *5-6. The Virginia Partnership Act recognizes that a partner’s interest comprises two components: a control interest and a financial or economic interest, and the court found this same division to be inherent in the LLC Act:
Unless otherwise provided in the articles of organization or an operating agreement, a membership interest in a limited liability company is assignable in whole or in part. An assignment of an interest in a limited liability company does not of itself dissolve the limited liability company. An assignment does not entitle the assignee to participate in the management and affairs of the limited liability company or to become or to exercise any rights of a member. Such an assignment entitles the assignee to receive, to the extent assigned, only any share of profits and losses and distributions to which the assignor would be entitled.
Va. Code Ann. § 13.1-1039(A). The Act goes on to provide a way for an assignee to become a member: “Except as otherwise provided in writing in the articles of organization or an operating agreement, an assignee of an interest in a limited liability company may become a member only by the consent of” a majority of those members or member-managers. Va. Code Ann. § 13.1-1040(A).
The trial court had concluded that Dewey’s death resulted in his dissociation under Section 13.1-1040.1(7) (an individual member is dissociated upon his or her death), and that therefore his rights to participate in the LLC’s management terminated and only the economic rights survived to be inherited by Janet.
Janet argued that Section 2 of the LLC’s operating agreement, which permitted her to inherit Dewey’s rights, superseded Section 13.1-1040.1(7)(a) and that therefore Dewey was not dissociated. Section 2 of the operating agreement said:
[e]xcept as provided herein, no Member shall transfer his membership or ownership, or any portion or interest thereof, to any non-Member person, without the written consent of all other Members, except by death, intestacy, devise, or otherwise by operation of law.
Ott, 2011 Va. LEXIS 214, at *1-2. But the court did not detect any intent in the operating agreement to supersede Section 13.1-1040.1(7)(a), pointing out that Section 2 of the agreement does not explicitly address statutory dissociation.
The court concluded: “Dewey thus was dissociated from the Company upon his death and Janet became a mere assignee by operation of Code § 13.1-1040.2, entitled under Code § 13.1-1039 only to his financial interest.” Id. at *10. The result was that Janet inherited the economic rights but was not admitted as a member, and therefore had no ability to vote her interest or otherwise participate in management. The court affirmed the trial court’s dismissal of Janet’s claims to management rights.
Not content to resolve the dispute before it, the court went further and opined that “it is not possible for a member unilaterally to alienate his personal control interest in a limited liability company. Code § 13.1-1039(A).” Id. The court pointed out that the phrase “[u]nless otherwise provided in the articles of organization or an operating agreement” modifies only the first sentence of Section 13.1-1039(A), and not the third sentence, which says: “An assignment does not entitle the assignee to participate in the management and affairs of the limited liability company or to become or to exercise any rights of a member.” (The entirety of Section 13.1-1039(A) is quoted above.) The court concluded that the operating agreement could not confer the power on Dewey to unilaterally convey to Janet his control interest. Ott, 2011 Va. LEXIS 214, at *11.
The court ignored Section 13.1-1040, however. That Section states that, except as provided in the LLC’s articles of organization or operating agreement, an assignee may become a member only by the consent of a majority of the members or managing members. This allows the operating agreement to limit or expand how an assignee can become a member. For example, the operating agreement could say that no consent of any member is required for an assignee (or certain classes of assignees) to become a member, and that any such assignee becomes a voting member upon the effectiveness of the assignment. This counterexample shows the risk in a court giving opinions beyond the dispute immediately before it.
The court also ignored Section 13.1-1001.1(C), which states: “This chapter shall be construed in furtherance of the policies of giving maximum effect to the principle of freedom of contract and of enforcing operating agreements.” That’s surprising, given its direct relevance to the court’s task of interpreting the Act’s strictures on the LLC’s operating agreement.
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