Who Are the Owners of an LLC?
A lender took an assignment of a 25% interest in an LLC in exchange for the lender’s cancellation of the LLC’s debt, but the lender was never admitted as a member. Later the lender agreed to sell his “25 percent ownership interest,” but his buyer defaulted and claimed that the lender did not have an ownership interest in the LLC.
Ownership of property is covered in a first-year law school class because it is a fundamental legal concept, but sometimes the application of even fundamental concepts can be troublesome. In this case the Kentucky Supreme Court overruled the Court of Appeals and held that in the context of an LLC, “ownership” and membership in the LLC are synonymous – that the owner of an economic interest in the LLC does not have an “ownership interest” if he is not admitted as a member. Spurlock v. Begley, No. 2009-SC-000050-DG, 2010 Ky. LEXIS 80 (Ky. Apr. 22, 2010).
Tate Begley loaned $75,000 to Caribou Coal Mining Processing, LLC (Caribou), in exchange for Caribou’s promissory note. The note was unpaid and went into default. Robert Griffin, the founder of Caribou, orally promised to give Begley a 25% interest in Caribou in exchange for the $75,000 debt. Begley and Ben Spurlock then entered into a one-paragraph written agreement (Sale Agreement) in which Spurlock agreed to pay Begley $70,000 in exchange for Begley’s “25 percent ownership of Caribou Coal Processing LLC.” Spurlock, 2010 Ky. LEXIS 80, at *8.
A year later Caribou was insolvent and had ceased operations, and Begley sued Spurlock for non-payment on the Sale Agreement. Spurlock defended on the grounds of failure of consideration, contending that Begley did not hold an ownership interest in Caribou. At trial the jury found that Griffin had indeed transferred a 25% ownership interest to Begley and ruled for Begley on his Sale Agreement with Spurlock. The Court of Appeals affirmed.
The Kentucky LLC Act uses the term “members” rather than “owners,” as do most other state statutes. Ky. Rev. Stat. § 275.015(16). If there is no written operating agreement, a person acquiring an interest directly from the LLC becomes a member only if all members consent in writing, and a person acquiring an interest by assignment from a member becomes a member only if a majority in interest of the members consent in writing. Ky. Rev. Stat. §§ 275.275(1), 275.265(1).
If the assignee is not admitted as a member, the membership interest becomes divided. The economic rights are held by the assignee and the governance rights are retained by the assignor, who continues to be a member. Ky. Rev. Stat. § 275.255(1)(d). If the members consent and the assignee is admitted, the transfer of the membership interest conveys both the economic and the governance rights. Spurlock, 2010 Ky. LEXIS 80, at *7.
After reviewing the Act’s provisions, the court concluded:
This, then, leads to the conclusion that simply acquiring economic rights does not, in and of itself, equate to “ownership” or “membership” in the limited liability company.
. . .
… In the context of limited liability companies, “ownership” and “membership” are synonymous.
Id. At *7-8. The court then reasoned that because Begley acquired only an economic interest and was not admitted as a member, he did not acquire an ownership interest in the LLC. Spurlock therefore had a valid defense of failure of consideration under the Sale Agreement.
The court’s analysis makes sense if one understands “ownership” in the sense of “[t]he complete dominion, title, or proprietary right in a thing or claim.” Black’s Law Dictionary 1260 (4th ed. 1968). After all, Begley did not have all of the rights of a member – he had the economic rights but not the governance rights. And if the word “membership” is used only for a person who is both admitted as an LLC member and who holds all of the associated economic rights, then the court’s conflating of ownership and membership is correct.
But as the Spurlock court itself pointed out, a member who transfers its economic interest to a non-admitted assignee continues to be a member even though it has no remaining economic rights. Presumably the court would not have found Begley to have “ownership” if he had been admitted as a member but had assigned his interest to a non-admitted assignee, leaving Begley a member holding governance rights and no economic interest. In that scenario, LLC membership would not equate to ownership.
More careful drafting of the Sale Agreement could have changed the result in this case. If the Sale Agreement had referred to an “economic interest” or simply an “interest,” rather than an “ownership interest,” or if it had included language otherwise clarifying that Begley had not been admitted as a member, then Spurlock would have had no defense. The court did not examine the intent of the parties; it simply construed any ambiguity in the phrase “ownership interest” against Begley because he drafted and prepared the Sale Agreement. Spurlock, 2010 Ky. LEXIS 80, at *8-9..
The court also could have been more careful with its language. Its generalized equating of “ownership” and “membership” reaches too far by ignoring the fact that an LLC can have a member with no economic interest. Words are slippery and should be used carefully. The question, as Humpty Dumpty said to Alice, is which is to be master, the words or their speaker.
