LLC statutes typically require that an LLC have at least one member. A corollary is that the death of an LLC’s only member results in the LLC’s dissolution unless the deceased member’s assignees or heirs vote within a limited time to admit one or more members. In a recent Alabama case an LLC’s manager continued operating the LLC after the death of the sole member, without asking the other three heirs to vote to continue the LLC. Ten years later the three heirs asked the court to enforce the dissolution and require that the LLC be wound up.L.B. Whitfield, III Family LLC v. Whitfield, No. 1110422, 2014 WL 803363 (Ala. Feb. 28, 2014). Notwithstanding the ten-year interval, the Alabama Supreme Court affirmed the trial court’s order that the LLC had been dissolved and that the LLC must wind up its business and distribute its assets.
Background. L.B. Whitfield formed an Alabama LLC in 1998 to hold his shares of stock in a large family business. L.B. was the only member, and he and his son Louie were the managers. When L.B. died in 2000, his will left the residue of his estate, including his interest in the LLC, to Louie and each of Louie’s three sisters in four equal shares. Louie was appointed executor of L.B.’s estate and continued as manager of the LLC.
Over the next ten years Louie and the three sisters accepted distributions from the LLC and in other ways treated the LLC as an ongoing entity. This state of affairs began to unravel in 2010, when a dispute arose between the sisters and the LLC over shares of stock the sisters had transferred to the LLC years earlier. The LLC filed a lawsuit against the three sisters, requesting a declaration from the court that the sisters had no right to reacquire the shares from the LLC.
In the course of the lawsuit the sisters learned that under Alabama law the death of an LLC’s only member will cause the LLC to be dissolved unless the deceased member’s assignees agree in writing within 90 days to continue the business and to admit one or more new members. They then sued for a court order requiring the LLC to wind up its affairs and distribute its assets to the sisters and Louie, on the grounds that it had been dissolved 90 days after L.B.’s death. The trial court so ordered and the LLC appealed to the Alabama Supreme Court.
Equitable Defenses. The LLC asserted the affirmative defenses of res judicata, laches, equitable estoppel, judicial estoppel, and waiver. These defenses all revolved around either the probate of L.B.’s estate or the ten-year period between his death and the sisters’ assertion of their claim that the LLC was dissolved. All were rejected by the Supreme Court.
Res Judicata. The LLC argued that its continuation had been adjudicated in the “Decree of Final Settlement” that the probate court entered for L.B.’s estate, because the sisters could have asserted in the probate that the LLC was dissolved but failed to do so. The Supreme Court rejected that defense because the LLC’s continuation was not a central or even a peripheral issue in the probate, and the mere listing of the LLC as an asset of the estate was not a determination that L.B.’s children had been admitted as members of the LLC. Id. at *6.
Laches. The LLC argued that the sisters’ ten-year delay in seeking a declaration of the LLC’s dissolution prejudiced the LLC. The court first pointed out that the sisters were not seeking to dissolve the LLC but were instead seeking recognition that the LLC had been dissolved shortly after L.B.’s death by operation of Alabama law. Laches is a delay that works a disadvantage to the other party, and the court found that the passage of time had worked no disadvantage to the LLC.
Equitable estoppel requires knowledge of the facts by the party to be estopped, lack of knowledge by the party seeking estoppel, and material harm resulting from the assertion of a claim inconsistent with earlier conduct. The court dismissed this defense, finding that the sisters were not aware that the LLC was dissolved until they consulted counsel following the LLC’s initiation of the lawsuit, that the LLC should have been aware of the law that governed its existence, and that there was no material harm resulting to the LLC.
Judicial estoppel applies when a person takes a position in a legal proceeding that is inconsistent with a position previously asserted. The LLC argued that the sisters’ position seeking enforcement of the LLC’s dissolution was inconsistent with their position in the probate of L.B.’s estate. But the sisters never contended in the probate that the LLC should continue or that they were members of the LLC, and the court saw no basis for judicial estoppel.
Waiver. The LLC argued that the sisters had waived their right to seek dissolution. But the court brushed aside the waiver claim, noting that this defense suffered from essentially the same deficiencies as the other defenses.
Dissolution. The LLC argued that it had not been dissolved because Louie’s actions following L.B.’s death continued the LLC. The court began its analysis by examining the relevant provisions of the Alabama LLC Act.
The Act provides that an individual LLC member ceases to be a member on his or her death, subject to contrary provisions in the LLC’s operating agreement. Ala. Code § 10A-5-6.06(b)(3)(a). There were no such provisions in the LLC’s operating agreement.
The Act also provides that an LLC is dissolved and its affairs shall be wound up
upon occurrence of the first of the following events: … When there is no remaining member, unless … [t]he holders of all the financial rights in the limited liability company agree in writing, within 90 days after the cessation of membership of the last member, to continue the legal existence and business of the limited liability company and to appoint one or more new members.
Ala. Code § 10A-5-7.01. L.B. therefore ceased to be a member on his death, and the sisters claimed that as the heirs of the financial rights in the LLC they had never agreed in writing to continue the business of the LLC.
The LLC contended, however, that Louie had the power to transfer his father’s membership interests to himself and his sisters, under Section 10A-5-6.04(a)(1) of the Act, and that he had done so by opening a bank account for the LLC to receive dividends on its shares of the family business and by working with accountants to open capital accounts for himself and his sisters. Section 10A-5-6.04(a)(1) empowers an estate’s personal representative to exercise the deceased member’s financial rights in order to settle the estate, but the court did not interpret it to authorize the personal representative to participate in management or admit members to the LLC. Whitfield, 2014 WL 803363, at *11. Furthermore, the court did not agree that Louie’s actions amounted to a written agreement by the holders of the financial rights in the LLC.
The court also found that its conclusions were supported by “the inherent nature of limited liability companies and [the] fundamental principles attendant to their formation and the acquisition of membership status in them.” Id. at *12. Those principles are that admission to membership in an LLC is not established by implication or by the actions of third parties, and that membership admission, under the LLC Act, must be evidenced by a written instrument signed by all existing members. Id.
The court accordingly affirmed the trial court’s ruling that the LLC had been dissolved upon L.B.’s death and the trial court’s order that the LLC be wound up, provide an accounting of its assets, and distribute the assets in equal shares to Louie and his sisters.
Comment. This decision is an interesting example of rights being enforced after a long (ten years) period, where the holders of those rights unknowingly let them lie fallow and unenforced.
The decision should also be a good warning for lawyers to keep in mind – when the single member of an LLC dies, there is only a limited period of time in which to take action to avoid the dissolution of the LLC, at least under Alabama law. Alabama law is not an outlier on that point; for example, Washington State (Wash. Rev. Code §§ 25.15.130, .270) and the Revised Uniform Limited Liability Company Act(§§ 602, 701) have similar provisions.
Whitfield is also an example of what can happen when parties launch litigation without full consideration of possible consequences. If the LLC had carefully analyzed its history and the circumstances attendant on the probate of L.B.’s estate, and considered the Alabama LLC Act’s rules on dissociation and dissolution, it might have forgone litigation and negotiated a settlement of the dispute over the shares of stock.