Death is almost always a complicated event for the survivors, who have not only emotional but also logistical considerations to manage. However, when an owner (typically called a member) of a limited liability company (LLC) dies, it exacerbates the difficulties for the surviving members. In addition to bearing the loss, they must determine whether the LLC can or even should continue.
These questions are just a handful of the issues that should be considered as part of an LLC business succession plan. Failure to address these issues and implement the proper documentation could result in conflict within the business, conflict within the family, or even the closing of the business—which may be completely opposed to the members’ original intent.
To truly answer what happens to an LLC after a member dies, you must consider a number of factors and their interactions, including the language of the company’s operating agreement, the state law that governs the entity, and the personal estate planning tools the deceased member employed.
LLCs and Operating Agreements
The structure of an LLC is one of the elements that creates complexity when determining the outcome of an LLC member’s death. LLCs provide substantial flexibility in addressing matters of ownership, management, and financial rights, which are primarily governed by a contract called the operating agreement. The execution of an operating agreement is not usually mandated by state law, but it is often the most critical component when dealing with an LLC member’s death. In the absence of an operating agreement specifying the members’ intentions about what should happen upon their death, the surviving members and the deceased member’s heirs must rely primarily on the default rules under state law. Although an operating agreement could be silent on the matter, for optimal control and intentionality, the members should make these decisions in advance and carefully document them in their LLC operating agreement, as well as their personal estate planning documents. In addition, it is crucial to ensure that there are no conflicting provisions in these documents that could create ambiguity about a member’s wishes.
Some operating agreements incorporate provisions for transferring assets upon specific triggering events, including a member’s death. These provisions are often called buy-sell provisions. Buy-sell provisions, along with other provisions in the operating agreement, may treat LLC membership interests as bifurcated into management interests and financial interests. It is not uncommon for LLC members to structure their rights in unique ways regarding how management authority is shared and how profits and losses are split. Moreover, in some cases, an operating agreement can restrict the type of ownership interest that an heir receives at the time of a member’s death to one of these two categories rather than transferring complete financial and management rights. Alternatively, a buy-sell provision may give the surviving members the option to purchase the deceased member’s interest at a fair price.
Common State Laws
When an operating agreement is not in place or fails to address business succession matters, the survivors of a deceased LLC member must look to the default state laws. Under such circumstances, these default rules will be used to determine how the LLC and membership interests are treated. For example, the laws in some jurisdictions state that the LLC must be dissolved upon the death of the last member. The dissolution process requires liquidation of the LLC. The assets and profits that remain after debts are paid are incorporated into the deceased LLC member’s interest and distributed among the LLC member’s heirs. In other jurisdictions, state law specifies that an LLC member’s interest cannot be transferred without the approval of all of the other members. These state variations in the law highlight how critical it is for LLC members to understand their unique jurisdictional rules.