As is the case with just about every provision in a limited liability company (LLC) operating agreement, the rules are flexible in regards to transferability of membership interests and admission of new members. This latest post in our series on LLC operating agreements details the default rules and common iterations of provisions related to transferability of member interests, the right of first refusal, and admission of a new member.
Transferring Your LLC Interest
Most LLC statutes distinguish between membership interests and member rights. The most important difference between the two is that the member’s transferable interest usually (but not always) includes only the member’s share in profits and losses and the right to participate in distributions (i.e. financial interests), and not the right to participate in management and control. Generally, a member’s financial interest in an LLC is freely assignable, at least in the absence of contrary agreement.
In Washington, the assignee of a member’s interest in not entitled to participate in management of the LLC unless all members approve management authority for the assignee or the LLC operating agreement grants management authority to the assignee. Once a member transfers his or her entire interest in an LLC the member is no longer a member of the LLC and relinquishes all power to exercise rights or powers of a member. The assignee will be not liable as a member of the LLC strictly because of the interest transfer until the assignee actually becomes a member.
Keep in mind, most LLC statutes allow for LLC operating agreements to create their own rules governing transfer of membership interests. Many require unanimous consent of all members in order to transfer an interest or resign from the LLC. Courts have enforced restrictions on assignment of financial rights. However, members must exercise any veto power they have under the operating agreement consistently with their fiduciary duties to the other members.
In addition to voting and management rights, LLC statutes generally deny assignees rights to information and to compel dissolution of the firm. However, assignees may be able to bargain for a separate agreement with the assignor in which the assignor member agrees to exercise his or her member rights on behalf of the assignee. Even if the assignor does not explicitly agree to protect the assignee, the duty is arguably implicit in an assignment of economic rights, since the rights are worthless without such protection. However, there are numerous situations where an assignee has no assignor to look to for protection—situations when the assignor is a dissociated member, a deceased member’s estate or heir, or a foreclosing creditor of a member. Assignee rights should be clearly provided for and spelled out in the operating agreement to avoid any unnecessary confusion or disputes.
Right of First Refusal
Most operating agreements have some sort of right of first refusal provision. The right of first refusal provision provides that in the case any member receives an offer from a third-party to purchase any portion of his or her membership interest, he or she must first offer the interest to the remaining members on identical terms and conditions as received from the third-party. Generally, the remaining members will have a set period of time to determine whether or not to exercise their right of first refusal. If the time lapses or no members exercise their right, then the third-party purchase is permitted.
In addition, many operating agreements include a “put” provision. This “put” guarantees that a severance of ownership will occur if there are irreconcilable disputes within the LLC. This is essentially a fallback provision when a member hasn’t received any offer from a third-party but wishes to either sell his or her interest to remaining members or purchase all the remaining members’ interests. This provision can be helpful in situations where no agreement can be reached to settle a severance of ownership amicably.
Admitting a New Member (after formation)
The default rule in Washington allows a new member to be admitted only by consent of all current members. However, operating agreements may (and almost always do) require other formalities for admission of new members. Unless provided for in the LLC statute, most cases have held that there is no requirement that members be listed in the operating agreement or articles, and membership can be shown by other evidence. In fact, in some jurisdictions a person may be admitted as a member of an LLC without owning any economic interest. LLC operating agreements often require admission of a substitute or additional member to be in writing.