What happens when an LLC member of a multi-member LLC dies….? This must happen frequently now because the New York LLC is an entity created by law 27 years ago, so nature must take its course. You may think that your heirs are automatically entitled to the wealth that you build up over a lifetime in the LLC. But, unfortunately, this is not always the case. If your LLC does not have an operating agreement protecting your heirs, they may inherit a practically worthless asset. Under the default rules of the New York Limited Liability Company Law, they are classified as mere assignees with no rights to management, voting or information about the LLC. They are at the mercy of the remaining members.
The Operating Agreement
Limited Liability Companies were envisioned by the legislature as entities shaped by their owners via the operating agreement. The agreement defines the rights owners (members) of an LLC have vis-a-vis the entity and each other. If there is no operating agreement, the default rules of the New York Limited Liability Company apply, and the rules are not good for a deceased owner’s heirs.
In a perfect world, every multi-member LLC would have an operating agreement that clearly sets out what happens upon the death of one of the members. One common choice is the “buy-sell” provision, which states that the deceased member’s estate shall automatically offer the member’s interest for repurchase by the LLC or the other members at fair value at the time of death. But we do not live in a perfect world, and many multi-member LLCs do not have a provision dealing with the death of its members, or even an operating agreement at all. So what then?
If there is no Operating Agreement dealing with when an LLC member dies
If there is no operating agreement dealing with the death of members, the default rules of the New York Limited Liability Compan Law apply.
If an LLC member dies, the LLC goes on, it does not dissolve magically, Section 701(b) NY LLC Law. The deceased member has effectively assigned his or her membership interest to his or her estate.
An assignment of a membership interest does not make the assignee a member, 602 NY LLC Law and 603 NY LLC Law. The only effect of the assignment is to entitle the assignee to receive the distributions and allocations of profits and losses to which the assignor would be entitled. In other words, an heir as the assignee gets all the financial benefits the member would have received but for his or her death. But the heir is not a member. To become a full-fledged member, the heir needs the consent of the remaining members. But they don’t have to give it, so the estate may forever remain a mere assignee of the economic rights.
What Rights does the Assignee have when an LLC member dies?
So the estate of the deceased member is a mere assignee with only economic rights. The assignee has a right to receive all financial benefits that the deceased member would have received but for his or her death. But all the useful rights of members under the NY LLC Law depend on being a member. The assignee cannot ask for access to books and records, cannot sue for breach of fiduciary duty on behalf of the LLC, cannot vote, cannot object, cannot prevent the other members from changing the operating agreement… and the list goes on.
Obviously, this puts the heir at the mercy of the remaining members. They have full control over whether to make any financial distributions and thus whether the heir will get any financial benefit from the LLC. Without any right to company information, the heir cannot even determine if the distributions he or she may receive are proper. The assigned interest may be utterly worthless until the dissolution of the LLC, which may never happen. The remaining members could devise a scheme depriving the estate of any financial benefit by amending the operating agreement and never distributing anything to the heir. The heir of the deceased member is not a member and cannot complain.
There are very few cases in New York discussing this unfortunate outcome. The LLC is still a relatively new entity, so there have not been many chances for it to arise. However, since it can sometimes result in grotesquely unfair consequences, I imagine judges will come up with some sort of new solution in the future.
How can you stop this from happening and protect your heirs?
You have to enter into an operating agreement that clearly spells out what will happen upon your death. It’s a simple as that. It may be unpleasant to think about death, but it’s sometimes necessary. Don’t assume that the other members will do “do the right thing” and take care of your spouse or children. Get everything spelled out in writing with the help of an attorney.