LLC Members

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Let me say up front, I don’t claim to know the answer to the question posed in this post’s title, or pretend there’s a simple yes-or-no answer. It very well may be that the answer depends on the unique facts and circumstances in any given case, including the one discussed below.

Having said that, take a look at a Schedule K-1 in the tax return of a limited liability company. I’ll make it easy; click here for the 2017 K-1 form available on the IRS’s website. Now tell me, in the Part II “Information About the Partner” section of the form, do you see a check box for a taxpayer who is a non-member/assignee/holder of an economic interest in an LLC?

That’s right, you don’t. As pertains to LLCs, the only choices are “LLC member-manager” or “other LLC member.”

I’m not a tax expert, but I’m fairly confident it makes no difference whether one or the other of those boxes is checked for a non-member assignee of an LLC interest, at least for tax purposes. But it can make a night-and-day difference for state law purposes to a litigant seeking to enforce rights as the assignee of a membership interest — be it to secure judicial dissolution, to enforce management, voting or inspection rights, or to prosecute derivative claims — and who relies solely on a K-1 as proof of his, her, or its member status.

It makes a difference because, under New York statutory and case law, absent provision in an operating agreement to the contrary, an assignee, non-member holder of an economic interest in an LLC has no standing to assert any of those rights or to obtain any of those remedies.

I’ve encountered the issue a number of times in my business divorce travels, almost always involving LLCs with no written operating agreement and that don’t observe governance formalities. It’s also an issue that surfaced in a recent decision in which the court held that the plaintiff, whose complaint asserts both direct and derivative claims for breach of fiduciary duty, and who was not an original member of the subject LLC and acquired his interest by undocumented assignment, established his member status based on his K-1, apparently in the absence of any written agreement with the other members or other evidence of any formal consent to his admission as a member. Rosin v Schnitzler, 2018 NY Slip Op 32320(U) [Sup Ct Kings County Sept. 4, 2018]. Continue Reading Is a Schedule K-1 By Itself Enough to Prove LLC Membership?

The rules surrounding the death of a partner or a shareholder are familiar to most practitioners. For general partnerships governed by New York’s Uniform Partnership Act, except as otherwise provided by agreement, a partner’s death automatically triggers dissolution and liquidation, unless the surviving partners continue the business in which event they are required to pay the estate the fair market value of the deceased partner’s interest. (The rules are different in states that have enacted the Revised Uniform Partnership Act.)

For close corporations, except as otherwise provided by agreement, the deceased stockholder’s shares may freely be transferred to his or her heirs as provided by will or intestacy laws, in which event the transferee (and, in the interim, the estate representative) possesses the full panoply of voting and other statutorily enshrined rights including the right to bring a shareholder’s derivative action and the right to petition for judicial dissolution.

What about limited liability companies? Are the rules that apply following the death of an LLC member more like those for partnerships or corporations?

The answer is, neither. LLCs have their own, distinct, statutory default rules applicable when a member dies. In addition, as illustrated by a recent decision discussed below, the disposition and rights associated with the membership interest of a deceased member are uniquely amenable to the preferences of the LLC members as expressed in the operating agreement.

Continue Reading Death of an LLC Member

Inadequate and erroneous documentation of ownership is an all too common feature of closely held businesses and, after disputes arise, a wellspring for litigation over an aggrieved business partner’s standing to assert financial claims or to seek judicial dissolution.

The reasons for this state of affairs are many and diverse, e.g.:  The owners lack a sophisticated understanding of the legal formalities attendant to ownership of the chosen form of business entity.  The owners are unable or unwilling to spend the money for proper legal and accounting services.  The owners are family members or long-time friends who trust one another and believe they don’t need any written agreement or certification of ownership interests.

When litigation erupts and the complaining party’s ownership interest is challenged, in the usual case the issue is whether the complaining party ever became a shareholder or, if the case involves a limited liability company, ever held a membership interest.  This type of dispute has been the subject of more posts on this blog than almost any other single subject.  (Click on the topic “Standing” on the right sidebar and you’ll see what I mean.)

A decision last month by Nassau County Commercial Division Justice Stephen A. Bucaria in Gitlin v. Chirinkin, Short Form Order, Index No. 012131/07 (Sup Ct Nassau County June 29, 2011), presents a twist on the usual fact pattern.  In Gitlin, no one contested that the plaintiff became a 50% member of the subject LLC at its inception.  Rather, the issue was whether the plaintiff’s membership interest subsequently terminated, as the other 50% member contended, such that the plaintiff had no entitlement to share in the profits of transactions that took place after his alleged termination.

Continue Reading Member of Real Estate LLC Never Withdrew, Held Entitled to Share of Sale Proceeds

Will there be a new wave of lawsuits by disappointed investors in business enterprises organized as limited liability companies, alleging that the investors were solicited to become members by slick, fast-talking promoters who concealed their own self-dealing in violation of a fiduciary duty of disclosure that existed even before the LLC was formed?  A recent New York appellate ruling has opened the door to just such suits.  

By the beginning of the 18th century, when Daniel Defoe wrote about the "Villainy of Stock-Jobbers", the public held a contemptuous view of those who traded in the proto stock markets of the time.  In the late 19th century, the term "promoter", referring to those who organized companies and sold shares, likewise took on derogatory shades amidst an industrial boom that experienced no shortage of flim-flam artists exploiting an unprecedented wave of public investment in railroads, utilities, heavy industry and real estate development companies. 

Common-law courts in the U.S. reacted by imposing fiduciary duties on corporate promoters, thereby providing some means of civil recourse for duped investors, and some incentive for greater disclosure by corporation organizers.  For example, in Dickerman v. Northern Trust Co., 176 U.S. 181 (1900), the U.S. Supreme Court wrote that a corporate promoter, which it defined as one who "brings together the persons who become interested in the enterprise, aids in procuring subscriptions and sets in motion the machinery which leads to the formation of the corporation itself," must be "treated as standing in a confidential relation to the proposed company, and is bound to the exercise of the utmost good faith."  The promoter, the Court went on, "is the agent of the corporation and subject to the disabilities of an ordinary agent.  His acts are scrutinized carefully, and he is precluded from taking a secret advantage of the other stockholders. . . . [and] must faithfully disclose all facts relating to the property which would influence those who form the company in deciding upon the judiciousness of the purchase."

Continue Reading Are LLC Organizers Fiduciaries?