LLC considered community property

Is Your Share of an LLC Considered Community Property in a Divorce?

While thousands of LLCs, or limited liability companies, are formed every year in Arizona, that’s just the business entity. What about the people who are members of the LLC? If a member gets divorced, is the LLC considered community property?

Defining Community Property

Arizona is a community property state. That means community property law controls the division of all assets of the marital estate. All community property acquired during the marriage is generally divided equally when divorce occurs. The only exception is when the presumption of community property is overturned or if the property is separate property.

If you formed an LLC while you were married, should you get divorced, your spouse may have rights to half of the economic benefits you receive from the business. However, your spouse will probably have no rights to the management or control of the business.

The same holds true if you die as a member of the LLC.

In the instance that you die as an LLC member, your heir, representative, or other successor may be assigned the membership. Still, though, they will not have control or a say in the business.

If the business is truly your business and your spouse does not want any part of it, it is wise to document that with a proper disclaimer.

If you have partners in the business who are married, even if you are not, you should have a proper operating agreement, which addresses the rights of all spouses who are not active members of the LLC to make sure you do not end up with someone else’s spouse as your partner. That could be a disaster.

Pre-planning to Protect Your LLC

These kinds of situations are why you need to be prepared in advance. Contingency plans help protect your business. More often than not, in the event of a divorce or death, members may prepare an operating agreement with buy / sell sections to purchase the membership interest from the surviving spouse or divorced partner.

As you form your LLC, it is important to consult with a professional business attorney. They can help you plan for any contingencies in advance so you can protect your LLC and determine if your LLC is considered community property. Attorneys provide counseling on these issues and present alternatives for your unique situation; online forms just do not.

Poulos Law Firm has extensive experience with forming LLCs and can support you and protect your investment from community property laws. Contact us to learn more.

LLC protect you

Will Your LLC Protect You?

There’s a reason it’s called a “limited” liability company and not a “no liability” company. But just calling yourself an LLC and filing your articles of organization isn’t enough. If something goes wrong, that LLC alone won’t be enough to protect your personal assets. In fact, you may have completely overlooked creating an operating agreement, especially if you filed your own paperwork or hired a low-cost agency via the internet.

Sure, there are advantages in LLC ownership, namely that there is flexibility in management, and profits and losses can pass directly through to the owner’s personal income tax return while personal assets are shielded from liability. But if you don’t operate the LLC as a real and separate business, you may be asking for trouble.

Is Your LLC in Compliance with Court Regulations?

You’ve likely heard the term “piercing the corporate veil.” When a disgruntled employee, customer, or anyone else who wants a piece of your pie chooses to sue you, that corporate veil is what protects your personal assets. However, if the court finds that you disregarded the corporate form, you’ll be left wide open.

Here are some things a court may consider:

  • Did you disregard LLC formalities?
  • Did you provide enough capital to run the business or remove capital, leaving the LLC bone dry?
  • Did you use the LLC bank account as your personal piggy bank?
  • Do you and your LLC share phone numbers, address, etc.?
  • Were your decisions to benefit you or the LLC?
  • Did you personally pay or guarantee the debts of the LLC?

Protect Your Company’s Limited Liability

There are a few things you can do to protect your company and yourself. You first need to keep your LLC papers and actions organized as if someone were looking over your shoulder. And make sure that you separate your personal stuff and your LLC:

  • Keep separate bank accounts.
  • Pay your business expenses from your LLC’s account.
  • Do not put personal funds in the LLC account.
  • Do not use LLC funds for personal expenses.
  • Set a percentage ownership for each owner and distribute profits accordingly, or draw an annual salary for each owner of the LLC.

By keeping everything very black and white, you’ll protect yourself and your LLC. Treat your company like the precious creation it is; it may surpass your own expectations in the long run, and such rewards are priceless.

Questions about Your LLC?

Poulos Law Firm has extensive experience forming and protecting LLCs. Whether you are considering launching a business or have an existing LLC, we can ensure that your business and personal assets are protected. Contact us to learn more.

Transferring LLC Membership Interests Part 3—Involuntary Transfers

An involuntary transfer of an LLC membership interest is just that—a transfer prompted by a creditor action or the occurrence of a triggering event outside of the member’s control. An individual or entity obtaining a membership interest as a result of an involuntary transfer usually cannot fully step into the shoes of the transferring member.

This statutory protection—often called a pick your partner provision—acts as a safeguard that provides LLC members with a certain amount of personal asset protection. For example, whereas the creditor of a corporate shareholder could reach and exercise shareholder rights to their full extent, the creditor of an LLC member can reach and exercise only the economic rights associated with membership interests—not the voting or management rights. The recipient of this type of membership interest is called an assignee.

Statutory Provisions – Creditor Action

If an LLC does not specify any transfer provisions, creditor actions are subject to state LLC laws. Each state, in its LLC statute, has provisions limiting what actions a creditor can take against an LLC member for personal debt. Depending on the state, the statutory remedies available to an LLC member’s personal creditors may include:

  • A charging order, which is a court order requiring the LLC to pay all the distributions due to the member-debtor from the LLC to the creditor.
  • A foreclosure on the member-debtor’s LLC ownership interest.
  • A court order to dissolve the LLC.

These remedies protect the other LLC members from the risk of having the creditor of a debtor-member step into the debtor-member’s place and share in the control of the LLC. To a varying degree, they also address the creditor’s right to satisfaction of the debt.

Transfer Provisions – Other Triggering Events

Transfer provisions are typically specified in the LLC’s operating agreement or in a separate buy-sell agreement. There may be some overlap with creditor actions, as these are often included as triggering events in the transfer provisions.

Examples of triggering events that can be specified in an LLC’s transfer provisions include the following:

  • A deceased member’s membership interest passes to a prohibited individual or entity
  • A member’s bankruptcy or other involuntary transfer of a membership interest to the member’s creditors
  • A member’s separation or divorce, or the transfer to a member’s spouse under property division or under a divorce or separation decree
  • A member’s membership interest becomes subject to a valid court order, levy, or other transfer that the LLC is required by law to recognize
  • A member’s breach of the LLC’s confidentiality
  • A member’s failure to comply with any mandatory provision of the operating agreement
  • A member’s failure to maintain a license or other qualification that disqualifies the member from engaging in the LLC’s primary business

If a triggering event occurs, the transfer provisions may prompt a mandatory redemption of the member’s membership interest or a right of first refusal to the LLC or to the other members. If an involuntary transfer does occur, the recipient of the membership interest—the assignee—typically receives only an economic interest in the LLC with no management or voting rights.

Transferring LLC Membership Interests Part 2—Voluntary Transfers

An LLC affords its members a certain amount of personal asset protection. Part of this protection hinges on the restricted transferability of LLC membership interests.  Restricted transferability protects the non-transferring members from creditors and unwelcome new members, which upholds the integrity and value of the non-transferring members’ membership interests.

  • Most (but not all) LLCs impose requirements or restrictions on the transfer of a member’s interest.
  • If the LLC’s operating agreement is silent on the transferability of interests, you must look to state law to be sure there are no default provisions restricting transferability.

This article, part 2 in a 3-part series, focuses on voluntary membership interest transfers done with the intent to grant full membership rights to the recipient.

Step 1 – Determine the Transfer Process

The LLC’s operating agreement should specify the process for transferring a membership interest. If the LLC has a buy-sell agreement in place, that must also be consulted.

  • Find the provisions that detail allowable transfers, the steps to complete them, and the method for calculating the value of the membership interest, if any.
  • The membership interests may be freely transferable but are likely subject to restrictions set forth in the operating agreement, the buy-sell agreement, or by state law.
  • Some transfers may be permitted without prior approval of the other members, such as transfers to a member’s immediate family or to a trust for the benefit of a member or a member’s immediate family.
  • The LLC or the other members may have a right of first refusal before a transfer can be made.

If the operating agreement or buy-sell agreement doesn’t specify the process for transferring a membership interest, you will have to look to state law. Once you determine the authority governing the transfer process—the operating agreement and buy-sell agreement or state law—be sure to note all requirements and restrictions.

Step 2 – Determine the Value

Calculate the value of your membership interest. If the operating agreement or a separate buy-sell agreement doesn’t address this, you will have to work with the other LLC members to determine and agree upon the value of the membership interest.

Step 3 – Follow Transfer Process

Complete the LLC transfer process as determined in Step 1. Make sure you follow all requirements. For example, if the operating agreement requires the unanimous written consent of all LLC members (a common requirement), meet with all of the LLC members to obtain their written consent.

Step 4 – Obtain or Draft the Transfer Document

 If the LLC does not have a standard transfer document, you will need to draft a transfer document.

  • Check the operating agreement or state law to determine what the transfer document must include.
  • Typically, it must include the transferor’s name, the LLC’s name, the recipient’s name, and the percentage of the membership interest being transferred.
  • If a form is not provided by the LLC, note that the form of the transfer document is usually subject to the LLC’s approval; make sure to obtain this approval if necessary.

 Step 5 – Execute the Transfer Document; Other Documents

 Sign and date the transfer document. Make a copy for your records, for the recipient, and for the LLC.

  • The recipient typically receives the original transfer document.
  • The LLC may have additional documents that the recipient must sign in order to be admitted as a member.
  • State law may require the operating agreement and certificate of formation to be updated with the new member information.
  • The LLC may pass the costs associated with the transfer to the new member.

Conclusion

Making a proper transfer of membership interests requires the transferor to jump through a lot of hoops. The first step in the process is determining which hoops are required. Taking the time to properly transfer membership interests ensures that the recipient obtains full membership rights and protection.

 

We offer proactive business planning strategies. We help businesses draft thorough operating agreements that provide clear directions to the LLC members—to exercise membership interest transfers and other important member rights. We also assist existing LLC members who want to properly transfer their membership interests in the absence of a thorough operating agreement.  Contact us today to learn more about our business services.

Transferring LLC Membership Interests Part 1—An Overview

Say you are a member of an LLC. You own membership interests in the LLC. But what if you want to leave the LLC? What if you get a divorce? What if you have creditors seeking immediate repayment? What can you do with your membership interests? The answer depends on how transferable those membership interests are.

A transfer of LLC membership interests can mean selling, donating, assigning, or gifting—basically one LLC member turning over his or her membership interests to another individual or entity. The transfer can be voluntary or involuntary.

● Examples of voluntary transfers include selling membership interests to a third party or to the remaining members, donating membership interests to a charity, or leaving membership interests to a trust upon death.

● Examples of involuntary transfers include those prompted by divorce, bankruptcy, and termination of employment.

The transferability of LLC membership interests is subject to competing interests. On the one hand, freely transferable membership interests can be more attractive to members because they are easier to dispose of or cash out of—in other words, the membership interests are more liquid and marketable.

On the other hand, LLC members usually want to maintain the right to “pick their partners.” If membership interests are freely transferable, the remaining members have no control over who comes in as a business partner when a member decides to transfer membership interests. Restricted transferability places limits on transfers and the status of the recipient.

Are Membership Interests Freely Transferable or Restricted?

The members decide. The good news about forming an LLC is how flexible the structure is. At the outset, the founding members can adopt transferability provisions— either in the operating agreement or in a separate buy-sell agreement.

● If neither document addresses transferability, the default provisions of state law prevail.
In other words, if the founding members fail to address transferability in the operating agreement or in a buy-sell agreement, they’ve relinquished control and subjected the members and the LLC to the state law default provisions.

● Although planning for a member’s departure from the LLC when you’re just forming it may be difficult, thinking through all the possible exit scenarios—and planning for them—is essential.

If your LLC is already up and running and you don’t have transferability provisions in place, the members can amend the operating agreement or adopt a buy-sell agreement. Look to the operating agreement for directions on how to amend the LLC’s terms.

How are Membership Interest Transfers Restricted?

While membership interests are freely transferable in the sense that any member generally can transfer his or her economic rights in the LLC (subject to the operating agreement, a stand-alone buy-sell agreement, and state law), the management or voting rights in the LLC are usually what are restricted—otherwise, other members would be forced to become “partners” with someone not of their choosing. Typically, a recipient of restricted membership interests can receive economic and management rights—a full membership interest—only with unanimous member consent.

operating agreement

Operating Agreement vs. Revocable Trust—Which One Wins?

As a member of an LLC, you have an operating agreement. But as an individual business owner, you may also have a revocable trust. When they don’t agree with or support each other, which one takes precedence in the eyes of the law?

Operating Agreement: One Side of the Equation

Let’s assume that you and a partner have formed an LLC. The two of you draw up an operating agreement to outline the business’s basic structure.

Each of you has 50% membership interest in the LLC. Through your operating agreement, you indicate that your membership interest includes:

  • the right to distributions, allocations, and information
  • the right to vote on matters that come before the members

You also specify that, in the event of a member’s death, all member interest will transfer to the surviving member. Alternatively, that member may bequeath his interest to an immediate family member—and only to that family member.

The Other Side of the Equation: Revocable Trust

Years after the formation of the LLC, your partner has completely forgotten about the operating agreement. Without giving it a second thought, he amends his revocable trust to provide a specific gift of half of the LLC’s distributions to a friend.

Then the partner dies.

His friend, armed with the information he received from the trust, shows up at the business asking for his share of the distributions.

Which has precedence: the operating agreement or the revocable trust?

The Legal Precedence

In a 2011 court case, a situation similar to this occurred. The case went to probate court. That court sided with the friend and determined that the LLC was an estate asset. Therefore, the friend was entitled to half of the distributions.

The deceased LLC member’s children appealed the decision, which was reversed in a district court of appeals.

This court stated that this particular trust provision was nullified to the extent that it was contradicted by the LLC’s operating agreement and contractual provisions.

Protect Your Assets and Business

If you are a member of an LLC, you want to protect your assets. And if you are in an LLC with another member, you want to be sure everyone is on the same page. While your operating agreement needs to be equitable, your revocable trusts should support your goals for the business.

Poulos Law Firm has more than 30 years of estate-planning experience. We ask the right questions to ensure you avoid these challenges. We can work with you, your family, and your business partners to create estate plans to meet your goals, now and into the future. Contact us to schedule your appointment and learn more.