An involuntary transfer of an LLC membership interest is a transfer prompted by a creditor action or the occurrence of a triggering event outside of the member’s control. An individual or legal entity obtaining a membership interest as a result of an involuntary transfer usually cannot fully step into the shoes of the transferring member. This protection provided by law, sometimes acts as a safeguard providing the LLC members with a certain amount of personal asset protection. For example, the creditor of a corporate shareholder could reach and exercise shareholder rights to their full extent, particularly if the shareholders do not have a shareholders’ agreement that speaks to what happens if a creditor attempts to do so.
The creditor of an LLC member under Florida law, where the LLC consists of two or more members, can reach and exercise only the economic rights associated with membership interests, not the voting or management rights. If an LLC does not specify any transfer provisions, creditor actions are subject to Florida law. Each state, in its LLC statutes, has provisions limiting what actions a creditor can take against an LLC member for personal debt.
Depending on the state, the 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 or a portion of the distributions due to the member (the debtor) from the LLC to the creditor.
- A foreclosure on the debtor-member’s LLC ownership interest.
- A court order to dissolve the LLC. This remedy may 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, dissolving the LLC may also address the creditor’s right to satisfaction of the debt.
- Other “triggering events” resulting in an involuntary transfer might be specified in the LLC’s operating agreement or in a separate buy-sell agreement.
Examples of triggering events that can be specified in an LLC’s operating agreement include:
- 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 a property division agreement or under a divorce or separation court decree.
- A member’s membership interest becomes subject to a valid court order, lien, 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 provisions 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, that may prompt a mandatory buy-back 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 often receives only an economic interest in the LLC with no management or voting rights.
Stross Law Firm offers proactive business planning strategies. We help businesses draft 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 an operating agreement or an operating agreement that does not include what is needed to transfer a member’s interest.