Thursday, December 15, 2011

LLC Membership Interests: The Supreme Court of Virginia's Decision in Ott v. Monroe

November 2011 was notable for a couple of reasons:
  1. First, the Virginia Cavaliers football team reeled off a string of impressive victories. Coach Mike London has the team on the right track (let's ignore that little episode with the Hokies on Thanksgiving Saturday).  GO HOOS!!
  2. Second, the Supreme Court of Virginia issued a rare -- and important -- opinion interpreting the Virginia Limited Liability Company Act.
The case is Ott v. Monroe (November 4, 2011), and, when you take a break from preparing for UVa's upcoming Peach Bowl battle against Auburn, you can read Justice Mims's opinion here.


As a general matter, the Limited Liability Company Act (the provisions of which you can peruse here) establishes a default framework for the rights and obligations of limited liability company members.

Usually (but not always!), the members of an LLC can "override" certain of the statutory provisions by agreeing otherwise in the LLC's Operating Agreement. Indeed, one of the attractive characteristics of an LLC is the flexibility that it gives the members to design a framework that suits their particular needs.


Ott v. Monroe addresses questions related to the death of an LLC member.

Admiral Dewey Monroe owned an 80% membership interest in L&J Holdings, LLC. Dewey died in 2004, and his will left his entire estate (including the membership interest) to his daughter Janet.

The remaining 20% membership interest in the LLC was owned by Admiral Monroe's wife Lou Ann, and the Operating Agreement between Dewey and Lou Ann appointed Lou Ann as the Managing Member of the LLC.

When Janet inherited the 80% interest from her father, she promptly notified Lou Ann that she was removing Lou Ann as the Managing Member (adding insult to injury, the proposed replacement Managing Member was none other than Janet - ouch!).


Janet filed a declaratory judgment in the Circuit Court of Stafford County, asking the Court to affirm her authority to remove Lou Ann as the LLC's Managing Member. The Circuit Court held in favor of Lou Ann, and Janet appealed to the Supreme Court of Virginia.


In its opinion, the Supreme Court addresses the question: What happens to an LLC membership interest upon the death of a member?  In arriving at an answer, the Court analyzed the relationship between the general ("default") rule in the Limited Liability Company Act and the specific rule set forth in the L&J Holdings Operating Agreement.

The Act establishes a general rule for transfers of membership interest (whether at death or during life), as follows:
An assignment does not entitle the assignee to participate in the management and affairs of the limited liability company or to become or to exercise any rights of a member. Such an assignment entitles the assignee to receive, to the extent assigned, only any share of profits and losses and distributions to which the assignor would be entitled.
This language means that the assignee of a membership interest only receives the assignor's economic rights in the LLC unless and until the other members choose to accept the assignee as a member of the LLC, in which event the assignee also receives the management rights previously held by the assignor.

In Ott v. Monroe, however, Dewey and Lou Ann had signed an Operating Agreement that seemed to override the statute by incorporating the following language:
Except as provided herein, no Member shall transfer his membership or ownership, or any portion or interest thereof, to any non-Member person, without the written consent of all other Members, except by death, intestacy, devise, or otherwise by operation of law.
Janet argued that this language (in particular, the phrase "except by death") means that Dewey's will transferred all of his LLC rights (the economic rights and the management rights) to Janet.


The Supreme Court of Virginia disagreed with Janet's position. Justice Mims writes that the management (or "control") interest of an LLC member "is personal to the partner and cannot be bestowed on another by the unilateral act of a partner even if the words of a partner do not expressly limit its scope."

The most significant part of the opinion comes next. 

Justice Mims initially states that the L&J Holdings Operating Agreement did not contain language superseding the statutory rule seeming to imply that the inclusion of such language would have enabled Dewey to transfer his entire LLC interest (including the management rights) to Janet if he had used more specific language in the Operating Agreement.

Then, however, he states that alternative language in the Operating Agreement would not have mattered, because the statute prohibits any unilateral transfer of an LLC management interest:
Even if [the L&J Operating Agreement] had superseded dissociation under Code § 13.1-1040.1, it is not possible for a member unilaterally to alienate his personal control interest in a limited liability company                  …
Code § 13.1-1023(A) provides that an operating agreement may not contain provisions inconsistent with the laws of the Commonwealth. Thus it was not within Dewey’s power under the Agreement unilaterally to convey to Janet his control interest and make her a member of the Company upon his death because the Agreement could not confer that power on him.
This language appears to preclude any direct transfer of LLC management rights, without the approval of other LLC members.

The reason that Ott v. Monroe is so significant is that the L&J Holdings boilerplate provision regarding transferability is very common in LLC operating agreements in Virginia. For that reason, the take-away practice point is clear: clients should be made aware of their limited ability to transfer LLC management rights (during life or upon death) absent the consent of other members.

And when you are finished reviewing your LLC Operating Agreement, give a shout-out to the ACC Coach of the Year: UVa's Mike London!