united-states shareholders
inheriting a share in a limited company: at what point do the rights from the share pass if membership consent has not yet been obtained?
<p>I would like to know which laws regulate inheritance of shares in LLC and whether there are any difficulties with the moment of transfer of rights from the share, if the heir has inherited a share, but the participants have not given their consent to his joining the LLC.
It turns out that the heir has received a share in the LLC without rights. What should he do?</p>

<p>When someone who owns a limited liability company membership interest dies, in the usual case, those membership interests immediate vest in the probate estate of the decedent as an &quot;economic interest&quot; in the limited liability company members that has rights to distribution and liquidation.</p>
<p>This economic interest is usually (but not always) transferrable in a transaction that is not a public offering of a security (a classification of the transfer that often requires LLC confirmation by the LLC's lawyers at the transferor's expense before it can be done). This restriction, or more stringent restrictions (including a total prohibition on transfers or a right of first refusal requirement before a transfer to a third-party) would be set forth in the operating agreement of the limited liability company in most cases.</p>
<p>But an economic interest owner does not have any of the voting rights of a member, and does not have the rights to access information of a member apart from what is necessary for the economic interest owner to comply with that economic interest owner's tax obligations.</p>
<p>These are essentially the same rights that limited partners in a limited partnership that has both general partners and limited partners would have in this non-limited liability company entity.</p>
<p>For a successor economic interest owner to the deceased member to regain the membership rights of the deceased member, there must ordinarily be a unanimous vote of the remaining members to do so.</p>
<p>This said, these rules related to limited liability company membership are typically only default rules of law that can be, and frequently are, modified by agreement in a limited liability company operating agreement.</p>
<p>One common modification made in some limited liability company operating agreement is to identify a class of &quot;permitted transfers&quot; in which the transferee of a membership interest who fits the permitted transfer definition is automatically admitted as a member of the company.</p>
<p>Another common modification made in some limited liability company operating agreements, or in a parallel &quot;buy-sell agreement&quot; is to provide that upon the death of a member that either the company (in what is called a redemption) or the other members (in which is called a cross-purchase) have either the right, or the obligation, or both, to purchase the deceased member's shares at a price and with payment terms and closing times set forth in the agreement.</p>
<p>This limitation has historical roots in the time period when U.S. tax law was struggling to develop a test based upon how similar an entity was to a partnership v. how similar an entity was to a corporation, to determine how the entity would be classified for tax purposes. If a limited liability company had this limitation on transfers of rights in the company, which is also found in unlimited liability general partnerships, this was an important factor in causing the limited liability company to be taxed as a partnership rather than as a corporation. In contrast, if a limited liability company had shares that could be freely transferred and retain all voting rights the way that shares in a corporation can be transferred, this would be an important factor tending to cause the company to be classified as a corporation for tax purposes.</p>
<p>This analysis ultimately became obsolete for tax purposes when the IRS adopted the &quot;check the box&quot; rule that allowed limited liability companies to simply decide for themselves whether they were taxed as a partnership or as a corporation in most cases. But, generally speaking, this aspect of limited liability company organizational law was retained anyway.</p>
<p>Stripped of the initial tax justification, the justification for this rule in the limited liability company context is very similar to the justification for this rule in the general partnership context.</p>
<p>Basically, in a closely held entity with only a handful of key members who are expected to be actively participating in the management of the business (frequently five or fewer), the fact that your fellow members were willing to have a management team for the company that included Sue, does not imply that the fellow members are willing to have a management team that that includes Sue's widower Sam, or Sue's executor, Sue's bankruptcy trustee, or a creditor of Sue who gains the membership interest in collection of a debt that sue owed unrelated to the limited liability company.</p>
<p>The limited liability company form of organization have grown very popular because it has facilitated pass through taxation of closely held entities with full limited liability in entities with equity financing structures that are more complicated than S-corporations, such as a lot of real estate development companies, many hard money lending operations, a lot of oil and gas investment companies, private equity funds, and hedge funds.</p>
<p>While a very large share of limited liability companies fit the description of the kind of company in which the default rules about the non-transferability of voting rights makes sense, there are other companies that don't fit that model, and most of the time, those companies either have a different rule through their operating agreement, or require votes of all members to admit economic interest owners to membership but routinely vote in favor of doing so as a matter of course.</p>
<p>As a practical matter, the first step of someone inheriting an interest in a limited liability company would be to ask for a copy of the operating agreement of the company and any applicable buy-sell agreement, and to inquire politely of someone who is a manager of the company regarding what the prospects of being admitted as a voting member of the company would be, or if anyone in the company would express an interest in buying out your economic interest for cash and/or a promissory note even in the absence of a formal obligation to do so and if so on what terms.</p>
<p>Even if an heir is not admitted as a member and does not receive a buyout of the interest, receiving the distributions associated with the economic interest in the company has significant value in most cases and is comparable to being a shareholder in a publicly held company who has no meaningful say in the company's management, being a limited partner in a limited partnership, or being a &quot;silent partner&quot; in a partnership.</p>
<p>The primary downside to an economic interest ownership is that the owner is subject to pass through taxation of their share of the company's profits each year, whether or not the company actually makes any distributions to its members and economic interest owners. The taxes due on this &quot;phantom income&quot; can turn the economic interest ownership into a burden rather than a benefit in the short term, unless the operating agreement mandates that the company make &quot;tax distributions&quot; calculated to at least give members enough cash to pay the tax obligations associated with their ownership interests.</p>
<p>Some operating agreements require tax distributions, others do not. The default rule is that tax distributions are not required but that a majority faction of members may not act in a manner calculated to &quot;oppress&quot; minority factions of members and economic interest owners. But proving an oppression case is very costly and has a very uncertain outcome tilted against the person bringing it, so this is usually not a desirable approach.</p>
