Members vs. Transferees
In last week’s post, I identified some of the key distinctions when one holds an interest in an LLC, but is not a member (see here). Members and transferees hold different rights. This post seeks to further explore the similarities and differences between members and transferees.
Rights of Members and Transferees
Members and transferees share the right to the LLC’s distributions. In addition, both members and transferees have their interests characterized in a like manner: both interests are personal property. RCW 25.15.246(1). It is worth noting that this characterization is significant for purposes of permitting oral LLC agreements, which are expressly permitted under RCW 25.15.006(7). If the LLC Act characterized interests held by members and transferees as real property, such oral LLC agreement may be void under the statute of frauds, which require contracts involving interests in real property to be in writing.
That is largely where the similarities end. As discussed last week, the LLC Act permits the transfer of transferable interests held by transferees, but not the transfer of membership interests. Members, unless otherwise stated in the LLC agreement, also have a right to participate in the management of the LLC and vote in LLC affairs, while transferees do not have such a right. Additionally, members have standing to bring a derivative action, while transferees do not. Furthermore, the LLC Act only permits members the right to examine LLC records.
Finally, and perhaps most significantly, members (in a member-managed LLC) do not owe fiduciary duties to transferees, nor do transferees owe fiduciary duties to members or the LLC. As this blog has discussed at length, which the LLC Act makes clear, members (in a member-managed LLC) owe fiduciary duties to the LLC and other members. RCW 25.15.038(1)(a) relevantly provides that “[t]he only fiduciary duties that a member in a member-managed limited liability company or a manager has to the limited liability company and its members are the duties of loyalty and care…” RCW 25.15.038 (emphasis added). Significantly, transferees are omitted from this clause.
Implications in Disputes
The distinction between members and transferees plays a significant part in determining the rights of feuding parties. When relationships are not deduced to writing through an LLC agreement, the first step in determining the rights of one with an interest in an LLC is to decipher whether interested parties are members, transferees, or hold no interest at all. Working through such a problem is neither easy nor cheap. Clients frequently come to me seeking relief from a decaying business relationship, only to provide me with 1) no LLC agreement, 2) oral representations as to their membership (which the opposing side naturally denies), and 3) K-1s. This lack of evidence creates problems for those seeking to assert their rights as a member. To be clear, K-1s express an intent to share in the profits and losses of the LLC. However, they are not per se evidence of membership. Labby v. Labby Memorial Enterprises, LLC, NO. 2:18-CV-01388, 2020 WL 5742539, at *1-2 (W.D. La. Sep. 24, 2020) (denying plaintiff’s contention that he was a member when the LLC sent him a K-1); see also Roberts v. Moise, A-1362-14T3, 2016 WL 456544, at *7 (“[P]laintiff failed to establish her entitlement to a membership interest in [the LLC]” even though the “2012 tax return and K-1 reflect[ed her] membership interest…”). Cases are clear that there must be something more than just mere K-1s to substantiate the existence of an individual’s membership interest.
To avoid the headache associated with determining who is a member, a transferee, or nothing at all, it is best practice to have a clearly drafted and specifically tailored LLC agreement to fit a party’s exact specifications. Well-drafted agreements distinguish the rights available to each respective party to the LLC, while making clear the nature of each party’s ownership (be it as a transferee or a member).
For more Washington business entity law considerations, refer to this blog every Wednesday at 12 PM, noon.