Question With No Answer (Yet): Conflict Within LLC Act
Posted Jul 29, 2020
By Washington State Business and Real Estate Lawyer David C. Tingstad
As a member of the drafting committee of Washington’s LLC Act, RCW 25.15 (the “Act”), I know the difficulty associated with drafting. The committee spent years pouring over the Act and continues to work to improve it. One of the issues that has provided some difficulty is an apparent contradiction between the dissociation provisions of RCW 25.15.131 and the transfer provisions of RCW 25.15.251.
The Conflict – Dissociation vs. Transfer
The dissociation provisions of the Act specify, among other things, several different ways a member becomes dissociated from an LLC. One way a member becomes dissociated is through a “transfer of all of the member’s transferable interest in the limited liability company.” RCW 25.15.131(1)(b). This transfer of all the member’s transferable interest may be akin to a member withdrawing. In Washington, there is authority for the notion that dissociation and withdrawal are synonymous. See Brower v. Hoerner, No. 36442-9-III, 2020 WL 1282511, at *4 (Wn. App. Mar. 17, 2020) (discussing whether member had “dissociated,” instead of “withdrawn”). The Act further states that in the absence of an LLC agreement to the contrary, a member may not withdraw from the LLC without the written consent of all other members. RCW 25.15.131(2).
The transfer provisions of the Act specify that, in the absence of an LLC agreement to the contrary, although a transfer of a “transferable interest” is permissible, the person receiving the transferable interest only becomes a “transferee.” RCW 25.15.251(1). (This blog has discussed at length the utility of the transferee and its relationship with the pick your partner principle, which you can find here.)
These provisions, however, stand in direct conflict: 251 permits a member to transfer all of their transferable interest without any consent, but 131(2) provides that such a transfer would cause the member to dissociate, which is not permitted without the consent of all the members.
Conflict Unresolved (At Least in Washington)
This conflict provides an interesting dilemma for practitioners. How would a court resolve the following case: a member of a multi-member LLC (with no written LLC agreement) attempts to transfer all of his or her transferable interest to a third party, and the other members sue to enjoin the member from completing the transfer.
The member attempting to complete the transfer would appear to have the grounds to complete the transfer under RCW 25.15.251(1)(a). However, the other LLC members would appear to have grounds to enjoin the transfer as the transfer would result in the transferor member’s withdrawal, and a member may not withdraw without the consent of all the members, per RCW 25.15.131(2). Given the conflict in the Act, it is difficult to determine the outcome of such a case—especially since no Washington court has broached the subject.
Conflict Resolved (in North Carolina)
In 2012, a North Carolina court examined these conflicting issues in Blythe v. Bell, No. 11 CVS 933, 2012 WL 6163118 (N.C. Super. Dec. 10, 2012). In Blythe, the court was faced with an almost identical statutory structure as the Washington Act (although the language is different), which permitted the transfer of an LLC interest but barred member withdrawal without consent.
Drymax Sports, LLC (the “LLC) had five members: Blythe; Hickory Brands, Inc. (“HBI”); Joseph, Rob Bell, and Virginia Bell. Two transfers were involved. First, in 2007, HBI transferred all its interest equally to Rob and Virginia (and HBI, therefore, ceased to be a member). Second, in 2008, Joseph transferred his interest to now-non-member HBI. After several years, disputes arose between the parties and Blythe brought suit over the effect of both transfers.
The court had to determine how to resolve the contradiction in the statute that allowed transfers that would eventually lead to a member’s withdrawal but also barred withdrawal. Ultimately, the court held that the 2007 transfer from HBI to Rob and Virginia was valid and passed along both economic and management rights from HBI to Rob and Virginia because Rob and Virginia were already members at the time of the transfer. However, with Joseph’s 2008 transfer, only the economic rights passed to HBI and, because HBI was not a member at the time of the transfer, the management rights did not transfer. Rather, the voting rights stayed with Joseph until HBI was admitted as a member.
How Would This Play Out in Washington?
It is difficult to say how this case would have been decided. However, one thing is clear: the result would have had to be different. I say this because of the provision in RCW 25.15.131 stating that a member is dissociated upon the transfer of all of their economic interest. If the LLC were in Washington and Joseph transferred all his interest to non-member HBI, Joseph would become dissociated and would lose all his management rights, per RCW 25.15.131(3)(a). Therefore, the result would likely not be the same in Washington. However, what exactly the result might be is impossible to say.
The importance of this issue cannot be understated. The dissociation and transfer provisions of the Act are in direct conflict. This conflict will continue to exist until the Act is revised or a court resolves a dispute on this issue. Until that day comes, members of LLCs with no LLC agreement need to understand the risk they run in attempting to transfer their interests. In a sense, non-transferring members appear to hold all the cards in determining whether an interest can be transferred.
These considerations are important for professionals counseling business owners. They serve as another reminder of the importance of drafting of an LLC agreement. A well-drafted LLC agreement can avoid these issues altogether.
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