A Trap for the Unwary Single-Member LLC: Why a Properly Worded Operating Agreement is Necessary
The death of the sole member of a single-member LLC may result in the LLC being forced to dissolve. Even if the next generation desires to continue the business after the death of the single member, they may not be able to do so.
The South Carolina Uniform Limited Liability Company Act of 1996 (the “Act”) contains a little known problem for single-member LLC’s. If the LLC has no operating agreement in place at the time of the death of the sole member, the LLC will be left with no voting members and will have no ability to admit voting members. Without voting members, new business operations cannot be approved.
The Act provides that a person may become a voting member of an LLC through only one of two ways: (1) by the consent of all the other members (but there are no other members to consent), or (2) through the authority stated in an operating agreement. The Act unfortunately does not provide flexibility and contemplates that upon the death of the sole member, the legal representative of the last surviving member wind up the LLC’s business. Winding up the business means that the legal representative may only preserve the company’s business or property as a going concern; prosecute and defend legal suits; settle and close the company’s business; discharge the company’s liabilities; and distribute the remaining assets.
What does this mean? The next generation cannot continue the business. Below are two examples to illustrate the problem:
-Suppose that a father is running his business as a single-member LLC with no properly worded operating agreement, and that the father dies leaving the business to his three sons in his will. The sons are left with two surprising choices: They must wind up the business, or they may continue the current operations of the LLC but may not transact any new business operations. This is regardless of how competent and involved the sons were with the company before the father’s death, and in spite of the family’s desire that the business continue.
-Suppose that a single-member LLC’s primary business is to develop commercial real estate. If the sole member dies without a properly worded operating agreement in place, the LLC must discharge the company’s liabilities and distribute its assets. This would be a disastrous result if the outstanding loan balance exceeds the value of the commercial properties. Even though these properties may be producing positive cash flow, selling the properties and paying off the creditors could result in a significant financial loss.
If you are currently the owner of a single-member LLC, solving this potential problem should be a pressing concern for you and your company. The solution is creating a properly worded operating agreement that addresses admission of new members upon the death of the single-member. Waiting until after the death of the single-member is too late.
For more information, please contact:
Julian “Jay” Hennig III