Dissociation of a Member from a Louisiana Limited Liability Company: The Need for Reform

• Author: Susan Kalinka
• Position: Harriet S. Daggett-Frances Leggio Landry Professor of Law, Louisiana State University, Paul M. Hebert Law Center
• Pages: 365-452

Page 365

The Louisiana Limited Liability Company ("LLC") Law has no comprehensive provision concerning the dissociation of a member. "Dissociation" is a term of art used by a number of LLC and partnership statutes to refer to a change in the relationship between a member and the LLC.¹ In some cases, the dissociation of a member can terminate all of the rights and responsibilities that attach to a member's interest. In other cases, dissociation will result in the termination of a member's right to participate in the business of the LLC or to exercise any of the rights of a member other than the right to share in the LLC's profits, losses, and distributions.

Unlike the LLC acts of many states,² the Louisiana LLC Law does not include a comprehensive statute designating events that may trigger the dissociation of a member. Instead, the LLC LawPage 366 provides individual statutes designating several dissociation events and the effects of such dissociation.³ The current dissociation statutes under the Louisiana LLC Law are problematic. This article discusses some dissociation events that are not, but should, be included in the Louisiana LLC Law and discusses the problems that may arise under the current rules.

Many, if not most, LLCs are classified as partnerships or, in the case of a single-member LLC, as an entity that is disregarded as a separate entity from its member, for federal and state income tax purposes.⁴ A partnership does not pay tax on its income.⁵ Instead, each partner reports its share of the partnership's items of income, gain, loss, deduction, and credit on the member's federal income tax return.⁶ The uncertainty as to whether or under what circumstances a member's economic rights in a Louisiana LLC may terminate can create obvious problems in accounting for and reporting each member's share of the LLC's income.⁷ Because there is some uncertainty as to whether a member can be expelled from an LLC, there are cases where a member will continue to share in the profits of and distributions from an LLC without performing services that had been expected by the other members, but not explicitly required under the terms of a written operating agreement.⁸Page 367

There is no provision in the Louisiana LLC Law that triggers the termination of all of a member's rights and responsibilities on the bankruptcy of the member, the expulsion of a member, or the sale of the member's entire interest in the LLC. Under the Louisiana LLC Law, a member may voluntarily withdraw from an LLC and receive a distribution in an amount equal to the fair market value of the member's interest.⁹ The Louisiana LLC Law also provides that a member's management rights terminate on the death, interdiction, dissolution, or termination of a member.¹⁰

However, the member's economic interest in the LLC continues after the death, interdiction, dissolution, or termination of the member and are assigned to the former member's legal representative or successor in interest.¹¹

The lack of a comprehensive dissociation statute can create uncertainties and problems for persons who deal with an LLC, and for LLCs, LLC members, and families of LLC members. While an LLC's articles of organization or operating agreement may provide that all of a member's rights and responsibilities terminate on the occurrence of certain events, there is no guarantee that a court will enforce such a provision, especially in the case of the bankruptcy, death, interdiction, dissolution, or termination of a member.

Before it was amended in 1997, section 12:1334(3) of the Louisiana Revised Statutes provided that, unless otherwise provided in the LLC's articles of organization or a written operating agreement, an LLC dissolved on "[t]he death, interdiction, withdrawal, expulsion, or dissolution of a member or the occurrence of any other event which terminate[d] the continued membership of a member" in the LLC unless within ninety days after the event, the LLC was continued by the unanimous consentPage 368 of the remaining members.¹² Under the former law, the events that triggered the termination of a member's membership in the LLC could cause the LLC to dissolve. Presumably, the dissolution of an LLC would terminate both the management and economic interests of each of the LLC's members.¹³ However, even under the former law, it was not certain whether the termination of a member's membership in the LLC terminated both the management and economic rights of the member if the other members consented to continue the LLC after the dissociation event.

Section 12:1334(3) was included in the Louisiana LLC Law to ensure that a Louisiana LLC would be treated as a partnership for federal tax purposes under former Treasury regulations that required an LLC to lack certain "corporate characteristics" to achieve partnership tax status.¹⁴ Under Treasury regulations issued in 1977, an unincorporated organization was classified as a partnership for federal tax purposes if the organization lacked two of the following four "corporate characteristics:" (1) continuity of life; (2) centralization of management; (3) limited liability; and (4) free transferability of interests.¹⁵ For this purpose, an organization lacked continuity of life if the death, insanity, bankruptcy, retirement, resignation, or expulsion of any member would cause a dissolution of the organization unless the remaining members agreed to continue the organization.¹⁶

In 1996, the United States Treasury Department issued the so-called "check-the-box" regulations, under which a domestic LLC is automatically classified as a partnership for federal tax purposes, regardless of whether the LLC has corporate characteristics, unless the LLC elects to be classified as a corporation.¹⁷ Because it wasPage 369 no longer necessary for a Louisiana LLC to lack corporate characteristics to be classified as a partnership, the Louisiana Legislature was able to ensure that the dissociation of a member would not interrupt an LLC's business operations by repealing former section 12:1334(3). When it repealed section 12:1334(3), however, the Louisiana Legislature failed to enact a statute concerning the effect of the expulsion or bankruptcy of a member. The Louisiana LLC Law never has included a provision terminating a member's management rights on the sale or exchange of the member's entire economic interest in an LLC. These omissions in the law can create significant problems for persons owning interests in and operating an LLC.

This article compares the current provisions (or lack thereof) in Louisiana LLC Law with the dissociation provisions of the Prototype Limited Liability Company Act ("Prototype Act")¹⁸ and the Uniform Limited Liability Company Act ("ULLCA").¹⁹ The Prototype Act was drafted in 1992 by the Working Group on the Prototype Limited Liability Company Act of the Subcommittee on Limited Liability Companies of the Committee on Partnerships and Unincorporated Business Organizations of the American Bar Association's Section of Business Law. The provisions of the Prototype Act are written as default provisions. In other words, many of the statutes begin with the words, "Except as otherwise provided in the articles of organization" or "Except as provided in the articles of organization or a[n] [written] operating agreement,"²⁰ or otherwise allow the members of an LLC to alter the statutory rules by a provision in the articles of organization or an operating agreement. Under the Prototype Act, the parties may alter the provisions under the Act affecting the management of the LLC's affairs, the conduct of its business, and the relationships among the members by including a different provision in the LLC's articles of organization or an operating agreement.

Neither the House of Delegates and the Board of Governors of the American Bar Association ("ABA") nor the Sections orPage 370 Committees of the ABA ever approved the Prototype Act or the policies discussed in the drafters' comments to the Prototype Act. Nevertheless, a number of states have used the Prototype Act as a model in drafting their LLC statutes.²¹

The National Conference of Commissioners on Uniform State Laws adopted the ULLCA in 1994 and the amendments made to the ULLCA in 1995 and 1996.²² Like the Prototype Act, the ULLCA was drafted to allow the parties flexibility; the ULLCA provisions also are written as default rules.²³ As of this writing, several states have adopted the ULLCA.²⁴

The basic theory underlying the dissociation statutes is the principle of delectus personae, that partners have the right to choose their associates.²⁵ The principle is especially important in the context of a general partnership because such partnerships tend to be closely held and managed by their owners.²⁶ The act of any partner in the ordinary course of the partnership's businessPage 371 generally binds the partnership.²⁷ Moreover, the act of one partner may cause each of the other partners to incur personal liability because each partner in a general partnership is personally liable for a virile share of all partnership debts and obligations.²⁸

The principle of delectus personae may be less compelling in the LLC context because members of an LLC are not personally liable for the debts or obligations of the LLC.²⁹

Nevertheless, the LLC acts of a number of states include comprehensive dissociation provisions because, in many cases, LLCs, like general partnerships, tend to be closely held, member-managed, and acts of each member of a member-managed LLC generally are binding on the...