Chapter 3 - § 3.3 • LLC MEMBER STATUS
| Jurisdiction | Colorado |
§ 3.3.1—Admission of the Original Members to an LLC
The statute is less than clear as to the admission of members at and following the formation of an LLC. As discussed in "Who is the Initial Member or Members?" in § 3.2.1, the LLC Act requires that the articles of organization state that there is at least one member of the LLC.193 The next mention in the statute is that "[a]fter the filing of a limited liability company's original articles of organization, one or more persons may be admitted as an additional member or members upon the consent of all members."194
The Colorado Business Corporation Act contemplates incorporation195 and then organization of the corporation.196 While there is no similar concept in the LLC Act, it is custom and practice among attorneys forming LLCs in Colorado to have the initial members admitted to the LLC at an organizational meeting of the LLC or by signing the operating agreement prepared for the LLC. If, however, there are one or more persons who have initially agreed to be members, but there will be additional members admitted later, a better procedure would be to have the initial member or members adopt a single-member operating agreement (or simple multi-member agreement) so that there will be a written procedure for appointing officers or a manager and conducting business. This can be useful, for example, for banking purposes and obtaining a tax identification number. When additional members are admitted, the members would adopt an amended and restated operating agreement to set forth their deal and to replace the initial operating agreement.
Where there is no written operating agreement (as is too frequently the case where LLCs are formed by lay persons or by attorneys not skilled in LLC practice), members are generally accepted by oral agreement among the persons forming the LLC197 or by their course of conduct. Without a written operating agreement, however, disputes can arise as to who are the original members and what are their agreed deal terms. See § 3.2.6 for a discussion of what should be considered for inclusion in an operating agreement, as well as these authors' view expressed in "Must There Be an Operating Agreement?" in § 3.2.5 that every LLC has an operating agreement at least to the extent that the member or members have agreed to form the company under a particular state law and to accept that law's default provisions in the absence of contrary agreement.
§ 3.3.2—Admission of Minors as Members
The LLC Act does not require members of the LLC who are individuals to be 18 or older. Based on the language of C.R.S. § 13-22-101(1)(a), however, these authors do not believe that individuals who are not at least 18 years of age can bind themselves to an operating agreement.198 If the owners of an LLC desire to have minors who have an economic interest in the LLC, a minor's interest should be held by a trust or a uniform transfers to minors account.199 The statutes permit a trustee to be a general or limited partner if permitted by the partnership agreement and the trust agreement.200 The statute also permits a trustee to retain an interest in a "family business."201 Although C.R.S. §§ 15-1-701 and 15-1-702 might be thought to create some ambiguity as to whether a trust could be an initial member of an LLC, a "person" may be a member of an LLC,202 and person is defined to include a trust.203 Accordingly, these authors believe that a trust may be a member of an LLC from the outset.
§ 3.3.3—Assignment and Admission of New Members to an LLC
Non-Bankruptcy Discussion
Unless the statutory requirement has been varied by the operating agreement, after the filing of the articles of organization for an LLC, a person may be admitted as an additional member only upon the consent of all existing members.204 This is the statutory embodiment of the "pick your partner" principle, which is fundamental in the LLC Act and partnership laws in Colorado and elsewhere. These authors believe that the policy behind these statutory "pick your partner" provisions is sound since, in creating or restructuring a business as a closely held LLC or partnership entity, the owners often wish to restrict themselves and each other from transferring a membership interest in an LLC or a partnership interest without the consent of the other owners.205
A membership interest in an LLC is personal property,206 and therefore should be treated as personal property under the Uniform Commercial Code that may be assigned.207 Upon the assignment of an LLC membership interest from one existing member to another existing member, the assignee (already a member) will succeed to the entire assigned membership interest and not merely be treated as an assignee.208 The LLC Act, § 7-80-702(3) states:
A person to whom a portion of a member's membership interest has been assigned or transferred and who has been admitted as a member has all the rights and powers and is subject to all the restrictions and liabilities of the assignor or transferor with respect to the portion of the membership interest assigned or transferred. (Emphasis supplied.)
In the case of an assignment by one existing member to another existing member, the transferee will be one "who has been admitted as a member." There is no requirement in the statute that the admission to membership be in connection with the transfer. On the other hand, where the assignment is to one not already a member, the assignee must be admitted as set forth in the operating agreement or (if no procedure for the admission of new members is set forth in the operating agreement) by unanimous consent of the other members.209
Unless otherwise stated in the operating agreement, the LLC has no obligation to admit a non-member assignee. Unless admitted as a member, the assignee only has the economic rights attributable to the membership interest assigned — the assignee does not have voting or other rights that a member may have, such as rights to information. An operating agreement could allow assignees to vote or to inspect records,210 but presumably could not grant an assignee the right to bring a derivative proceeding.
The admission of the assignee as a member "terminates the assignor's . . . rights and powers as a member with respect to the portion of the membership interest assigned . . . and releases the assignor . . . from liability to the [LLC] other than for liabilities under section 7-80-502 [liability for contributions] or 7-80-606 [liability for distributions]."211
In the case of a member who transfers all of his or her membership interest, the transferor member ceases to be a member whether or not the assignee is admitted as a member.212 Since the statute only affords a release to the transferor if the transferee is admitted as a member, a member who intends to transfer all of his or her membership interest would do well to obtain an agreement from the LLC that the transferee will be admitted as a member and an agreement from the transferee that the transferee will accept and agree to membership in the LLC and do all things reasonably necessary or required by the LLC to effectuate the transferee's admission as a member.
Most lawyers likely would advise a client against drafting the LLC operating agreement to prohibit all transfers. In addition to the courts' general aversion to restraints on alienation, prospective members will usually be interested in exit strategies for their investment in the LLC. An article by Daniel S. Kleinberger213 discusses an Iowa state trial court decision214 that may be the exception that proves the rule. There, the Iowa court upheld a provision in an operating agreement that required all transfers (with a few stated exceptions) to be approved by the LLC's directors (this LLC's term for its managers). The operating agreement provided that the directors' decision was to be in their sole discretion and any purported transfer made without the directors' approval was void. In reaching its decision to uphold the very restrictive transfer provisions, the court rejected the reasonableness standard for transfer restrictions and applied a strict contractual analysis. Rather than distinguishing between the transfer of economic rights (which did not include voting or management rights) and the transfer of a membership interest (which did), the court applied the "pick your partner" principle in saying: "Contrasted with other principles of incorporated business organizations, '[o]ne of the most fundamental characteristics of LLC law is its fidelity to the "pick your partner" principle.'"215
Effect of Bankruptcy216
Upon the debtor filing a petition under the United States Bankruptcy Code, the debtor's assets become property of the debtor's bankruptcy estate.217 Section 541(a)(1) of the Bankruptcy Code provides,
(a) The commencement of a case under section 301, 302, or 303 of this title creates an estate. Such estate is comprised of all the following property, wherever located and by whomever held: (1) Except as provided in subsections (b) and (c)(2) of this section [541], all legal or equitable interests of the debtor in property as of the commencement of the case.
By operation of law, therefore, the filing of the bankruptcy petition creates an estate, which includes the owner's interest in an LLC or partnership.218 The bankruptcy estate may be managed by a third-party trustee (under Chapter 7) or the debtor in possession (under Chapters 11 and 13).219 Although some might think this would be a transfer that arguably should be subject to the "pick your partner" limitations, bankruptcy law says no.220 Under bankruptcy law, unless the operating agreement is treated as an "executory contract" under the Bankruptcy Code, which is then rejected by the trustee, the trustee succeeds to all rights that the bankruptcy owner has in the LLC or partnership, including voting rights, economic rights, and the other rights of a member or...
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