A recent Delaware Court of Chancery decision is required reading for anyone who wants to know the requirements for validly transferring a member’s interest in an LLC, for example, upon death or bankruptcy of a member. 

In Gurney-Goldman v. Goldman, C.A. No. 2023-1124-JTL (Del. Ch. July 12, 2024), the court explained some aspects of the Delaware LLC Act in connection with the transfer of membership interests that, in the court’s words: “To put it mildly, [. . .] is not a well developed area of Delaware law.” Slip op. at 31. See Section 18-705.

As a bonus of sorts, the decision also features an exemplary overview of the dissolution process for both LLCs and corporations. See footnote 69.

Factual Background

The essential factual background involves four siblings who inherited a real estate empire in New York City involving “literally hundreds of entities.” Although the siblings hired one of the largest New York law firms to create the legal structure for their business, the court observed that entity formalities were not always observed and that some of the LLCs did not have any written operating agreements.

Moreover, there were no documents establishing the transfer of interest in key entities from the widow of the patriarch to the siblings. The management structure was not formalized. The 2 siblings who were the primary decision-makers did not have clear documentation to establish the basis of their authority.

After one of the two siblings who had historically been the decision-makers for the operation of the business passed away, his son sought to take over the role of his father in managing the business but the remaining sibling who historically managed the business did not agree that the son had a right to take over his father’s managerial role.

The LLC at the heart of this case, SG Windsor, did not have a written LLC agreement.

Issues Addressed

The litigation sought: (1) a declaration that SG Windsor is a member-managed entity; (2) that the estate of the sibling who historically was a co-manager of the LLC became a member of SG Windsor or, to the extent the estate is only an assignee, that the son is able to exercise governance rights in his capacity as an executor to the estate.

Key Takeaways

There are many principles in this epic decision of both well-settled and not well-traveled aspects of the Delaware LLC Act that should be of interest to anyone who either forms or litigates Delaware LLCs.

  • Under the LLC Act, the default rule is that an LLC is member-managed.  See 6 Del. C. § 18-402.

LLC Agreement Terms/Formation

  • Although SG Windsor did not have a written LLC agreement, the statute allows for an LLC agreement to be “oral or implied.”  See § 18-101(9).
  • The court explained that an implied agreement is one inferred from the conduct of the parties “though not expressed in words.”  See cases cited at footnote 16.
  • The court explained that to prove an implied agreement, the court must be able to infer “as a fact, from conduct of the parties showing, in light of the surrounding circumstances, their tacit understanding. The failure to object may be treated as acceptance.”  See Slip op. at 13-14 and footnotes 19-20.

Appointment of Manager

  • The court referred to “manager” as a term of art under the LLC Act, which defines it as a person who is either named as a manager in the LLC agreement or designated pursuant to a similar instrument.  This term of art should be distinguished from the colloquial use of the word manager where, as here, a person manages the company without the formal title or documentation giving him that title. See § 18-101(12).  See Slip op. at 16.

Transfer of Membership Interests in LLC

  • The default rule under the LLC Act when a member transfers its member interest is that the recipient of the interest does not automatically become a member.  See § 18-702. Rather, the recipient only holds the right of an assignee. Slip op. at 20-21.
  • The assignee does not receive any of the governance rights associated with the interest, nor does an assignee have the right to seek books and records or seek statutory dissolution.  Slip op. at 21 and footnotes 40-42.
  • The court explained the reasons for the default rules include the “pick-your partner principle” which underlies § 18-702(b)(3), and which essentially tries to avoid a situation where a new co-manager is imposed on a member as opposed to a new “passive co-investor.”  Slip at. 21-26.

How to Become a Member

  • To implement that principle, the LLC Act addresses: “(i) what a member is, and (ii) how an assignee becomes a member.  Slip op. at 23.
  • § 18-301 describes how an assignee becomes a member. After the formation of an LLC, the requirements for becoming a member are described in § 18-704(a). Those two ways include: (1) pursuant to provisions in the LLC Agreement; or (2) upon the affirmative vote or written consent of all the members of the LLC.

Death of Member

  • The court instructed that the death of a member who was a natural person terminates that person’s membership. See footnote 52 and accompanying text.
  • A member’s interest in an LLC, like other personal property, transfers by operation of law to the estate of the deceased member.

§ 18-705 – Rights of Personal Representative

  • § 18-705 authorizes the personal representative of a deceased or disabled member to exercise all the member’s rights only as provided in § 18-705, and those rights are limited as an assignee as compared to plenary rights.
  • The court was not persuaded by the Schedule K-1 forms that the parties used because those forms offer two options: (i) general partner or LLC member-manager, or (ii) limited partner or other LLC member. The second box was checked for the three living siblings and the estate, which is inconsistent with the positions taken by the parties in the lawsuit.

Can an Executor Exercise Member-Manager Powers under § 18-705

  • The court explained that this is not a well-developed area of Delaware law, but the court did a deep dive with extensive citations to treatises, case law and other learned commentary.
  • In the course of a short law review article  on § 18-705, the court elucidated several key points.
  • A consequential point for single-member LLCs is the court’s instruction that pursuant to § 18-801(a)(4), the general rule is that when the member of a single-member LLC who is a natural person dies, the default rule is that the LLC is dissolved.
  • Regarding dissolution, in connection with the deep dive into § 18-705, the court provided an illuminating footnote that spans over 4 pages and that provides a paradigmatic encapsulation of the stages of dissolution for both a corporation and an LLC. The court explained that the shuttering of an entity involves: “ … two distinct events that bracket an intermediate period of activity. The first event is dissolution, marking the point at which the entity enters the intermediate period called winding up.  The second event is termination, which takes place after the entity completes winding up.”  See footnote 69.

Stages of Dissolution for LLC and Corporation

  • The court went into further detail by comparing the stages for dissolution of a corporation and an LLC. Referring to DGCL § 278, the court described the Certificate of Dissolution as marking the start of the 3-year winding-up period that includes things such as marshalling assets and distributing any remaining assets after payment of liabilities. At the end of the winding-up period, the corporation’s existence terminates.
  • As for an LLC, dissolution marks the start of the winding-up period.  See § 18-801(a). The winding-up period is similar to that of a corporation. See § 18-803, § 18-804. At the end of the winding-up process an authorized person files a Certificate of Cancellation. See § 18-203.

§ 18-705 Needs Fixing

  • The court suggested that the language in § 18-705 referring to termination makes little sense based on the foregoing overview of termination ending the existence of an LLC, and that the legislature should consider a clarification and refinement of the language in the statute. See footnote 69.

History of § 18-705

  • The court provides an extensive historical overview of the origin of § 18-705 and the limits of the power of a personal representative of a deceased member.  See Slip op. 31-69.