Family businesses large and small, whether related to real estate or something else, often use an LLC as the ownership vehicle to operate. Often the founder of the business maintains a controlling position in the LLC, while other family members receive only an “economic interest”—the right to receive money and enough information to file their taxes, but not much more than that.
When the founder passes away and the interests of the LLC go to various family members, or if the founder separates, it can become very important to determine who gets exactly what types of rights in the LLC. If a surviving family member or spouse receives only an economic interest, they cannot make decisions for the company or even know much about what is happening in the company. Most importantly, they cannot say how much money the LLC should distribute to its members and when.
Instead, any economic stakeholder gets only money – if the LLC’s management decides the time is right – and a bit of information. Often this is exactly what the founder wanted. For example, the founder may not trust the business judgment, the development of a family member, or future generations in general. The founder may not want a family member to second guess the decisions of another family member or group.
Recent lawsuits involving the Bich family’s estate have emphasized the importance of these distinctions. A family-owned LLC owns hundreds of thousands of shares in Bic, an international manufacturer of pens, lighters, and other products. Husband and father Bruno Beach owns 99% of the economic shares in the company. The LLC agreement also gave him the right to appoint the manager of the company, that is, the person who can manage and control the company and make all its decisions.
Bruno and his wife, Veronique, at some point entered into a postnuptial agreement, an agreement between spouses who are already married but wish to resolve future disputes over the division of assets if they separate or divorce. This agreement stated that if the parties separated, Bruno would transfer to Veronique his 99% “share” in the LLC. He did not mention his right to appoint a director for the company.
In the end, the two parties separated. After that Bruno dies. At some point along the way, Bruno and his three sons, who owned the other 1% of the LLC, entered into an agreement transferring to Bruno’s sons the right to appoint the LLC’s director.
Veronique sued, demanding that she receive not only Bruno’s 99% economic interest, but also his right to appoint the director of the LLC. Presumably, she would have used this right to appoint herself or a trusted third party to run the LLC, thus ensuring that the LLC distributes the funds. This was a very important item on the agenda for her because she would receive 99% of these distributions as a 99% economic interest owner. On the other hand, if you can’t directly or indirectly control your LLC, you may never distribute a penny to it. She said the reference to Bruno’s “interest” should include all of his rights under the limited liability company agreement because they existed when he signed the postnuptial agreement or possibly at a later date. These rights would have included his right to appoint a director of the LLC.
court unacceptable Her broad reading of the term ‘interest’, concluded that she could only recover Bruno’s economic interest of 99%, and had no claim to his right to appoint the director of the LLC and thus initiate distributions by the LLC.
As part of the basis for the decision, the court noted that Delaware law governs an LLC. Delaware law has defined an “interest” in an LLC as nothing more than an economic interest. In general, the court noted, the postnuptial agreement only referred to Bruno’s 99% “interest”, specifying the percentage involved. He says nothing about any of his other rights under the LLC agreement. As a result, the postnuptial agreement did not require Bruno to transfer these rights to her. He can do whatever he wants with them.
She ended up owning an LLC almost entirely but without the ability to start distributions. Control of the distributions was indirectly with the three children of the happy couple.
When negotiating any LLC agreement and planning the death or divorce of any members, or other transfers within the family, Bich’s story stresses the importance of understanding exactly what rights exist within the LLC. Then an understanding of the works and the documents themselves must carefully distinguish between economic rights and administrative rights. Sometimes these rights have to end in the same place. Sometimes they shouldn’t.
Author thanks Peter Mahler from Farrell Fritz, PCto bring the author’s attention to this issue.