An involuntary transfer of an LLC membership interest is just that—a transfer prompted by a creditor action or a triggering event outside of the member’s control. An individual or entity obtaining a membership interest because of an involuntary transfer usually cannot fully step into the shoes of the transferring member.
This statutory protection—often called a pick your partner provision—acts as a safeguard that provides LLC members with a certain amount of personal asset protection. For example, whereas the creditor of a corporate shareholder could reach and exercise shareholder rights to their full extent, the creditor of an LLC member can reach and exercise only the economic rights associated with membership interests—not the voting or management rights. The recipient is called an assignee.
Statutory Provisions – Creditor Action
Creditor actions are subject to state LLC laws if an LLC specifies no transfer provisions. Each state, in its LLC statute, has provisions limiting what steps a creditor can take against an LLC member for the personal debt. Depending on the state, the statutory remedies available to an LLC member’s creditors may include the following:
- A charging order, a court order requiring the LLC to pay all the distributions due to the member-debtor from the LLC to the creditor.
- A foreclosure on the member-debtor’s LLC ownership interest.
- A court order to dissolve the LLC.
These remedies protect the other LLC members from the risk of having the creditor of a debtor-member step into the debtor member’s place and share in the control of the LLC. To a varying degree, they also address the creditor’s right to the satisfaction of the debt.
Transfer Provisions – Other Triggering Events
Transfer provisions are typically specified in the LLC’s operating agreement or a separate buy-sell agreement. There may be some overlap with creditor actions, as these are often included as triggering events in the transfer provisions.
Examples of triggering events that can be specified in an LLC’s transfer provisions include the following:
- A deceased member’s membership interest passes to a prohibited individual or entity
- A member’s bankruptcy or other involuntary transfer of a membership interest to the member’s creditors
- A member’s separation or divorce, or the transfer to a member’s spouse under property division or a divorce or separation decree
- A member’s membership interest becomes subject to a valid court order, levy, or other transfer that the LLC is required by law to recognize
- A member’s breach of the LLC’s confidentiality
- A member’s failure to comply with any mandatory provision of the operating agreement
- A member’s failure to maintain a license or other qualification that disqualifies the member from engaging in the LLC’s primary business
If a triggering event occurs, the transfer provisions may prompt a mandatory redemption of the member’s membership interest or a right of first refusal to the LLC or the other members. If an involuntary transfer occurs, the membership interest recipient—the assignee—typically receives only an economic interest in the LLC with no management or voting rights.
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