There are several different ways to structure an LLC in Tennessee. The company can be a member managed, manager managed, or director managed organization. The two most common types for people who want to participate in managing the business are member and manager managed.
In a member managed LLC, there are typically only one or two members that are the owners of the business. Each member shares in the responsibility for day-to-day operations of the company.
In a manager managed LLC, there usually many members but only a few members actually conduct day-to-day operations. This type of company is used often by family-owned businesses so children can be members but not immediately take on all the responsibilities of the company.
It is important to remember that all members hold an interest in the company, regardless of the type of LLC. But what happens when a member dies? In other words, what happens to the ownership interest in the company the deceased member held? Does it go to the other members? Does it go to the deceased member's family? Does the company just dissolve?
Many people do not consider this issue when forming an a company. In fact, some Tennessee residents inaccurately think that the ownership interest will automatically fall in equal parts among the other members. It may or it may not. It depends on the structure of the company and whether there is a written operating agreement saying where those interests go.
Whether you are already a member of an LLC or are contemplating starting one, here's what you should keep in mind if a member dies:
What Does Tennessee Law Say About the Death of Members?
T.C.A. Section 48-249-601, governs the dissolution of any LLC created after June 1, 2006. Subsection (b) of this statute explicitly provides that the death of a member does not cause the dissolution of the company. In other words, if an owner of the company passes away, it does not automatically mean that the LLC is terminated.
So what happens to a deceased member's interest? Without an operating agreement stating otherwise, Tennessee law holds that the member interest passes to his beneficiaries in a will or to his heirs is if he did not have a will.
Sometimes when a deceased member's interest passes to their family through a will or intestacy, the family may be ill equipped to manage the business. The spouse or children may have little interest, experience, or maturity to deal with the complexity of running the company. In those circumstances, it is beneficial to have a well-written and comprehensive operating agreement in place.
What Does Your LLC Operating Agreement Say About the Death of Members?
While Tennessee law states that membership interests pass to beneficiaries and heirs, an operating agreement can circumvent this distribution. An operating agreement can state that at the death of a member, the surviving/remaining members must purchase the interest of the deceased member. Other times, these agreements will state that the surviving members will have a certain time period in which to purchase the membership interest at fair market value before that interest passes to the beneficiaries and heirs.
Of course, operating agreements may provide for many different options for the purchase of a member's interest. It just depends on what the members can agree to and what they ultimately desire to accomplish.
Use Life Insurance to Facilitate a Buyout
Many times these buyouts are funded with life insurance. Here is how that works: The business purchases a life insurance policy on each member. The business pays the premiums of the policy. If a member dies, the other members make a claim on the policy, thereby providing them liquid funds in which to purchase the deceased's membership interest. The members then maintain control of the company and the member's family gains the value of their loved one's interest.
The Key Takeaway
When establishing a limited liability company in Tennessee, you have the ability to determine what happens when a member dies. However, if you fail to create an operating agreement or do not plan for death it could create problems down the road. Remember, the death of a member does not mean a dissolution of the company. Without an operating agreement, the membership interests passes to the beneficiaries or heirs. Those persons may not have any interest or aptitude for running a company and it could cause substantial issues for the company. Always consult with an experienced business attorney in Tennessee who focuses of starting a business. That lawyer is likely to have the insight and knowledge to create a comprehensive and thoughtful operating agreement unique to your needs.