AuthorThe Texas and Taxes Law Blog Archives
February 2025
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Everyone has heard of a Last Will and Testament to dispose of your assets and appoint someone in charge of it, but that does not mean that everyone does it! Most people die without a will, according to many studies. What happens to a business entity that you co-own with another person? That is the subject of this article.
First, it depends on the type of business. Historically, before the 2000's, the entity choice was either a partnership or a corporation. A corporation's shares of ownership were, and still are, freely transferrable, unless there was a stockholder or buy-sell agreement that provided otherwise. Thus, if a shareholder died, and there was no restriction on transfer, the shareholder's will beneficiaries or heirs under state law, without a will, would inherit the stock. The result is that a person could end up in business with his business partner's wife or minor children--not a good result. In contrast, a limited liability company has ownership interest called "membership interest," and under a company agreement, the membership interest is typically not transferrable. If there is no company agreement, Texas law provides that a member who dies ceases his membership interest, and his will beneficiaries or heirs become assignees. An assignee is a person who takes over the ownership interest without getting the full membership interest, so the assignee has no right to vote. Because the assignees have no right to vote, an effective change in control of the LLC has occurred. For example, assume an LLC with two members: one who owns 90% and one who owns 10%. Without a company agreement, Texas law actually says that the two members have equal votes. How many LLC members know that? Assume the 90% member dies. The 90% ownership interest is converted to an assignee's interest of 90%, and the 10% member has 100% of the vote! What does an assignee have as to rights? An assignee has the right to receive distributions and allocations of profits and losses and to inspect books, records, and information of the LLC generally on a more restrictive basis than that of a member. Instead, a buy-sell agreement should be used to provide for the transfer of ownership, the retention of the ownership interest with those who will operate it, and the provision of value to the deceased or departing owner. In a sense a buy-sell agreement is a "Last Will and Testament" of a business, but it may, and hopefully, only address an ownership interest in it and not the ultimate demise of the business! Death A buy-sell agreement should obviously address death. The deceased member's membership interest (or shareholder's shares) should be acquired pursuant to the agreement, resulting in the remaining owner's full ownership of the company. The agreement would require the deceased owner's successors, assigns, and executors/administrators to sell the membership interest pursuant to the agreement. Typically, life insurance can be used to help fund the purchase price. Other Events under the Buy-Sell Agreement A buy-sell agreement should also address other terminating events--what lawyers sometimes call the "4 D's." These D's are (1) death, (2) disability, (3) dissociation, and (4) deadlock or just dissolution. If an entity owner, particularly one active in the business, becomes disabled, then the other owners and the company should have the right to acquire (an option) such person's interest; otherwise, the other shareholders and company must answer to and work with someone else: an agent under a power of attorney, a trustee, or a guardian appointed by a court. These persons may have different ideas about running the business. If an owner who is an employee or otherwise a service provider for the company stops working for the company, quits, gets fired, gets convicted or charged with a crime, or loses a license, then the ownership interest should get acquired or forfeited. For example, in a buy-sell agreement for a law firm, if a lawyer loses his license, then he cannot legally own the interest in the firm, and his interest should get acquired. Deadlock: disagreement Sometimes, companies, particularly 50/50, get deadlocked, and nothing can get done, because the owners often disagree, resulting in deadlock and a company unable to act. I've heard this story too (and more than once). The shareholders got along great, but one got comfortable and started spending more time with whiskey than the company. In an LLC, one member has no right to expel another member under such circumstance under the Texas Business Organizations Code. Instead, a buy-sell agreement or company agreement should address expulsion, especially in dire circumstances. Without planning, everything you worked for could get destroyed, and on the way to that destruction, while you are the only one making the company profitable, you are doing it for half the profits in the above example. Contact us to discuss the legacy of your business. Comments are closed.
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