California limited liability company disputes | Courtroom war stories and lessons learned

Family Trusts and LLC Membership

LLC members often hold their membership interests in a family trust.  The benefits of trusts are well known — they generally allow assets to be easily transferred after death without the time, hassle, and expense of court probate proceedings.

But LLCs — and the operating agreements that govern them — can throw a wrinkle into the normal trust process.

A recent opinion filed by California’s Sixth Appellate District — Premiere Raspberries, LLC v. Dutra — deals with the interplay between family trusts and LLC membership interests.  While the opinion was not published (and therefore is not binding “precedent”), published LLC opinions are rare in California, and unpublished opinions can still shed light on how courts evaluate these issues.

Facts: LLC sues deceased member’s successor trustee; loses and gets hit with attorney fee award under operating agreement

James R. Dutra was the managing member of Premiere Raspberries LLC, with a 49% membership interest.  Before his death, he transferred his LLC membership interest to his living trust.  After James R. Dutra’s death, James M. Dutra (the decedent’s son) became the successor trustee and began the process of settling the estate.

The LLC sued Dutra, seeking a preliminary injunction.  The LLC sought to stop Dutra from using a portion of the LLC’s property without permission and without paying rent to operate a pumpkin selling business and children’s bounce house for several weeks around Halloween.  After the trial court denied the injunction, the LLC dismissed its action.

Dutra then filed a motion seeking recovery of his attorney fees expended in the action, based on an attorney fee recovery provision in the LLC’s operating agreement, which on its face only applied to “members” of the LLC.

The trial court granted the motion and awarded attorney fees to Dutra.  The LLC appealed.

Court of Appeal: successor trustee was not a member, but could still rely on the operating agreement’s attorney fee provision

The Court of Appeal affirmed the trial court’s decision.

The court first confirmed that Dutra was not a member of the LLC, under both the LLC’s operating agreement and California’s LLC laws.  The LLC’s operating agreement required that members could only be admitted by following the procedures in the operating agreement — i.e., any transfer of a member’s membership interest needed to be approved by a majority interest of the LLC’s members.  Without such approval, any transferee would hold only an “economic interest” (or “transferable interest”) in the LLC — not a full membership interest.

Dutra argued that under the operating agreement, following his father’s death the LLC had the ability to initiate a “buyout” option that would have allowed the LLC to purchase the membership interest.  But the LLC failed to exercise the buyout.  As a result, Dutra contended, he as successor trustee succeeded to his father’s whole membership interest in the LLC as a matter of law.

The court rejected Dutra’s argument.  Without approval of the transfer by a majority interest of the LLC’s members as required by the operating agreement, Dutra only acquired the economic / transferable interest from his father — which does not include the full “membership” interest and does not include any managerial or voting rights.  The court concluded:

In short, the transfer of a member’s interest, without more, does not confer member status on the transferee.  Nor does the subsequent death of the member confer a membership interest, though the deceased member’s legal representative may exercise the right to settle the estate.

However, that did not resolve the issue of whether Dutra could rely on the operating agreement’s attorney fee provision.  Even though Dutra did not become a “member” of the LLC, the court held he was still entitled to recover attorney fees “as the deceased member’s legal representative and assignee of contractual rights for claims related to the LLC and its operating agreement.”

The LLC’s operating agreement expressly allowed a deceased member’s legal representative to “exercise all rights of that Member for the sole purpose of settling the estate or administering that Member’s property.”  The court held this provision gave Dutra broad authorization as successor trustee in the context of litigation involving the LLC, and brought him within the operating agreement’s attorney fee clause.

Lesson

After the death of an LLC member whose membership interest was held in a family trust, the successor trustee does not necessarily become a “member” of the LLC.  Membership status will depend primarily on the provisions of the operating agreement, and perhaps also by the default rules of California’s LLC statutes.

But even if the successor trustee is not a “member,” the trustee might still be entitled to rely on the operating agreement’s attorney fee provision addressing conflicts between “members.”