On January 1, 2014, the North Carolina General Assembly repealed Chapter 57C of the North Carolina General Statutes and replaced it with Chapter 57D, which became the new North Carolina Limited Liability Company Act (the “New LLC Act”). See N.C. Session Law 2013-57. This New LLC Act provides both corporate and estate planning attorneys with a great opportunity to review and revise the terms of their client’s operating agreements.
Although the New LLC Act (as well as the previous version of LLC Act) ostensibly limits the scope of an LLC to engagement in “any lawful business,” see N.C. Gen. Stat. § 57D-2- 01(c), the New LLC Act defines the term “business” (other than in the context of a foreign LLC transacting business in North Carolina) as “[a]ny lawful, trade, investment or other purpose or activity, whether or not conducted or undertaken for profit.” N.C. Gen. Stat. § 57D-21-03(3) (emphasis added). As such, North Carolina LLCs are not limited to profit-making enterprises, but may be used for nonprofit and socially beneficial enterprises as well. Therefore, LLCs can be used in lieu of a trust for cost-sharing purposes or to jointly own property or to achieve any other legal objective, including estate planning.
A major benefit of utilizing limited liability companies for estate planning purposes is their inherent flexibility.
The stated intent of the North Carolina General Assembly in passing the New LLC Act was to grant parties the power to customize and specify the terms of their operating agreements as “they determine to be appropriate with minimum prescribed formalities or constraints.” N.C. Gen. Stat. § 57D-10-01(b). Estate planning attorneys should therefore be mindful of ways that an LLC operating agreement could achieve a client’s particular objectives, as the flexibility granted by these freedom of contract principles most likely means that a peculiar or unusual term contained in an operating agreement will not be found to violate the New LLC Act or common law.
Among the changes to the New LLC Act is a clear delineation between the different types of LLC ownership interests. For example, the New LLC Act defines an “economic interest owner” as possessing rights in the “capital, income, losses, credits, and other economic rights and interests of the LLC,” but is not a member of the LLC and so does not have non-economic rights related to LLC governance provided to members under the operating agreement or default provisions of the New LLC Act. See N.C. Gen. Stat. § 57D-1-03(10), (11). Conversely, a member of an LLC would generally have both economic governance rights in that LLC (subject to potential particularized modification and/or divestment of some of these rights as specified by the parties in the operating agreement).
Understanding the difference between an economic interest owner and a membership interest is very important for an estate planning client. For example, it may be preferable to clearly and precisely define the rules for a desired membership arrangement in the operating agreement by defining or limiting voting, information and dispute rights of members, rather than outright elimination of these rights through economic interest status, which would provide the economic interest owner with none of these rights of governance. See Warren P. Kean and Edward W. Griggs, Estate Planning with the New North Carolina LLC Act, North Carolina Bar Association, at IV-C-6, (July 2014).
One area where limited liability company law can be useful in the estate planning context is in the creation and maintenance of trusts. Revocable and irrevocable trusts may be interest owners of LLCs. Trustees of revocable and irrevocable trusts can be appointed as managers and other company officials of LLCs. As a result, there are several important issues to consider when incorporating LLCs in estate planning involving trusts, including: (1) the capacity or death of a member or company official, (2) the obligations and duties of the various constituencies of the LLC, (3) the effect that changes in the trustees or beneficiaries of a trust that are members or company officials of an LLC may have on the trust’s status as a member or company official, (4) the ability or inability of interest owners to transfer their ownership interests and other liquidity issues, (5) whether to provide for permitted transferees, and (6) the economic and governance/ management and information rights and other interests of interest owners and their assignees, and the circumstances under which those rights may be lost or compromised. See Kean & Griggs, supra, at IV-C-21.
For clients interested in retaining control over the investment decisions concerning trust assets, limited liability companies can provide a means through which to bifurcate a trustee’s more traditional accounting, reporting, and distribution duties from its investment obligations. A properly drafted operating agreement could allow for a client to maintain control over a trust’s investments by funding the trust with ownership interests in LLCs that vest control over the management of the assets in individuals or entities other than the trustee of the trust. This would allow for a client to maintain a degree of control over a trust’s investments while still retaining the planning benefits a trust allows for, such as providing for alternative beneficiaries. Id.
Estate planning attorneys must understand how provisions within an operating agreement will affect both the other provisions within the operating agreement itself, as well as their effect on related estate planning instruments, such as trusts, and identify any issues that need to be addressed regarding the client’s estate planning strategy. For example, estate planning attorneys must be aware of how a simple transfer of an ownership interest in an LLC to the owner’s revocable trust may not be permitted under the operating agreement and may thereby trigger an unintended buy/sell procedure, or how a deceased member’s unsatisfied capital call can create a need for the LLC to take action pursuant to Article 19 of Chapter 28A of the North Carolina General Statutes regarding the presentation of creditor’s claims against the decedent’s estate. Specifying processes and procedures within the operating agreement that address these and other issues before an estate plan is implemented can mitigate the costs associated with addressing these issues when they invariably arise.
In summary, the New LLC Act makes several changes to North Carolina limited liability company law, including differentiating between LLC membership interests and LLC economic interests. These and other changes to the New LLC Act can affect estate planning strategies and asset management, especially when a trust is funded with ownership interests in an LLC or where a trustee has been appointed to a managerial position in an LLC. The New LLC Act can provide a flexible alternative to more traditional estate planning instruments, though practitioners must be aware of the ways in which limited liability company law interacts with the law of trusts and successions and work to mitigate and prevent the issues that may arise from these interactions.