What Happens to an LLC Interest When a Member Dies or Divorces?

The core rule: economic rights transfer, membership does not

Texas separates the money from the vote. A membership interest can be assigned in whole or in part, but section 101.108 says the assignment does not entitle the assignee to participate in management, does not make the assignee a member, and does not let the assignee exercise a member's rights. Section 101.109 describes what the assignee does get: the income, gain, loss, deduction and credit allocations tied to the interest, the distributions the assignor would have received, and the right to reasonable information and inspection for a proper purpose. The assignee becomes a member only with the approval of all members, unless the company agreement provides a different path. Until then the assignor, if living, remains a member with whatever rights he did not assign (section 101.111).

Section 101.1115 applies that framework to death and divorce. On divorce, the member's spouse becomes an assignee of whatever part of the interest the spouse holds. On a member's death, the surviving spouse and the heirs, devisees and personal representatives become assignees of their respective shares. Section 101.1115(b) then preserves any agreement to buy or sell the interest on death or divorce, which is where most well-drafted companies have already answered the question.

Death of a member

The company does not dissolve. The deceased member's interest passes under his will or by intestacy, through the probate estate, and whoever receives it holds an assignee's rights: distributions, allocations, information. The surviving members keep voting and managing. The heirs can become members only if all members approve or the agreement allows it, and in a two-member company that means the surviving member decides whether the founder's children get a vote.

Two exceptions. First, the company agreement often provides otherwise, for example by admitting a deceased member's spouse automatically, or by requiring the company or the other members to buy the interest at a stated price, funded by life insurance. Second, if the deceased member was the only member, section 11.056 treats the end of the last member's membership as an event requiring winding up unless, within one year or the period the agreement sets, the legal representative or successor agrees to continue the company and becomes a member, or designates someone who does. A single-member LLC with no plan can end by default.

Divorce of a member

Texas is a community property state. Family Code section 3.003 presumes that property possessed by either spouse during the marriage is community property, and the spouse claiming an asset as separate must prove it by clear and convincing evidence. An LLC interest acquired during the marriage with marital effort or funds is presumptively community, even if it is titled in one spouse's name. An interest acquired before marriage, or by gift or inheritance, is separate, but increases in value attributable to the owner-spouse's labor and distributions received during the marriage can be community, and tracing is often disputed.

On divorce, the court divides the community estate in a manner it deems just and right (Family Code section 7.001). Three outcomes are common: the member-spouse keeps the entire interest and the other spouse receives offsetting assets; the interest is split and the non-member spouse becomes an assignee of her share; or the agreement's buy-sell provision is triggered and the company or the members buy the non-member spouse's share. Where the non-member spouse ends up holding part of the interest, section 101.1115 makes her an assignee: she receives her share of distributions and may obtain information, but she does not vote or manage and the other members need not deal with her as a member.

Example

Suppose two members own a Fort Worth engineering LLC 50/50 and one of them divorces. He formed the company during the marriage, so his 50 percent is presumptively community. The divorce court awards his former wife half of his interest. She now holds a 25 percent assignee interest: she is entitled to 25 percent of every distribution and to the K-1 allocations, and she can demand reasonable information for a proper purpose. She cannot vote, attend members' meetings as of right, or manage. Her former husband remains a member with a 25 percent interest and his full management rights. If the company agreement had a divorce buy-back clause at appraised value, the company could instead buy her 25 percent, and the valuation would follow the agreement's definition. If the agreement had nothing, the three of them are in a long-term relationship none of them chose, which tends to produce disputes over distributions and information.

The disputes that follow

• Distributions stop. The remaining members declare none, or pay themselves through compensation instead, leaving the assignee with tax allocations and no cash. The assignee's rights are the member's economic rights, so disguised distributions to insiders are actionable; see when the company is profitable but you receive no distributions.
• Information is withheld. Section 101.109 gives the assignee a right to reasonable information and an accounting for a proper purpose, and section 101.054(e) bars the agreement from unreasonably restricting an assignee's section 101.502 rights.
• Valuation. A buy-sell triggered by death or divorce almost always produces a fight over the number, especially where the formula is stale or the standard of value is ambiguous; see how valuation disputes are decided.
• Admission. Heirs who expected to step into a parent's shoes learn that the other members can refuse to admit them, and the other members learn that refusing may leave them with a permanent passive co-owner who sues over every distribution decision.
• Estate and company claims in different courts. Contests over the will or the estate's administration belong in probate court; disputes over how the LLC is being run belong in district court. The Texas Business Court excludes Estates Code and Family Code claims entirely (Government Code section 25A.004(g)).

What the company agreement can do

Section 101.052 lets the agreement govern these questions, and section 101.1115(b) confirms the Code does not impair buy-sell agreements on death or divorce. Common provisions: a mandatory purchase of a deceased member's interest at an agreed or appraised value, with life insurance to fund it; a company or member option to purchase a non-member spouse's share on divorce; automatic admission of a surviving spouse or named heir; a requirement that each member's spouse sign a consent acknowledging the transfer restrictions; and a defined standard of value and payment schedule. None of this is legal advice for a particular company, but a dispute in a company with these clauses is usually about enforcing them, while a dispute in a company without them is about everything.

Practical steps when a death or divorce occurs

1. Pull the company agreement and read the transfer, death, divorce and buy-sell sections together.
2. Identify exactly what passed and to whom: the will, the probate inventory or the divorce decree, matched to the company's records.
3. Confirm whether a buy-sell trigger occurred and what deadlines it sets; many run from the date of death or the decree.
4. Document the assignee's status in the company records, and continue allocations and distributions on that basis.
5. Decide, among the members, whether to admit the assignee or to buy the interest, and get a valuation done to the agreement's standard before negotiating.

When to involve a litigator

When the assignee and the members cannot agree on admission, a buyout or distributions, or when the probate or divorce proceeding is being used to reach the company itself. The entity-law and family-law questions interact, and a position taken in one court can bind in the other. Tina Wysk represents members, heirs and former spouses in disputes over LLC and partnership interests in Dallas state and federal courts. Related issues among relatives are covered in family business disputes in Texas.