As we discussed in an earlier blog, beneficiary designations can be effective estate planning tools. “Transfer on death” (TOD) designations are particular beneficiary designations allowed under both Missouri and Kansas law. TOD designations are used for many types of property, including vehicles, stocks, mutual funds, and other securities.
Use of a TOD designation is available for transfers of interests in limited liability companies (LLC). Under Missouri law, a TOD designation is not specifically authorized for LLC interests, and is accomplished as a transfer of a contract right. Kansas has a specific statute on point and a more formal procedure for registering TOD designations with the LLC.
In either state, it is important that the LLC Operating Agreement specifically provide for TOD designations and include procedures for recognizing the transfer at death. LLC Operating Agreements often include restrictions on the ability of owners to transfer their ownership interests in the LLC so transfer restrictions in the Operating Agreement must provide a mechanism for recognizing TOD designations and permitting those transfers.
Two other key documents are important for recognition of a TOD beneficiary designation for a membership interest in an LLC.
The LLC should issue a Membership Interest Certificate to the member, representing his or her ownership in the LLC (similar to a Stock Certificate) and referencing the TOD beneficiary designation. If the member keeps the original of the Membership Interest Certificate, the LLC needs to keep a copy in its corporate records.
Also, at the time the TOD designation is made, there should be a Transfer on Death Agreement like the one discussed below, which will automatically transfer the membership interest to the TOD beneficiary upon the member’s death but no earlier. If the member properly revokes the TOD designation before he or she dies, this Transfer on Death Agreement becomes null and void.
There is the potential for a TOD designation of a member to be challenged, particularly if the designated beneficiary receives an interest of significant value that is inconsistent with the deceased owner’s other bequests or transfers. To reduce this risk, we recommend a formal Transfer on Death Agreement be incorporated in the Operating Agreement (ideally as a separate exhibit) that documents the process to be followed in implementing the TOD designation as well as the actual transfer of the membership interest to the beneficiary. This agreement would be similar to (although probably not as detailed as) the corresponding agreements used by financial institutions with established practices of recognizing TOD designations.
Although the TOD designation may be a powerful estate planning tool for the members, it may be difficult procedurally for the remaining members when a member passes. It is important for the LLC members to discuss whether they want to allow TOD designations when the Operating Agreement is being drafted and then to work with an experienced business lawyer who can help ensure that any TOD designations for the membership interests are recognized.