Key Takeaways

  • An assignment of interest refers to transferring a member’s rights in an LLC (such as economic or voting rights) to another party.
  • Assignments can be partial or complete and may require member or manager consent, depending on the operating agreement and state law.
  • Assignment of interest does not always mean full membership transfer—assignees often need approval to gain full rights.
  • Documentation such as an Assignment of Interest Agreement is essential to clarify the terms, effective date, and responsibilities.
  • Legal nuances, such as tax implications, voting rights retention, and restrictions under the operating agreement, should be carefully reviewed.

Assignment of interest takes place when a company is formed and the members or owners decide on the ownership percentages they will each hold. It also occurs when a member decides to leave the company and transfer their interest to another.

What Is an LLC?

An LLC, or limited liability company, is a business structure that offers liability protection to its members. The members of an LLC are essentially its owners, like the shareholders in a corporation. In the event of any financial or legal issues with the business, the members are protected from creditors taking any of their personal assets.

The interest percentages allotted to the LLC members are usually proportional to their capital contributions or their managerial responsibilities. This is also called their membership interest. LLC members who hold interest in the business are entitled to profit distribution as well as voting rights over company matters.

When members of an LLC retire or leave the business, they can assign their interest to another existing member or a new member. The LLC's operating agreement should outline how such a transfer should be handled. If there are no provisions for assignment of interest in the operating agreement, the state in which the LLC conducts business should have rules and regulations to follow instead.

LLC members tend to have more control over the daily operations of the business when compared to corporate shareholders. Usually, the members of an LLC are actually the individuals who started the business, so they have a strong desire to see the company succeed.

How Assigning Interest Works

LLC members assign interest when they need to hand their rights and responsibilities to the company over to another individual or business entity. One member's interest can be transferred to another in full or in part.

For instance, a retiring LLC member's interest in the business including all of the following aspects:

  • Voting rights
  • Managerial duties
  • Profit sharing

That member might choose to give their managerial duties to one person and their voting rights and profit shares to another. Basically, members reserve the right to assign their interest in any way they see fit, as far as the operating agreement allows.

Once the new member receives the interest, they inherit all of the rights and responsibilities that come with LLC membership that particular business, unless the operating agreement states otherwise.

Sometimes membership interest can be transferred, but the original member can hold onto their voting rights in the business, while the new member takes over the other rights and duties.

What Is an Assignment of Interest Agreement?

Assignment of interest agreements are the documentation for any transfer of interest in an LLC. In the contract, you should find the following information:

  • Name of original interest holder
  • Type of interest being transferred
  • Name of the individual or entity to receive the interest
  • Name of the LLC
  • Percentage of interest being assigned
  • Date of assignment
  • Other applicable terms and conditions

Once the assignment of interest agreement is signed by both parties, the giver of the interest and the receiver, the new holder of the membership interest agrees to follow the rules laid out in the various documents that govern the LLC. Such documents likely include the operating agreement and formation documents.

If the membership interest requires any initial or ongoing contributions to the business, the new interest holder is required to offer or continue such payments.

Aspects of Assignment of Interest to Keep in Mind

Depending on where the LLC is registered, the state might have specific laws regarding how assignment of interest is to be handled. Anytime major decisions or changes are happening in a business, it's always a good idea to double check the laws for the area.

Some states don't require the approval of LLC members for an assignment of interest, but they do limit the rights of the new member or receiver of the interest.

Operating agreements are the main governing power in such events, so an LLC might choose to forbid any interest assignments or transfers when they form the business. LLC members also reserve the right to lay out certain restrictions for interest assignments like the requirement of unanimous member approval.

The LLC's articles of organization may also include details regarding the assignment of membership interest.

Assignment of Interest vs. Sale of Interest

Although used interchangeably, these terms can carry different legal meanings:

  • Assignment of Interest refers broadly to the transfer of rights (economic or managerial) without necessarily involving payment.
  • Sale of Interest involves a monetary exchange, typically governed by stricter terms, and may include warranties, representations, and due diligence.

While all sales involve assignments, not all assignments are sales. For instance, gifting interest to a family member would be an assignment but not a sale.

Tax and Legal Considerations

Assignments of interest can have significant tax and legal implications for both parties:

  • Capital Gains Taxes: Assignors may owe taxes if they sell their interest at a gain.
  • Pass-through Income: The assignee may begin receiving taxable income after the transfer, even if cash distributions are not made.
  • Liability Exposure: If the assignment isn't structured or documented properly, legal disputes can arise regarding who is responsible for debts, voting, or contributions.
  • SEC Compliance: In rare cases, particularly for large or investment-focused LLCs, securities laws may come into play.

It’s advisable to consult a tax advisor or legal professional before finalizing an assignment of interest.

Common Restrictions in Operating Agreements

Operating agreements often include provisions to control or limit interest assignments. Common restrictions include:

  • Right of First Refusal (ROFR): Requires the selling member to offer their interest to existing members before assigning it to outsiders.
  • Manager or Member Approval: Assignments may require majority or unanimous approval.
  • Disqualifying Events: Certain events (e.g., bankruptcy or death of a member) may automatically trigger assignment rules or conversion of the interest to a non-voting economic interest.
  • Prohibition on Transfer: In some cases, the operating agreement may entirely prohibit the transfer of interest without written consent.

Such restrictions protect the LLC from being disrupted by outside or unwanted members.

Steps to Complete an Assignment of Interest

To ensure a valid and enforceable transfer of LLC interest, follow these steps:

  1. Review the Operating Agreement: Confirm whether assignments are allowed and whether member approval is required.
  2. Notify Other Members: Provide written notice, especially if required by the operating agreement.
  3. Draft the Assignment of Interest Agreement: This legal document should include the names of the assignor and assignee, the percentage being transferred, and the effective date.
  4. Obtain Necessary Approvals: Some states or agreements require majority or unanimous consent for the assignee to become a full member.
  5. Amend LLC Records: Update the LLC’s internal records and possibly file changes with the state, depending on local laws.
  6. Issue a Membership Certificate (if applicable): For LLCs that use certificates, a new one should be issued to the assignee.

Types of LLC Interest Transfers

There are two primary types of interest transfers in an LLC:

  1. Economic Rights Transfer: The assignee receives the right to profits, losses, and distributions but not management or voting rights. This is common when the operating agreement restricts full membership transfer without consent.
  2. Full Membership Interest Transfer: This includes both economic and managerial rights. In most cases, this requires approval from the other members or compliance with the procedures outlined in the operating agreement or state law.

Understanding this distinction is crucial, as the transfer of economic interest does not necessarily result in the assignee becoming a full-fledged member of the LLC.

Frequently Asked Questions

  1. Can an LLC member assign interest without the other members’ consent?
    It depends on the operating agreement and state law. Many LLCs require approval for full membership transfers but allow economic interest assignments without consent.
  2. Does assigning interest mean the new party automatically becomes a member?
    No. Economic rights can be transferred independently, but managerial rights typically require approval and formal admission as a member.
  3. What is included in an assignment of interest agreement?
    It typically includes the assignor and assignee names, type and percentage of interest being transferred, date of transfer, and any conditions or consents.
  4. Is an assignment of interest taxable?
    Yes, it can be. The assignor may owe capital gains taxes, and the assignee may be liable for income taxes on future profits.
  5. Can assignment restrictions be changed after the LLC is formed?
    Yes, but all members usually must agree to amend the operating agreement to modify assignment-related provisions.

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