OCTOBER 8, 2012 VOLUME 19 NUMBER 37
Bear with us. This story will be a little dense and involve more difficult legal issues than we usually like to tackle. The good news: at the end you get an honorary law degree. Well, not really — but you’ll probably deserve one.
Matt Silver (not his real name) had a living trust, and had transferred nearly all of his assets to the trust. He was also a “member’ of a limited liability company — an LLC — but he had not gotten that LLC interest transferred to the trust before he died in 2007.
A short side-excursion into LLCs is in order. These popular business entities have been around since 1977, when Wyoming first introduced the concept. They merge some of the advantages of a corporation (including the ability to shield the individual participants from potential personal liability for claims and lawsuits) with some of the advantages of partnerships (including tax treatment as if the LLC members were partners — thereby avoiding corporate income taxation). The business participants are usually called “members” and the entity is governed by its operating agreement.
But a type of entity that was invented in 1977 is still pretty new by legal standards. Heck, two of the partners at Fleming & Curti, PLC, were already practicing law when Wyoming came up with this new idea (to be fair, Robert Fleming and Tom Curti were just one year into their law practices when the Wyoming legislature acted). Note, as an aside, that “PLC” at the end of the law firm’s name: even we are a limited liability company (the “P” denotes that we are a professional limited liability company — a type of LLC restricted to professionals like lawyers). Bottom line: that all means that the rules governing LLCs are less clear than those governing corporations, partnerships, trusts and other types of business and personal associations.
Back to Matt. He had not gotten his LLC interest transferred to the trust. That meant that it might be subject to the probate process — thereby increasing the complexity and cost of getting it to his heirs. But it also created a larger problem: Matt’s death meant that there was only one remaining member of the LLC, and he could reform the LLC in such a way that Matt’s interest could be bought out at “book value.”
Another side-excursion, to discuss “book value.” That means the carrying value on the books of a business organization — essentially, the contributions of the partners, shareholders or members (depending on the type of business entity). Book value is often (not always) far less than the market value of the partnership interest, shares or (in the case of LLCs) membership interest. In other words, if Matt’s LLC membership interest was part of his probate estate it would be worth far less (the court opinion does not tell us how much less, so we use the scientifically accurate “far less” metric) to his heirs than if his trust was the member.
Back to Matt again. The surviving LLC member filed a probate, alleging that a Personal Representative (what we used to call “Executor” — we’re not going into another side-excursion for that one) was necessary to complete the forced liquidation of Matt’s LLC membership. His trustee objected, claiming that Matt’s LLC was part of the trust — and that the surviving member should be estopped from claiming otherwise.
“Estoppel” is an interesting legal concept. Basically, the argument is that even though something may not be true, the court may sometimes tell at least some people that they may not raise objections. Usually, the person whose objection is not permitted has done something, said something, or benefited in some way from treating the thing as true. They are said to be “estopped” — barred — from saying otherwise.
Back to Matt. His trustee argued that Matt, the other LLC member and other people in Matt’s life had met shortly a year before Matt’s death. At that meeting the other LLC member had said that he supported Matt’s efforts to transfer the LLC into his trust, and that he would do “whatever was needed” to help complete the transfer. Even though Matt apparently never followed up, his trustee maintained, the remaining LLC member should be estopped from claiming that the LLC had not been transferred to the trust.
Confused yet? We warned you that this was a little dense. Maybe if we get right to the resolution we can make a couple points that will help you with your own estate planning.
The probate judge agreed with the surviving LLC member. Matt had failed to transfer his LLC interest to the trust, and his business partner was now the sole member (and able to force liquidation of Matt’s interest at book value). It was Matt’s inaction, not the surviving member’s change of heart, that had prevented the transfer. The Arizona Court of Appeals upheld the probate court’s ruling, and noted that even if Matt had signed transfer documents he probably would only have transferred his interest, not his membership, in the LLC. In other words, even if he had completed the transfer his business partner would be the sole LLC member — unless the operating agreement was also amended to name the trust as the member, not just the owner of Matt’s share. Matter of Estate of Shiya, October 2, 2012.
So why did we pick this dense fact pattern, and what is the takeaway message? It is simply this: it is not enough to complete your living trust planning, even if you get it just right and the lawyer writing the trust perfectly captures your wishes. “Funding” the trust is the key. Assets have to be retitled to the trust’s name, and that can sometimes mean more than just changing names on the title, or just signing a batch of documents. Funding can require some follow-up, and some continuing maintenance.
A smaller takeaway point from Matt’s case: avoiding probate is not always the only issue to be considered in trust creation and funding. There may be other consequences — good or bad — flowing from the decision to create and fund a living trust. In Matt’s case, it looks like an effective transfer into the trust might have given Matt’s chosen successor trustee to step into Matt’s shoes and act as member of the LLC — and (not incidentally) significantly increase the value of his interest in that LLC.