Many Ohio small businesses are organized as limited liability companies (LLCs). An LLC combines the legal liability protection of a corporation with the tax benefits of a sole proprietorship or partnership. In addition to filing an Articles of Organization with the State of Ohio, most LLCs also have an “Operating Agreement,” which is a contract between the LLC and its members (owners), specifying their respective rights and obligations.
You might wonder if an Operating Agreement is necessary if you plan to form a one-member LLC, i.e., you are the sole member. While not strictly necessary under Ohio law, an Operating Agreement is still a good idea for a one-member LLC, as it may help clarify a number of matters, such as what happens to the business in the event of your death or retirement. Succession planning is a key feature of most Operating Agreements, as they can help ensure an orderly transition or winding-up of the business, and hopefully minimize the potential for litigation.
Husband, Stepchildren Disagree Over Wife’s Operating Agreement
Unfortunately, litigation is sometimes unavoidable. An Ohio appeals court recently addressed a case involving an LLC where the sole member died and there was a disagreement between her husband and her estate over who now owned the business. Although nominally a probate dispute, the case turns on the court’s interpretation of the LLC’s operating agreement.
The sole member formed the LLC in 2004 to operate the campground where she also lived. She signed an Operating Agreement—essentially, a contract between herself and the LLC—which included provisions for her death. These provisions stated her husband, whom she married a few days after forming the LLC, would be allowed to remain at the campground for the rest of his life. He would also receive any income from the LLC. The actual ownership of the LLC would be apportioned two-thirds to the husband and one-third to the wife’s three children from a previous marriage. These provisions would cease to apply if the couple were not married at the time of her death or if the husband “should ever vacate the premises.”
During the couple’s marriage, they moved out of the campground into another home. After the wife died in 2013, the children argued their stepfather no longer had any right to ownership or income from the LLC, as their prior move constituted “vacating the premises,” as specified in the Operating Agreement. The trial court granted summary judgment to the husband, but the Ohio Court of Appeals, 3rd Appellate District, reversed, stating there were still factual questions requiring resolution.
Specifically, it was still unclear whether the husband’s membership in the LLC ever “vested” due to his “vacating” the property, as the children claimed. The appeals court said read in isolation, the vacate clause supports this reading. But taken as part of the entire Operating Agreement—which is, after all, a legal contract—the court was not so sure. The court said the other clauses indicated the wife’s intent was for the husband’s interest “to not vest only in the event of a separation” or divorce. The wife also intended to ensure her husband had a place to live after her death. The fact the couple jointly chose to move during her lifetime again suggests that was no longer an issue, but the wife still did not want to terminate her husband from assuming majority ownership of the LLC. Again, the appeals court left it to the trial court to make a final determination on these issues.
Need Help With an LLC?
As this case illustrates, seemingly straightforward language in an LLC Operating Agreement can lead to complex legal problems. If you are forming an LLC and need advice from an experienced Youngstown business attorney, contact the Law Office of John C. Grundy.