Question

22.2 Limited Liability Companies 7. How did LLCs finesse the requirement that they not allow too-free transferability of the interest?

Answer 1

Again, the issue here is that if the interest of an investor in the LLC is as freely transferable as the interest of a shareholder in a business (an individual may transfer the attributes of his interest without the permission of the others), the LLC is likely to be said to have a check mark in the "corporate-like" box: too many of them and the company will not be allowed to pass through taxation. Thus the trick for the LLC promoters is to limit free transferability enough to pass the test of not being a company, but not so much to make it really impossible to divest yourself of the interest (then it's not a really liquid or attractive investment).

The general rule for some states ' LLC laws is that the remaining members must vote unanimously to approve a member's interest delegated or transferred to engage in the management of the LLC. Since this prohibits a participant from transferring all attributes of the interest (the right to engage in management is not transferred or assigned), the LLC created under the standard clause will not have "free transferability of interest," but if the LLC agreement requires majority approval to transfer all attributes, this would also meet the condition that there is no free transferability of interest

For many businessmen, the limited liability company has become the entity of choice. It is created by state authority that issues the "organization certificate" upon request. It is controlled either by managers or members, it gives limited liability to its members, and it is taxed as a partnership. But only if the firm lacks enough corporate attributes to escape being labeled as a corporation will these happy results be obtained. The company's certificate usually limits its continuity of life and the free transferability of interest in order to avoid too much "corporateness." The ongoing game is about finishing these limits: making them as unconstrained as possible