Why is there a need for a springing member?
The need for a person standing by — ready to “spring” into action and become a member — arises because the LLC laws generally require an LLC to have at least one member at all times. The laws also provide that at any time the LLC has no members, it has to dissolve.
However, that is often not what the member, or the non-members controlling the LLC, had in mind. So the LLC laws give them an out. The LLC will not have to dissolve if the operating agreement provides that upon the event causing the termination of the membership of the last remaining member (or within a short period of time thereafter), another person, designated in the operating agreement, is admitted as a member of the LLC. Designating a springing member is one of the options the LLC has to prevent its dissolution when there are no members left.
How is a springing member different from other members?
A springing member is different from what we typically think of as an LLC member in several ways. A springing member exists solely for the purpose of satisfying the requirement that an LLC has at least one member. The person designated as the springing member does not become a member until the last member ceases to be a member.
The springing member has no economic interest in the LLC, has no right to distributions, and has no obligation to make capital contributions. (It should be noted that early LLC laws required a member to have an economic interest. Although those provisions have generally been repealed, checking the governing statute is still advisable.)
The springing member also has no management rights. And as soon as the LLC admits another member, the springing member ceases to be a member.
Which LLCs might designate a springing member?
Any LLC can designate a springing member in its operating agreement. Although the need seems most obvious for a single-member LLC, multi-member LLCs may also want to protect against dissolution in case they lose some members and are left with just one member for a period of time.
Springing members are also designated in LLCs where the member is an individual or where it is a corporation, LLC, or other entity. Below are two examples of how springing members might possibly be used, one involving individuals as part of an estate plan, and the other by entities seeking financing.
Springing member in estate planning
Many business owners who form an LLC to own their business want the business to continue after their death and want their heirs to inherit the business.
Owning an LLC membership interest is different from owning corporate stock. Upon the death of a shareholder, all of his or her rights in the stock become part of the estate. Not so in an LLC. Upon the death of a member, the member’s economic interest — e.g., the right to distributions — passes to the estate, but not the entire membership interest. So when the single member in a single-member LLC dies, the LLC will be left without a member.
An example of what can happen if no provision is made for what will happen when a sole member dies is Felt v. Felt, 928 N.W. 2d 882 (Iowa App. 2019). A farmer formed an LLC and transferred his interest in the farm to the LLC. He was the sole member. His son was named as a manager. After the farmer’s death, the son continued to operate the farm. But, a dispute arose between the son and his siblings. The siblings sued, claiming the LLC had to dissolve because it was without a member for more than the period of time Iowa’s LLC law gives an LLC to designate a new member to avoid dissolution. The trial court ruled that the son could be admitted as a member and continue operating the farm because that was the farmer’s intent.
However, the appellate court reversed. The court held that regardless of the farmer’s intent, according to the LLC law and the operating agreement the son was not admitted as a member, the LLC was without a member for too long, and the LLC had to be dissolved.
Springing members in financing transactions
Springing members may also be found in LLCs formed for the sole purpose of holding assets securing large loans. Many lenders, as a condition of making the loan, require the borrower to create an LLC and place the assets securing the loan in the LLC.
In general, if a member files for bankruptcy, that is considered an event terminating its membership. Therefore, if the borrower is the sole member of the LLC, and the borrower files for bankruptcy, that could leave the LLC without a member. If the LLC dissolves, its assets become part of its bankruptcy estate, making it harder for the lender to receive the full value owed it.
A springing member can come in and prevent the LLC’s dissolution for being without a member.
A springing member should not be confused with an “independent member”, which is something else a lender may require as a condition to making the loan. Like a springing member, an independent member has no economic interest in the LLC. But unlike a springing member, an independent member is a member upon being inserted in the operating agreement and his or her role is to prevent the LLC from declaring bankruptcy, not to step in if it does declare bankruptcy.
Who should be designated as the springing member?
If it is determined that a springing member should be designated in the operating agreement, the next question where to find the person willing and able to fill this role? Fortunately, some corporate service companies provide springing member services. This is a popular option because it helps ensure the role will be filled even though it is unknown if and when a springing member will be needed and that the person designated knows what to do when “springing into action”.
CT Corporation offers a springing member service. For more information, contact a CT Corporation specialist today.