A recent Maryland Court of Special Appeals decision has potentially far-reaching interstate consequences for limited liability company members who are subject to Maryland’s Statute of Wills. A limited liability company’s operating agreement governs, among other things, the transfer of a member’s interest. The Court in Potter v. Potter held that one such transfer – a transfer of a member’s interest upon the member’s death – is subject to Maryland testamentary and probate laws.¹ Accordingly, the transfer of such interest upon a member’s death must comply with the Maryland Statute of Wills.²
In 1984, James Potter (James) married Ruby Potter (Ruby). Thereafter, James acquired a membership interest in TR Steak Pasadena, LLC, a Maryland limited liability company (LLC). James’s rights and obligations as a member of the LLC were defined by the TR Steak’s Third Amended Operating Agreement (Operating Agreement) and the Third Amended Members’ Agreement (Members’ Agreement). As explained by the Court, the Operating Agreement provided that:
if a member dies, his or her “living trust, estate, legatee or other successor interest” will “automatically and immediately” become a “Successor Member” as long as the successor is a member of the “Permitted Group,” as defined in the members’ agreement.³
However, no definition of the “Permitted Group,” referenced in the Operating Agreement, appeared in the Members’ Agreement. Instead, the Members’ Agreement, designated Ruby as the successor of James’s membership interest, concerning only his right to share in the profits, losses, and distributions.
James’s signature on the Operating Agreement was not witnessed. And the Court noted that his signature on the Members’ Agreement “appears to have been witnessed by one individual, but the signature is indecipherable and the witness is otherwise unidentified.”⁴
Later, James and Ruby separated and executed a separation agreement. Besides the mutual and general assignment and release of “any and all rights or interest which [the releasing party] now has or may hereafter acquire,” Ruby specifically waived “any and all interest” in James’s LLC membership interest.⁵ Additionally, the separation agreement stated that James “shall maintain his share/membership interest… free and clear of any rights, title, or interest” that could be asserted by Ruby.⁶ However, James never changed his designation naming Ruby as the successor of his interest in the LLC.
James then married Denise Potter (“Denise”). In 2017, James died intestate (i.e., without a will). Denise opened a small estate in the Orphans’ Court for Anne Arundel County and was appointed as personal representative. Denise identified James’s LLC membership interest as an estate asset. Ruby countered by filing a declaratory judgment action asserting that she was entitled to the LLC interest, because she was listed as the successor in the members’ agreement. Denise responded that the membership interest was an estate asset, because the relevant LLC documents could not pass title since they did not comply with the requirements of the Maryland Statute of Wills. Ruby and Denise filed for summary judgment. The Trial Court granted summary judgment in favor of Ruby. Denise appealed.
The Court began its analysis by considering the definition of “property” in the Maryland Estate and Trusts Article. The Court emphasized that, as defined in the statute, “property” includes any interest in real or personal property “which does not pass, at the time of the decedent’s death, to another person by the terms of the instrument under which it is held, or by operation of law.”⁷ The Court noted Denise’s position that, generally, Maryland law requires a document purporting to pass title to property upon the owner’s death to comply with the Maryland Statute of Wills. And the Court agreed with Denise that “what renders a document testamentary is its effect, as opposed to its form or the parties’ subjective intent.”⁸ The Court was clear that the intended effect of the LLC’s relevant Operating and Members’ Agreement provisions were “to transfer ownership of property upon the death of a member;” thus, the Members’ Agreement was a testamentary document subject to the Maryland Statute of Wills.⁹
The Court subsequently confronted and dismissed Ruby’s argument that Maryland LLC members are permitted to sidestep the Maryland Statute of Wills if all members expressly agree that the Maryland Statute of Wills does not apply to the membership interests. Here, the Court stated that “to be legally effective, a provision in an operating agreement must be ‘not inconsistent’ with the laws of this State.”¹⁰ One such law, noted the Court, is the Maryland Statute of Wills. So, the Court reiterated that it has consistently interpreted the Maryland Statute of Wills to mean that:
a contract that attempts to transfer title to property upon the death of an individual is testamentary in nature unless it is both irrevocable and based on a present legal obligation whose performance is deferred during his or her lifetime.¹¹
The Court clarified that James’s designation of Ruby was not irrevocable, as he could change the designation at any time. Moreover, the Court stated that the designation did not arise from a duty owed to her. Accordingly, the Court found that the provision purporting to transfer James’s interest to Ruby was inconsistent with Maryland law, and the LLC was not authorized to include it in its operating agreement.
Lastly, the Court concluded that both the Maryland Statute of Wills and the Corporations and Associations Article are “harmonized.”. In other words, the Court determined that the relevant provisions of the two statutes can be read and applied together so that “no part of either statute is rendered ‘meaningless, surplusage, superfluous or nugatory.”¹² The Court opined that the members of the LLC “should have executed wills whose terms dovetailed with the provisions of the operating and members’ agreement.”¹³
The outcome and effect of Potter v. Potter is clear—a membership interest in a Maryland limited liability company is a property interest that is subject to Maryland’s testamentary and probate laws. As such, a member intending to pass his or her interest automatically upon death via limited liability company operating and membership agreements, must ensure that they comply with the Maryland Statute of Wills. Alternatively, the members should execute wills with terms “dovetailing” the provisions of the operating and membership agreements. Significantly, the decision may not only impact limited liability companies organized in Maryland. Rather, it may apply more broadly, reaching even those companies organized under any other state’s laws so long as any member is subject to Maryland’s Statute of Wills.
Our team can help you navigate the rules and laws regarding the transfer of a business interest and assist with any other legal need your business may have. Contact us at 410-497-5947 or schedule a consultation with our brief contact form.