Less than a year ago, the Maryland Court of Special Appeals decision in Potter v. Potter caused real concern about the efficacy of LLC and partnership agreement provisions that are commonly drafted to direct an entity’s composition after the death of a member/partner.¹
Indeed, the ruling generated enough concern—particularly amongst owners of small, closely held businesses—that legislative measures to reverse the decision were promptly pursued. On May 12, 2022, Governor Hogan approved a bill, effective October 1, 2022, that reverses Potter v. Potter and clarifies that:
transfers on death, pursuant to the operating agreement of an LLC or a partnership agreement, are effective according to the operating agreement or partnership agreement and are not to be considered testamentary (i.e., interests transfer according to the terms of the agreement and not by a will or the laws of intestacy).²
Prior to the Potter v. Potter ruling, entity owners and their advisors generally viewed LLC operating agreements and partnership agreements as valid and enforceable contracts, especially in the context of business succession planning. Understandably, many individuals were unpleasantly surprised in 2021 when the Court of Special Appeals held that an LLC operating agreement’s member interest transfer provision (more specifically, a provision directing the transfer of a member’s interest upon the member’s death) was subject to Maryland testamentary and probate laws. In the Potter case, since the relevant LLC operating provision didn’t comply with the Maryland Statute of Wills, it failed to govern the transfer and the interest ended up in the estate (subject to state testamentary and probate laws).
The key take-aways from this new piece of legislation are that: (1) LLCs and partnerships may transfer, or assign, LLC or partnership interests to other persons—even nonmembers/nonpartners—via the operating or partnership agreements, and (2) that transfers on death pursuant to such agreements’ terms are not to be considered testamentary in nature. While this new change is a welcome relief for so many who had believed that their LLC or partnership agreements’ terms would be respected, it is wise to remember that a significant life event (divorce, marriage, death, etc.) should always prompt one to reevaluate the need to update existing business and estate documents to ensure that they continue to reflect the desired outcomes.
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.