Family limited partnerships (FLPs) and limited liability companies (LLCs) are useful vehicles with which to transfer wealth. A membership interest in an LLC and a partnership interest in an FLP partnership are often referred to as Units. The value of Units for estate and gift tax returns is fair market value (FMV). Where there is no established marketplace for the sale of Units in closely-held LLCs and FLPs (hereinafter, collectively, “LLCs”) one must obtain an appraisal.
An appraiser takes note of the fact that is no market and that the owner is often unable to force the LLC to redeem the Units. Unable to convert the Units into cash makes them worth less than their pro rata share of the LLC’s assets. Certainly, the FMV of the Units is less than one hundred cents on the dollar and forms the basis for any discount. A key component of the discount is the inability of the Owner to force redemption of the Units. Everyone assumes they are entitled to a discount but seldom understands the basis for it.
The impact of state law went unnoticed until the decision in Auriga Capital Corp. et al. v. Gatz Properties, LLC. The decision caught the attention of practitioners within and without Delaware, because the trial Court definitively ruled that traditional fiduciary duties of care and loyalty apply by default to managers of Delaware limited liability companies absent a contractual provision that clearly alters or eliminates such duties On appeal, the Delaware Supreme Court, acting en banc, affirmed the trial court's award of damages and attorneys' fees, but squarely rejected the "[trial] court's pronouncement that the Delaware Limited Liability Company Act imposes 'default' fiduciary duties on upon LLC managers and controllers unless the parties to the LLC Agreement contract that such duties shall not apply.” Fortunately, Delaware acted quickly to resolve this question.
If there is a duty of care and loyalty imposed by state law, it stands to reason that the value of the Units will be higher than if there were no such duty. Do you know if state law governing your LLC permits your agreement to eliminate the duty of care and loyalty? Does your appraisal assume that the holding of the Delaware Supreme Court is the law in your state?
State law still matters for federal estate and gift tax valuations.