The Hohfeldian Concept of Share in Limited Liability Companies: A View from the Common and Civil Law Traditions

Abstract

This Article draws upon the question: How do restrictions on transfers of shares of limited liability companies (LLCs) affect the “physiology” and “morphology” of property rights in those shares? The purpose of this Article is to scrutinize the effects such restrictions have on the definition of property rights members of LLCs hold in their shares. In this context, I use the term “un-consented transfer of shares” as my laboratory. Frequently, the operating agreements of these companies foresee that members who wish to sell their shares in the company must seek the consent of the other members or the management board for the transfer of shares. This is the case because LLCs, like their European counterparts, have a closed nature. Unlike corporations, LLCs are not typically designed to capture public investment. Therefore, the shares of LLCs are not supposed to be freely sold to third-party investors outside the company, unless their members agree otherwise. An unconsented transfer of shares stands for a transfer by a member of the company (seller) for which consent was not sought. For example, section 18-702 of the Delaware LLC Act provides that a LLC interest is assignable in whole or in part except as provided in the LLC operating agreement.1 Likewise, Louisiana Revised Statutes section 12:1330 foresees that “[u]nless otherwise provided in the articles of organization or an operating agreement, a membership interest shall be assignable in whole or in part.”2 The Delaware LLC Act as well as the Louisiana Revised Statutes are “default” statutes. As a consequence, if members do not agree on a certain matter in their operating agreements, then the respective default provision of the LLC law will apply.

Empirically, operating agreements often refer to the effects of breaching a clause providing for restrictions on transfers. In some cases, the LLC agreement establishes that any attempt to make any sale of, or create, incur, or assume any encumbrance with respect to any membership units will be null and void and ineffectual and shall not be binding upon the managing member, if there is one, or the company. Non-transferring members will have all rights and remedies available under the agreements. Additionally, it is sometimes submitted that the purported transferee will have no rights or privileges in or with respect to the company, and the company will not give any effect in the company’s records to that attempted sale or encumbrance. Alternatively, there are operating agreements in which it is established that in case shares are transferred against the provisions of the agreement they should be redeemed. Furthermore, in some cases it is also agreed that any transfer, assignment, encumbrance, pledge, hypothecation, or transfer, which shall result in the termination of the relevant company for federal income tax purposes, will be null and void ab initio and of no legal force or effect whatsoever. Other contractual clauses stipulate, in addition, that after a transfer of any part of a membership interest is executed the membership interests transferred shall continue to be subject to the terms and provisions of the relevant agreement and any further transfers are required to comply with all the terms and provisions of the agreement. At times, it is also set forth that a transfer of any units in the company entitles the transferee of such units to receive only the economic interests. The transferee obtains no right to vote or participate in the management of the business and affairs of the company. Notwithstanding the foregoing, a transferee shall be included within the term “member” for the respective purposes of the agreement, except for purposes of the rights of a member to purchase units of other members. The transferor remains a member of the company with all rights to vote and manage unless and until non-transferring members owning a majority of the outstanding units in the Company (other than the units held by the transferor or the transferee) consent, in their sole discretion, which can be unreasonably withheld, to make the transferee a member.

The exclusive transfer of economic rights to the transferee gives members of the company flexibility. Management rights, however, are influenced by property-rights principles. Therefore, the free transfer of managing rights is restricted pursuant to the way the concept of transfer is tailored in the agreement. The agreements, in general, adopt a broad concept of transfer. For example, transfer means sell, assign, convey, contribute, distribute or give. It may mean transfer by operation of law, whether directly or indirectly, voluntarily or involuntarily. The meaning can comprise the transfer upon foreclosure of a pledge, encumbrance, hypothecation or mortgage. The reason why restrictions on transfers and members rights are so detailed in the agreements has largely to do with this broad concept, which encompasses several forms of bargaining. Members enjoy management rights and economic rights, which they have to account for each and every time they transfer their units. The effects of the un-consented transfer of shares determined in the agreements echo this dual structure of the shares. Besides, they are reflective of the multiple layers of bargaining covered by the concept of transfer.

In view of the partial unenforceability of the un-consented transfer of shares, for only economic rights can be transferred, it is crucial to understand how the share sale and purchase agreement (SSPA) is affected and the effects restrictions have on the definition of members’ property rights in their shares. This begs a careful study of the nature of the shares (are they composed of management rights, economic rights, or other types of rights?). Answering this question is a very important task that will enable the definition of property rights in shares and clarify which rights can be lawfully transferred. It will open the floor to revisiting and rethinking old principles of property law, such as the principle of numerus clausus. It will establish the ground for a new conceptualization of property rights, which does not rely so much on an individualistic perception of the institution. Finally, it will provide room to explore whether it is possible to create an alternative system of transfer of property rights in shares through the adoption of a principle of abstraction and a principle of separation, which is dominant in German contract law and other German-speaking countries.3

This Article is structured in the following manner. Part II dwells on a definition of consent lato and stricto sensu. The purpose of these definitions is to distinguish between those situations in which an overall authorization is required by the law for the execution of a transaction from those situations in which compliance with specific requirements such as the consent of the company, pre-emption rights, and other types of restrictions are demanded by the law or the company’s articles. On one hand, this Part tries to understand if consent lato and stricto sensu are part of the SSPA. On the other hand, it tries to explain how these two forms of consent are liable to affect the validity of the SSPA. Part III focuses on the characteristics of the shares. It argues that, physiologically, rights in shares are similar to property rights. This Part also pays attention to the morphology of shares and tries to describe their structure. Part IV suggests a reconceptualization of property rights based on a new reading of classical principles of property and contract law such as the principles of numerus clausus, consensualism, abstraction, and separation. Part V concludes.