The Invisible LLC Member Looks in the Mirror and Is Not There

What happens if you are not named as a member of a limited liability company on any official documentation even though you think you own 1/2 of the company??

In Chase v. Hodge, decided on March 5, 2024, by the U.S. Court of Appeals for the Fifth Circuit, Chase unsuccessfully attempted to prove his ownership in Helping Hands Capital, L.L.C.? Chase claimed that he, Hodge, and Guedri were each intended to be equal owners of Helping Hands when it was formed in 2013.? But neither Guedri nor Chase were ever listed as owners of Helping Hands.? According to Hodge, Guedri and Chase were never owners.? Hodge said Chase had an ‘economic benefit only’, not ‘legal ownership.’?

Whatever his involvement, Guedri exited the deal in 2016, after which Chase thought he and Hodge were now 50/50 owners.? Hodge says not so.

Chase, Guedri and Hodge had been co-owners of another business at the time Helping Hands was formed in 2013.? It is not unusual, in my experience, for co-owners who have become accustomed to working together, to form new entities and fail to document the ownership of those entities.?

That appears to be what happened here.? Chase had the burden to prove that there was a contractual agreement making him a member of Helping Hands, but by law he needed that in writing.?

When I’ve had clients like Chase cross my legal threshold without the regular LLC documents to prove their ownership, I’ve looked at the entity’s public records and the tax documents that they have received.? So did the court.? The Certificate of Formation provides that the entity is member managed.? That means that all members must be listed, but only Hodge was listed.? This is a major blow against Chase.? Chase argued the Certificate of Formation is not required to list all members, but it is if it is a member managed entity listing all members is required.? That is why I try to steer my clients away from being Member-managed, so they do not have to disclose their ownership publicly.

Next, if Chase was a member, he should have received K-1s from the LLC, but he did not.? He did receive 1099s, indicating, as Hodge argued, that he was an independent contractor.? The 1099 does not prove that Chase was not a member, but the lack of a K-1 is significant.? In response, Chase argued that if the LLC was taxed as a C corporation, there would be no K-1s, so the fact he never received a K-1 should not have alerted him that he was not a member.? That is a lawyer argument but not very tied to reality.? Most LLCs are formed to obtain the benefit of partnership tax treatment and they do not elect to be double taxed under Subchapter C.? The lack of K-1s each year to Chase certainly should have put him on notice that the world was not as he believed it to be.

For some of the reasons I pointed out above, and others, Chase was unable to prove by any written source that he was a member of Helping Hands Capital, and he lost his case both at the district court level and on appeal.?

My Take: No matter how familiar you are with your business partners in prior deals, you must treat each deal on a stand-alone basis as if it is the only deal between you and your partners and seek to document it accordingly.? If the documentation does not occur, or if it does not match your understanding of what the deal is, you have to stop, figure it out, and correct it.? ??

May you find joy in what you do and who you are with.