Q: My son wants to invest in his friend’s LLC and has asked for a loan that would be supported by the LLC interest he buys. What do we need to do to show that I have an interest in the business if the loan is not paid?
A: Your son is proposing to use the money you lend him to buy a limited liability company (LLC) membership interest and to “pledge” the interest to you as security for repayment of your loan to him. To assure that you can have a perfected interest that allows you to assume ownership of the LLC interest upon loan default, you would need to make sure: (1) the LLC interest is a security under Article 8 of the Uniform Commercial Code; and (2) you have perfected your security interest in the LLC membership interest pledged to you.
Assuring that an LLC interest is a security requires that the limited liability company operating agreement of the LLC includes a statement that each membership interest in the LLC constitutes a “security” within the meaning of Article 8 of the Uniform Commercial Code (including Section 8-102(a)(15)) applicable in the jurisdiction of the LLC’s formation. You will need to review the LLC’s operating agreement and ask that this statement (or something like it) be inserted if it is not already included in the operating agreement.
Then you will need to perfect your interest in the pledged LLC membership interest by obtaining control over the interest while the pledge is outstanding and by filing a UCC-1 financing statement in the state where your son resides. To obtain control over the LLC interest while the pledge is outstanding, you will need to possess the original certificate representing the LLC membership interest. But if, as is the case with many LLCs, your son’s investment LLC does not issue certificates representing membership interests, you will need to make sure the LLC acknowledges your rights to the membership interest by signing a control agreement (acknowledging that you have the right, upon exercise of the pledge, to own the membership interest and become a full member of the LLC) or, at least, countersigning the pledge agreement between you and your son.
Also, when filing the UCC-1, it will be important that you adequately describe the pledged interest and indicate that the interest encompasses both economic and governance rights.
M.L. Geffert can be reached at [email protected].
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