When It Comes to Transfers of Ownership Interests, Where There’s a Will There’s Not Always a Way
August 09, 2021
My partner Frank McRoberts recently posted about two New York cases, one involving an LLC and the other a close corporation, in which the courts resolved conflicts between, on the one hand, provision in the operating/shareholder agreement dictating or otherwise restricting the identity of transferees of an owner’s interest upon death and, on the other hand, testamentary bequests of the same interests in the wills of the deceased owner. In both cases, the courts ruled that the transfer provisions in the operating/shareholder agreements prevailed over the inconsistent testamentary bequests.
A recent appellate ruling by a Florida appellate court in Finlaw v Finlaw, resolving a dispute over the ownership of a partnership interest that a deceased partner devised by will to her grandson, presented an interesting twist on the same issue. It also provides a reminder of the need for careful drafting of transfer restrictions in the owners’ agreement as a means of eliminating or at least reducing the likelihood of litigation when the deceased owner’s will bequeaths an interest to someone other than a permitted transferee under the owners’ agreement.
The case involves an Ohio partnership formed in 1986 by two married couples, the Finlaws and the Palmers. In the following decades, three of the four original partners died. After both Palmers died, their interests transferred to their son as expressly permitted by the partnership agreement. When Mr. Finlaw died, his partnership interest passed to his wife, Twila, also as expressly permitted by the partnership agreement. At that point, Twila and the Palmers’ son each held 50% partnership interests.
In 2014, Twila made a will naming her grandson Jeffrey as her estate representative and devising the remainder of her estate to him, which included her partnership interest. After Twila died in 2016, her will was admitted to probate in Florida and Jeffrey was appointed personal representative of her estate.
Twila’s Son Stakes His Claim to Ownership of the Partnership Interest
Enter Twila’s son, Roger, her only child, who filed a claim in the probate proceeding asserting an interest in the partnership, arguing that Jeffrey was not a permitted transferee and that he, Roger, was a required transferee under Article XIX of the partnership agreement entitled “Death of a Partner” and providing:
Any partner shall have the right and privilege of leaving his or her interest in the Partnership by last will and testament to his or her spouse or to his or her lineal descendants.
To protect and preserve the family character of this Partnership, each of the undersigned partners agree to have prepared and to execute a last will and testament so as to ensure that his or her interest in this Partnership will, upon his or her death, pass to and vest in his or her surviving spouse. Each partner, who shall ultimately become a surviving spouse, further agrees to have prepared and execute a last will and testament so as to vest his or her interest in this Partnership in his or her children (lineal descendants). Should any partner neglect or fail to execute such last will and testament, so as to ultimately cause his or her partnership interest to pass to and vest in an individual, who is not a spouse or lineal descendant of these partners, then upon such event, the Partnership shall be liquidated and dissolved forthwith.
However, should the legatee of any deceased partner wish to sell the interest in this Partnership, which he or she has acquired by virtue of the death of a partner, such shall be accomplished in the same manner and form as if the legatee desires to resign as an active partner, all as provided above.
Notice that the first paragraph gives “[a]ny partner” the right to leave a partnership interest to “his or her lineal descendants” without more, whereas the second paragraph requires a surviving spouse to execute a will vesting his or her interest “in his or her children (lineal descendants).”
The term “lineal descendant” is generally defined as someone who is in direct line to an ancestor, such as child, grandchild, great-grandchild and down the line. Hence the crux of the controversy in Finlaw: As the term is used in Article XIX, does lineal descendants include children as well as other lineal descendants such that Twila was authorized to devise her interest to her grandchild Jeffrey? Or did Article XIX require Twila to devise her interest to Roger, her only child (and presumably Jeffrey’s father, although the court’s opinion doesn’t say one way or the other) as the sole permitted lineal descendant?
Roger Sues for Declaratory Judgment . . . And Wins After Trial
Roger subsequently filed a complaint in a separate action asserting his standing as a creditor of Twila’s estate and seeking a judgment declaring that under Article XIX, Roger and not Jeffrey is the sole beneficiary of Twila’s partnership interest. After a trial, the lower court ruled in Roger’s favor, placing primary importance on Article XIX’s second paragraph and stating that “[t]o expand the plain language meaning of ‘children’ to include any other lineal descendants of the Decedent would unnecessarily expand the standard definition of ‘child’ or ‘children’ beyond its plain meaning.” The trial court ordered Jeffrey as estate representative to assign Twila’s partnership interest to Roger.
Jeffrey Appeals . . . And Roger Wins Again
Jeffrey appealed the decision, arguing that the lower court erred in its interpretation of Article XIX by excluding him as a permissible transferee under Twila’s will. His argument focused on Article XIX’s first paragraph generally granting partners the “right and privilege” of leaving a partnership interest by will to spouses and lineal descendants without distinguishing between children and other lineal descendants.
The appellate court disagreed. It concluded that Article XIX’s second paragraph, requiring a surviving spouse to execute a will vesting the interest “in his or her children (lineal descendants),” served as an “explicit further limitation on the devise.” As the court explained:
The grandson has not reconciled his position that all lineal descendants are appropriate recipients of the surviving spouse’s partnership interest with the fact the parties specifically chose to limit the devise to “children” in the agreement. He does not explain how he could fit within that express limitation set by the partners. Instead, the grandson points to the decedent’s attorney’s testimony that the decedent intended to leave her interest to the grandson despite the contrary terms of the partnership agreement. That reliance is misplaced. . . . Thus, having agreed in the partnership agreement to devise the partnership interest only to her children who are lineal descendants, the decedent’s subsequent devise to her grandson instead was contrary to the terms of the agreement. The trial court did not err in so concluding.
Jeffrey alternatively argued that if he was not entitled to inherit Twila’s partnership interest, the lower court should have dissolved the partnership under Article XIX’s provision that, should any partner fail to execute a compliant will and cause the partnership interest to vest in someone “not a spouse or lineal descendant of these partners, then upon such event, the Partnership shall be liquidated and dissolved forthwith.”
The appellate court again disagreed, writing that “dissolution is required only where the partnership interest passes to and vests in someone who is not a spouse or lineal descendant of the partners.” Since Jeffrey as grandson is a lineal descendant, the court held, “this provision was not triggered.” The court further explained its reasoning as follows:
Moreover, the stated intent for the restrictions imposed under section XIX was to “protect and preserve the family character of” the partnership. Considering the section as a whole, it is clear the partners agreed that transfers that violate the restrictions—but which were still within the family, such as to the grandson here—would simply be ineffective by operation of controlling Ohio law, as set forth above. By contrast, transfers to individuals outside of the family would destroy the family character and thereby call for the drastic remedy of dissolution. Thus, because the decedent’s attempted transfer to the grandson kept the interest within the family, the trial court correctly concluded that the dissolution provision was never triggered and properly declined to dissolve the partnership.
Was Article XIX at War With Itself?
Article XIX of the partnership agreement is not a model of clarity, to put it mildly.
If the partners’ intent was to limit the transfer of partnership interests to the partners’ children, there was no need to use the more inclusive term “lineal descendants” which Roger’s and the court’s interpretation essentially rendered meaningless as used both in Article XIX’s first paragraph and the second paragraph’s last sentence requiring dissolution if the will of a deceased partner — whether first or second to die — causes his or her partnership interest “to pass to and vest in an individual, who is not a spouse or lineal descendant of these partners.”
Had the court ruled in Jeffrey’s favor, arguably that would have rendered the word “children” in Article XIX’s second paragraph meaningless. In other words, Article XIX’s use of the term “lineal descendants” three times, but only once in conjunction with the word “children,” rendered the provision ambiguous. Perhaps the only solid conclusion is that the drafter of Article XIX created a provision at war with itself, leaving the court with the unhappy task of divining the intent of the original partners, none of whom was alive and available to testify at trial, by choosing between two inconsistent but equally reasonable interpretations.
I asked my partner Eric Penzer, who concentrates in trusts and estates litigation, for his perspective on Finlaw. Here’s what he wrote:
The first paragraph of Article XIX expressly, and unequivocally, grants to any partner the authority to bequeath his or her partnership interest to “his or her spouse or to his or her lineal descendants.” The use of the phrase “lineal descendants” in that provision cannot be deemed insignificant. Had the partners sought to limit the permissive transferees to only those lineal descendants in the first line of succession, they certainly could have, and most likely would have, used the simpler and more readily understood term “children.” They did not. The first paragraph of Article XIX provides the “backdrop” against which the courts could have construed the subsequent provisions of the Article.
At best the subsequent reference to “children (lineal descendants)” in the second sentence of the second paragraph of the Article is ambiguous; and when read together with the first paragraph of Article XIX and the third sentence of the second paragraph of the Article, the reference is nonsensical. Absent extrinsic evidence concerning the parties’ intentions, it is anyone’s guess what they intended through the use of that phrase. The exercise in which the courts engaged in attempting to reconcile these provisions is of the result-oriented variety.
Assuming, however, that the courts were correct in their determination that Twila’s bequest to Jeffrey was impermissible, the proper remedy would have been to dissolve the partnership, with the result that Jeffrey would have inherited the economic interest attendant to Twila’s interest therein. Indeed, that is the result provided in the third sentence of the second paragraph of Article XIX – bequeath your interest to a permissible transferee or dissolve the partnership. The remedy the courts granted, essentially providing a “forced inheritance” to Roger, who Twila clearly intended to inherit no portion of her estate, is not only contrary to Twila’s testamentary intent, but worse, finds no support in the agreement itself.