When forming a new LLC, business founders should be aware of the impact of community property law. Community property law is a legal system that gives a person’s spouse partial ownership in all property acquired during the marriage. The spouse’s interest vests automatically and regardless of whether the spouse is listed as a member in the formation document or operating agreement.
There are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. If a LLC member who lives in one of these states forms an LLC, that member’s spouse generally has a community property interest in the LLC. Even if the spouse is not listed in the documents, the community property interest can give the spouse the ability to manage, control, or dispose of a membership interest in the LLC.
Community property rights can result in unintended consequences to the LLC and—if the LLC is or could be owned by multiple members—to the other members. Business founders who form an LLC with a co-owner do so because they want to be in business with the co-owner. The same may not be true for the co-owner’s spouse. Community property rights can force a co-owner into a business relationship with someone they hardly know.
There are two ways to plan for community property interests acquired by a spouse: conversion to separate property and spousal consents. Each of these options are discussed below.
Converting Community Property to Separate Property
One way to deal with community property interests is to have each member’s spouse sign an agreement acknowledging that interests in the LLC are the member’s separate property and should not be considered community property under state law. Doing so effectively converts the community property to separate property and removes any doubt about the spouse’s interest in the LLC.
Although converting community property to separate property resolves the issue, it is not an acceptable choice for many founders. It requires a post-nuptial agreement which, to be enforceable, may require a formal disclosure of all marital assets and advising the spouse to find his or her own attorney to negotiate the agreement. This type of legal complexity is often unpalatable to many married couples, who would prefer to avoid a potentially adversarial relationship with each other over a new business formation.
Using LLC Spousal Consents to Plan for Community Property Interests
A spousal consent is a document—signed by the spouse of a member—that consents to the operating agreement and acknowledges the business structure. The following sample form is illustrative of the provisions typically included in a spousal consent.
Unlike the first option, a spousal consent does not change the nature of the property from community property to separate property. Rather, it agrees that the spouses will work things out so that, if they divorce, the non-member spouse will accept assets other than the LLC membership interest as part of the divorce settlement.