Chutzpah Too Far
A recent decision of the Eight Circuit Court of Appeals, it interpreting the Illinois LLC Act, held that a member of an LLC cannot extract 30% of the value of the venture when they did not put up 30%. of the risk-capital. Lincoln Provision, Inc. v. Puretz, No. 14-1028, __F.3d __ (8th Cir. Jan. 5, 2015).
Lincoln Provision and Aron Puretz agreed to form Hasting Acquisition, LLC; Puretz was to put up 70% of the required capital while Lincoln was responsible for the 30% balance. They were otherwise to be equal owners. The purpose of the LLC was to bid for and hopefully acquire from a bankruptcy sale two cattle processing plants in Nebraska. Hastings needed to post a $250,000 earnest-money deposit in order to bid; Lincoln put up $100,000 and Puretz the balance of $150,000. Hastings put in the successful bid of $3,900,000 for the two plants.
Even as Hastings was successful in the bid its two members were unable to come to agreement as to the terms of the operating agreement. Puretz advanced to Hastings all of the $3.9 million purchase price; Lincoln did not put up anything toward the purchase except the $100,000 it put up toward the earnest money deposit.
After negotiations had entirely broken-down, Lincoln, through counsel, withdrew from the LLC. Under the Illinois LLC Act, if a member withdraws and the LLC does not dissolve, the withdrawing member is entitled to the fair value of their interest in the LLC. ILCS § 180/35-60(d)-(e). The trial court awarded Lincoln $880,000 as follows: 50% of $3.9 million ($1,950,000) less the 30% of the purchase price Lincoln did not contribute ($1,170,000) plus the $100,000 Lincoln paid toward the earnest money deposit.
There followed this appeal. The Court of Appeals rejected the trial court’s calculation of Lincoln’s value, finding that there was ample evidence of the parties’ agreement that distributions would be first to repay contributed capital before other distributions. As Lincoln had contributed only $100,000, as of the date of its dissociation that was all it was entitled to receive.
Initially, this case is a warning against entering into an LLC before the operating agreement has been agreed upon. Further, it cautions against admitting a member to the LLC based upon future capital contributions obligations unless admission is made contingent upon full performance of those obligations (i.e., make full performance upon the contribution obligation a condition precedent to member status). Why "Chutzpah"? Well, if the classic definition is murdering your parents and then throwing yourself on the mercy of the court because you are an orphan, then I think it applies as well to defaulting on the obligation to contribute to the venture but then insisting that you are entitled to a share of its value.