LLC Restricted to Penalty Detailed in Operating Agreement to Apply Upon Failure to Meet Capital Contribution Obligation

LLC Restricted to Penalty Detailed in Operating Agreement to Apply Upon Failure to Meet Capital Contribution Obligation

It is not at all atypical for LLC operating agreements to provide that, from time to time, that members may be required to contribute additional capital to the venture. It is likewise not atypical for one or more members to fail to satisfy those obligations. Anticipating that circumstance, it is incumbent that the operating agreement address what happens upon such a default, including how those funds may be otherwise raised and the consequences to the defaulting number. In a recent case out of the North Carolina Business Court, the court held that where the operating agreement identified either of a pair consequences to a member defaulting upon an additional capital contribution obligation, the company could not otherwise address the default. Chisum v. Compagna, 2017 NCBC 61, 2017 WL 3113414 (N.C.B.C. July 20, 2017).

Chisum was a member in Judges Road Industrial Park, LLC (“Judges Road”), the other members being Rocco Compagna and Richard Compagna (collectively “Compagna”). The operating agreement for Judges Road provided that, from time to time, the members would make additional capital contributions when determined that such were needed by the Managers. That determination by the Managers required, in effect, approval of a majority in interest of the members. Initially, Chisum held 35% of the interest in Judges Road. Over time, there were certain reassignments in the ownership of the company, ultimately reducing, it would seem, Chisum’s interest in the company to 16.66%. The operating agreement went on to detail the consequences of any failure to contribute additional capital, pursuant to which the other members were allowed to contribute the missing funds to the company or, in the alternative, loan them to the company.  If treated as a capital contribution, the contributing members pro rata portion of the company would increase.  It came to pass that an additional capital contribution of $100,000 was to be made, of which Chisum was to pay $16,666.66. When Chisum did not meet this capital contribution, Compagna satisfied it in full, and asserted that in consequence Chisum’s interest in the company was reduced to zero. Chisum objected, asserting that, under the operating agreement, he was at most subject to dilution, but not termination as a member.

Parsing the operating agreement, particularly section 8.1(b) thereof, and as well considering the method of valuation to be applied upon the proposed transfer of a membership interest, the court concluded:

This Court has thoroughly considered the language of section 8.1(b) of the Operating Agreement and concludes that it is unambiguous and does not permit a member’s Membership Interest to be diluted to zero, or extinguished, by his failure to contribute capital in response to a capital call. The unambiguous language of the Operating Agreement provides that a contributing member making a Capital Contribution for a non-contributing member is credited with one additional Capital Unit for each $1,000,000 of “Additional Capital” contributed. Each member’s Membership Interest is then adjusted by dividing the member’s aggregate Capital Units by the new total aggregate number of Capital Units held by all members. As a result, the contributing member’s Membership Interest proportionally increases, the non-contributing member’s Membership Interest proportionally decreases. Since the non-contributing member is not required to sell his Capital Units to the contributing member, the non-contributing member’s Membership Interest can be proportionally reduced in relation to the total number of Capital Units outstanding, but can never be reduced to 0.

With respect to the ability, in a Kentucky organized LLC, to define the consequences of any failure to contribute additional capital or otherwise satisfy obligation undertaken in the operating agreements, see KRS § 275.003(2).