The use of the limited liability company (“LLC”) corporate structure has become very common in the real estate industry. It is the go to structure for the acquisition and development of properties by parties joining together behind a venture. LLCs are governed by operating agreements among the members. These agreements are akin to the shareholder agreements among the shareholders of closely held corporations, and they govern many aspects of the operations of the venture. One element in these operating agreements that bears close scrutiny by all of the members is the enforcement mechanisms that they put in place should any members fail to honor their obligations to fund future capital calls.
In truth, many LLC operating agreements contain inadequate payment enforcement provisions, making them potentially problematic and inequitable for the company itself and the members who honor their obligations and make future capital calls on a timely basis. For example, if a member fails to meet their financial obligations, it is fairly common for these agreements to provide that the other members of the LLC may contribute the missing funds and treat them as a loan to the non-funding member. Often times, the agreements provide that the loan will then be repaid to the funding members, with interest, once the LLC is in a position to make future distributions to its members, with no further enforcement methodology.
Such arrangements provide an unmerited level of flexibility to the non-funding member, as it enables them to weigh the pros and cons of making their required contributions or taking a loan from their partners to avoid any additional loss risk exposure in the endeavor.