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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.
A better option would be to require the non-funding member to repay the amount in a short period of time, or suffer some sort of economic consequence. A simple and effective method to address this issue is through the use of these contractual provisions:
In the event that any Contribution Loan has not been repaid in full by the Non Contributing Member within one hundred twenty (120) days of the date the Contribution Loan is made, the Contributing Member may elect to proceed under Subparagraph (i) or (ii) below.
(i) Upon thirty (30) days’ prior written notice to the Non-Contributing Member, each Contributing Member may elect to treat the outstanding principal balance of the Contribution Loan as an Additional Capital Contribution by the Contributing Member, and the Percentage Interest of each Member shall thereupon be recalculated as of the effective date of such Additional Capital Contribution, and the Non Contributing Member’s interest in the Company shall be diluted, or
(ii) The Contributing Member may elect to make written demand upon the Non-Contributing Member for payment in full of such Contributing Member’s Contribution Loan, including accrued and unpaid interest attributable to such Contributing Member’s Contribution Loan, and upon failure of the Non-Contributing Member to pay the Contribution Loan and accrued and unpaid interest thereon in full within ten (10) days of such demand, to treat such failure to pay as an event of default under the Contribution Loan, in which case the Contributing Member shall have all available remedies at law or in equity (including the right to foreclose on the Non Contributing Member’s interest in the Company under any security interest granted in the operating agreement).
This remedy seems more rational and just. By adding teeth to the enforcement of capital calls under LLC operating agreements, all of the members are able to steer clear of any additional risk exposure.
Our firm’s real estate and corporate attorneys have more than forty years of experience in structuring corporate documents, and we focus on drafting appropriate contractual provisions to protect our clients’ interests.