McBride Law Blog

Capital Contribution, Post 2

McBride Law Blog

// R. Shawn McBride // No Comments »

Post 2

Chiu v. Chiu, a case that was decided just this February, involved a dispute between two brothers regarding a limited liability company formed to hold title to a warehouse, with a 75% / 25% ownership split based on their initial cash contributions.  The brothers did not have a written operating agreement.  The case raised various issues, but of note, the court had to decide whether funds subsequently provided by one of the brothers, was a loan or capital contribution.  The trial court had determined that it was a capital contribution.  Reversing the trial court’s decision, however, the appeals court held that the lower court “incorrectly determined that the subsequent contributions by Man Choi Chiu should be treated as capital contributions, and not as loans, as the record was bereft of any evidence of an agreement between the members to such treatment.”[1]  The court did not elaborate on this issue further, but it seems pretty clear from the opinion that, absent contrary agreement or provisions in an operating agreement, additional capital infusion by an LLC member is to be treated as a loan, rather than a capital contribution.

 

This, of course, was not the first case on the issue.  The Chiu court cited Mizrahi v. Cohen, another recent case, which involved a dentist and an optometrist as 50% / 50% members of an LLC formed for the purpose of the construction and operation of a mixed use commercial/residential building.[2]  Here, the parties did have an LLC operating agreement (“LLC agreement”), which provided that each owned a 50% membership interest in the company.[3]  The LLC agreement did not set forth the amount of the parties’ initial capital contributions, but it did provide that, after the “initial capital contributions,” no member would be required to contribute additional capital unless required by a vote of all the members of the company.[4]  The parties contributed approximately equal funds at first, but as the business began to operate at a loss, the contributions by the dentist far exceeded those by the optometrist.[5]  When the dentist sued for dissolution of the LLC and an accounting of the proceeds of the company, the lower court held, and the appeals court agreed, that the capital contributions of the dentist were to be treated as loans to the LLC to the extent that those contributions exceeded those made by the optometrist, so as to avoid an inequitable result.[6]  Here, the distinction mattered greatly because the LLC agreement provided for the repayment of debts of the LLC upon dissolution, but not return of capital contributions.[7]

 

Finally, Duff v. Curto[8] involved an ambiguous, if not incomplete, LLC agreement.  The LLC agreement at issue required each member to provide 50% of the capital contributions to the real estate LLC and referred to Exhibit “A” for the specific amount of initial cash contribution by each member, but that column of the membership table in the exhibit was left blank.  As it turned out, Curto failed to make any capital contributions whatsoever, while Duff contributed funds to cover the cost of construction and loss upon the sale of the property.  Duff sued, asserting breach of contract, negligent/intentional misrepresentation, unjust enrichment, conversion, and fraudulent inducement, based on Curto’s failure to make any capital contributions.  Finding that the LLC agreement was ambiguous, the court considered extrinsic evidence of the parties’ intent and concluded that the funds were a loan and not a capital contribution.[9]

 

Overall, looking at the particular circumstances of each case, the results are not surprising.  Nevertheless, these cases should serve as a reminder that it is far more prudent to have a written LLC agreement at the outset of a business relationship that spells out each business partner’s rights and obligations with specificity.  The importance of advance planning and well-thought-out “business pre-nups” is here to stay.

 

About the Author

 

So-Eun Lee – So-Eun Lee is an associate attorney in the New York office of The R. Shawn McBride Law Office, P.L.L.C.  She concentrates her practice on business law.  So-Eun can be contacted at: (347) 921-0173 or soeun.lee@rsmlawpllc.com.  Her profile is available on www.mcbrideattorneys.com.

Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Office, P.L.L.C. which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: (214) 418-0258; shawn.mcbride@rsmlawpllc.com, or www.mcbrideattorneys.com.

 

[1] Chiu v. Chiu, 2015 N.Y. Slip. Op. 01427 (N.Y. App. Div. Feb. 18, 2015), at 3.

[2] See generally Mizrahi v. Cohen, 104 A.D.3d 917 (N.Y. App. Div. 2013).

[3] Id.

[4] Id.

[5] Id.

[6] Id.

[7] Id.

[8] See generally Duff v. Curto, 2012 N.Y. Slip. Op. 30264(U) (Sup. Ct. Suffolk Cty. Jan. 25, 2012).

[9] Id. at 4.

Posted In: Multiple Owners, Partnerships, Uncategorized

Facebooktwittergoogle_pluslinkedinmailAbout the Author Shawn works successful, private business owners in their growth and missions to make a company that stands the test of time. You can email or call (214) 418-0258.


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