In Mizrahi v. Cohen,  a dentist and an optometrist formed a limited liability company for the purpose of the construction and operation of a mixed-use building in which they intended to set up their individual offices. They did not have an LLC agreement at the time the LLC was formed but it was implemented a few months later when they purchased the land because the lender required an LLC agreement. The attorney who represented both members at the closing drafted an LLC agreement. The agreement provided, among other things, that:
Each member owned a 50% membership interest in the company;
After the initial capital contributions, the amount of which was not set forth, no member would be required to contribute additional capital, unless required by a vote of all members;
No member had the right to receive any return of any capital contribution; and
Upon dissolution, the LLC assets were to be distributed first to creditors of the company and then to the members, in proportion to their respective ownership shares.
They both contributed about the same amount towards the down payment and made approximately equal capital contributions to the LLC for about three years. However, at some point, their contributions started to differ. Over time, the dentist contributed approximately $1.4 million in capital to the company, while the optometrist contributed only about $317,000. The accountant for the LL stated the LLC experienced net operating losses in each year and it would have failed without the use of proceeds of the mortgage loan and capital infusions by the dentist, which were used to cover its operating expenses. The dentist filed a suit, seeking judicial dissolution of the LLC and an order authorizing him to purchase the optometrist’s membership interest upon dissolution.
On appeal, the court determined that the trial court correctly ordered the dissolution of the LLC since it was not reasonably practicable for the LLC to continue to operate under the circumstances, because it was financially unfeasible. Considering the dentist’s excess capital contributions, the court found that the LLC agreement was silent as to the issue of equalization of capital contributions. And because the written agreement was unclear in this respect, the lower court considered an affidavit submitted by the optometrist, which showed that the excess contributions were to be treated as loans to the LLC. Therefore, the court held that the excess capital contributions were loans to the LLC that could be repaid upon the dissolution of the LLC, and the appeals court agreed.
Here, again, the two business partners would have benefited from a more carefully drafted LLC agreement tailored to their specific needs, clearly explaining their respective capital obligations and buyout provisions. The importance of a well-written operating agreement can never be emphasized too much.
This post was the fourth part of our multi-part series on business partnership, disagreement, and dissolution. You can find the other posts by searching our blogs. If you have any questions about the content of this blog or any business law issues not discussed here, please contact us.
This posting is intended to be a tool to familiarize readers with some of the issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity. Freeimages.com/Photographer Gregory Kazarian.
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Make sure you download our free reports on how to build your company the right way.About the AuthorR. Shawn McBride — is the Managing Member of The R. Shawn McBride Law Firm, PLLC. Shawn works successful, private business owners in their growth and missions to make a company that stands the test of time. You can email R. Shawn McBride Law Firm or call (214) 418-0258.