Beware of "Capital Calls" in LLC Operating Agreements
One item often overlooked by parties while negotiating or deciding to enter into an Operating Agreement for a limited liability company or (“LLC”) with more than one member is what is often times referred to as a “capital call.” Buried deep in what can be voluminous pages of “legalese” contained in many LLC operating agreements, may lurk a requirement that members of the LLC contribute additional capital to the LLC - that is, more than their original investment . This can be triggered by majority vote, or, if so provided in the Agreement, by demand of a single Managing Member if he or she is given such power.
Many investors in an LLC assume that once they make their initial capital contribution, they will not be required to contribute more, even if the underlying business is performing badly, unless they specifically agree to do so, or if “everyone” agrees to do so. Many times quite the opposite is true, and the unsuspecting investor could be facing some rather negative consequences.
For example, if a “capital call” provision exists and is exercised by the majority members or by the managing member and one of the members cannot afford to put in the required capital, such member could face expulsion from the LLC, dilution of their ownership percentage in the LLC, super-dilution of their ownership percentage to the point where their percentage is effectively worthless, or other negative consequences. (There can be other consequences, but these are some of the typical ones seen in these types of agreements)
Capital calls in and of themselves are not “bad” or disadvantageous, and can and do serve an important purpose for the LLC and its members, but the members negotiating their operating agreement should be aware of such provisions and discuss fully with the other members when and on what terms capital calls can be made, if at all. For more information, please contact us.
