A Member has not met his capital requirement, what can we do?

Steven D. Goldberg, Esq. Wilmington, DE
Contact me if you need assistance in forming/organizing a Delaware business entity or any matter of Delaware law. Delaware Forms and Publications are available at http://www.delawarellclaw.com

This is unfortunately a common problem.  Section 18-502 of the Delaware LLC Act addresses this question.  Under Section 18-501 the contribution may be in the form of  “cash, property or services rendered or a promissory note or other obligation to contribute cash or property or to perform services.” The problem thus arises when the future obligation is not met.

Section 18-502(a) provides in part that “a member is obligated to a limited liability company to perform services, even if the member is unable to perform because of death, disability or any other reason.” The Section goes on to state that in the case the member fails to meet his or her obligation they are obligated to the company for the moneys-worth of the obligation. “The forgoing option shall be in addition to, and not in lieu of, any other rights, including the right of specific performance, that the limited liability company may have against such member under the limited liability company agreement or applicable law.”

Section (c) provides in part that the agreement “may provide that the interest of any member who fails to make any contribution … shall be subject to specified penalties for, or specified consequences of, such failure. Such penalty or consequence may take the form of reducing or eliminating the defaulting member’s proportionate interest in the limited liability company, subordinating the member’s limited liability company interest to that of nondefaulting members, forced sale of that limited liability company  company interest, the lending by other members for the amount necessary to meet the defaulting member’s commitment, a fixing of the value of his or her limited liability company interest by appraisal or by formula and redemption or sale of the limited liability company interest as such value, or other penalty or consequence.”

As we can see the Act gives the drafter of the company agreement many options to enforce the member’s obligation by way of penalties or consequences. In the absence of a carefully drafted agreement the remedy for a member failing to make the contribution is a suit at law to enforce the monetary obligation or an action at equity to specifically enforce that obligation.  In a recent case the Court of Chancery invoked some of these remedies in the case of a member who flagrantly and repeatedly violated the agreement to the financial detriment of the other members. Given the level of violation in that case I would not rely on that case on lieu of a carefully drafted agreement.

The question, and the provisions of Section18-502, point up the need for a carefully and professionally drafted agreement. You may reach me at sgoldberg@stevendgoldberg.com.

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