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LLC Operating Agreements: Not Just a Form

On Behalf of | Dec 6, 2019 | Bankruptcy, Business, Firm News

By: Laura Day DelCotto

In financial workout, litigation and bankruptcy settings, we often see problems and disputes which have arisen in limited liability company (LLC) settings. More often than not, financial issues among and between members bubble up to the surface. Being the most solvent of all the members is never a good place to be when everyone has guaranteed debt. Likewise, being the member who gets the most out of the deal may mean the other members will be less than pleased in some aspect of the ongoing business affairs, and seek ways to change them.

The Kentucky Court of Appeals has recently issued a good reminder that the LLC operating agreement sets the standard. This is common sense and nothing new, but you’d be surprised how often the operating agreements are not being followed. They also may seem irrelevant to members in the day to day affairs of running the business. We see all formats of operating agreements, everything from big-firm lengthy documents, to free online versions, to those written up by non-lawyer members themselves.   Whatever the case, the words matter.

An Example in Practice

In Blue Equity Holdings Kentucky , LLC v. Cobalt Riverfront Properties, LLC and Cobalt Enterprises, LLC, the Blues Brothers of Jefferson County appear to have had a falling out over the ongoing “management fees” paid to one brother. The fees were approximately $140,000 annually from a parking lot vs. listing the property for sale, allegedly for a value in excess of $40 million.  The Jefferson Circuit Court dismissed the action for a judicial dissolution, which was upheld in an unpublished opinion by a panel of the Kentucky Court of Appeals, No 2018-CA-001092-MR, issued on August 30, 2019.

KRS 275.290(1) governs judicial dissolution, and provides that a court may act to dissolve an LLC upon a showing that “it is not reasonably practicable to carry on the business of the limited liability company in conformity with the operating agreement.” In this case, both courts held that the Operating Agreement was unambiguous.  It had a broadly worded “purposes” clause and no time restrictions or other remedy to oust the one brother member who was placed in charge of decisions. Operating the property as a parking lot was well within the “purposes” clause.

As the state court opinion noted, “[T]he plain language of the Operating Agreement does not support Petitioner’s attempt to substitute its opinion as to when the Property should be sold for that of Respondents, and Petitioner may not invoke KRS 275.290 to accomplish that end….”  While one appellate judge dissented, finding that disputes over what is “reasonably practicable” would be a fact question, this position did not carry the day.  The dismissal of the action was affirmed.

In all settings, large and small, please remember that the LLC operating agreement is crucial. It is not just some “form” to use and merely skim, change the names, and sign.  Think about what could go wrong, what might change down the road, and make efforts to use non-legalize words that express the members’ intent. Also know that no matter what, internal LLC member disputes are a fact of life, and are costly to deal with after the fact.

About DelCotto Law Group

DelCotto Law Group is Kentucky’s asset protection law firm known for its commitment to the lifetime success of its clients. With offices located in Lexington, Louisville and Danville, DLG serves Kentuckians with complicated financial matters, especially in the areas of bankruptcy and complex litigation. For more information please call (859) 231-5800, email [email protected] or reach us on our contact page.