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Additional Capital Contributions in Member-managed, Operating-company LLC Agreements
Practical Law Legal Update 6-526-5025 (Approx. 5 pages)
Additional Capital Contributions in Member-managed, Operating-company LLC Agreements
by PLC Corporate & Securities
| Published on 25 Apr 2013 • USA (National/Federal) |
A discussion of different drafting approaches for authorizing a managing member of an operating-company LLC to make capital calls.
Capital contributions are the contributions of cash or assets made by a subscriber to an entity either in exchange for an initial equity interest or as part of an ongoing obligation, or capital commitment, to fund the entity. In the context of an investment in a limited liability company, the initial capital contribution is made in exchange for the new member's membership interest. Additional capital contributions may be made periodically, in accordance with a schedule set by the entity's budget or business plan or pursuant to a particular capital call after the initial issuance of the LLC interest.
Whether or not the members expect to have to make additional capital contributions often turns on the transaction context. In private equity buyouts, the members of the holding-company LLC expect to make their entire required investment at the outset to finance the acquisition of the target company. If the company requires additional capital, the members expect the company to raise it either with debt financing or new equity-securities issuances that run through the LLC agreement's pre-emptive rights. To draft the LLC agreement for a private equity holding company, use Standard Document, LLC Agreement (Multi-Member, Board-Managed) (Private Equity Buyout).
Operating companies and joint ventures, by contrast, often need additional capital contributions to fund their ongoing businesses. For this reason, LLC agreements for operating companies and joint ventures usually contemplate the possibility that the members will need to make additional capital contributions. Because this requires a commitment from the members to put up more capital, the provisions governing additional capital contributions can be quite detailed and heavily negotiated. This is particularly the case when a managing member has the authority to make capital calls that the non-managing member must adhere to.
The following example of provisions for the authorization of the managing member to make capital calls is taken from PLC Corporate & Securities' newest resource, Standard Document, LLC Agreement (Two Members, One Managing Member), an LLC agreement drafted specifically for joint-venture operating-company LLCs. Section 3.02(a) of the Standard Document reads as follows:
"(a) In addition to the Initial Capital Contributions of the Members, the Members shall make additional Capital Contributions in cash, in proportion to their respective Membership Interests, as determined by the Managing Member from time to time to be reasonably necessary to pay any operating, capital or other expenses relating to the Business (such additional Capital Contributions, the "Additional Capital Contributions"), provided, that such Additional Capital Contributions shall not exceed corresponding amounts expressly provided for in the Budget, as it may be amended from time to time. Upon the Managing Member making such determination for Additional Capital Contributions, the Managing Member shall deliver to the Non-Managing Member a written notice of the Company's need for Additional Capital Contributions, which notice shall specify in reasonable detail (i) the purpose for such Additional Capital Contributions, (ii) the aggregate amount of such Additional Capital Contributions, (iii) each Member's share of such aggregate amount of Additional Capital Contributions based upon each such Member's Membership Interest, and (iv) the date (which date shall not be less than [NUMBER] Business Days from the date that such notice is given) on which such Additional Capital Contributions shall be required to be made by the Members."
This provision, as drafted, gives the managing member the power to determine the timing and amount of additional capital contributions, but only up to amounts expressly contemplated in a budget agreed to by the parties (see Section 7.06).
The provision also requires the additional capital contributions to be made in cash. If the members want the ability to use non-cash assets to make additional capital contributions, the phrase "in cash" in the first sentence should be deleted and the following sentence about how to value contributed assets should be added:
"If the Additional Capital Contribution shall not be in cash, but shall be in the form of assets, the amount of such Additional Capital Contribution shall be the Book Value of such assets."
If the members also want to give the managing member some discretion to request amounts exceeding the budget to cover unforeseen costs and expenses that are still necessary for the operation of the LLC, they should consider adding the following sentence after the first sentence to allow the managing member to request up to a certain amount above the budget:"Notwithstanding the foregoing, the Managing Member shall be authorized to call for Additional Capital Contributions in an amount of up to [PERCENTAGE]% in excess of the corresponding amounts set forth in the Budget, which amounts shall also constitute Additional Capital Contributions."
Alternatively, instead of giving the managing member the discretion to make capital calls within the limits set by the budget, the members may agree to set the schedule of additional capital contributions in the budget and not provide the managing member with any discretion to decide when and how much money is needed. In that case, Section 3.02(a) should be replaced with the following:"In addition to the Initial Capital Contributions of the Members, the Members shall make additional Capital Contributions in cash, in proportion to their respective Membership Interests, in such amounts and at such times as set forth in the Budget, as it may be amended from time to time in accordance with Section 7.06 (such additional Capital Contributions, the "Additional Capital Contributions")."
If the parties decide to go with a pre-approved schedule, the notice requirement is not necessary.
Another alternative would be to give the managing member full discretion to determine the timing and amount of additional capital contributions. In this case, delete the proviso at the end of the first sentence in Section 3.02(a) and add the phrase "in its sole discretion" after the phrase "as determined by the Managing Member."
If the non-managing member does not want to give the managing member full discretion and there is no pre-approved budget or schedule of contributions, it can try to limit the managing member's ability to make capital calls by only permitting it to request additional contributions for emergency or unanticipated and nondiscretionary expenses (expenses the company must pay by law or contract).
Further Provisions Governing Capital Contributions
The remainder of Section 3.02 of the Standard Document goes on to detail the consequences for failing to make a mandated additional capital contribution. These include provisions for the non-defaulting member to make a loan to the defaulting member and "cram down" the loan into an equity interest if not repaid.
The Standard Document includes other provisions common to member-managed operating companies, including:
- Veto provisions for the non-managing member (Section 7.02).
- A buy/sell procedure for resolving deadlocks (Section 7.07).
- Provisions for removing the managing member (Section 7.10).