Formation-of-an-LLCThe South Carolina limited liability company is the business structure of choice for the majority of new business owners.  Formation of an LLC can offer many advantages.  Chief among those advantages is an LLC’s flexibility, both its tax structure and governance of its internal affairs. With less stringent requirements for compliance and less necessary paperwork than South Carolina corporations, LLC’s are easier to keep in good legal standing.

The flexibility provided in the LLC structure, however, is not permission to be informal in its formation or governance. Consider the recent case before the 8th Circuit Court of Appeals, Robl Construction, Inc. v. Homoly – April 1, 2015.

Background. In 2002 two individuals formed a two-member LLC, owning 60% and 40%, respectively. The LLC began to have financial problems in 2004, operating at a loss between 2006 and 2011. During this time, one member, the contributing member, periodically advanced nearly $450,000 to the LLC. Such advances are the subject of the member dispute, with the contributing member contending that non-contributing member personally guaranteed to pay his portion of the advances, pursuant to the terms of a standalone Buy-Sell Agreement and the LLC’s Operating Agreement, and also claiming that the non-contributing member had breached such Operating Agreement by failing to repay his 40% share of the loan.

The non-contributing member in turn argued that while the advances may have been a loan, the non-contributing member never personally guaranteed to repay it. In the absence of a clearly drafted LLC Operating Agreement, the member dispute centered on e-mail correspondence between the parties as well as interpretation of the LLC’s Buy-Sell Agreement.

A limited liability company is the premiere business structure in South Carolina for new enterprising business owners or executives. Through tax structure flexibility and internal governance leniency, a limited liability company minimizes legal paperwork and regulatory constrictions to help young businesses focus on getting their company off their ground. As evident in Robl Construction, Inc. v. Homoly, growing businesses must still be incredibly careful to comply with the legal guidelines of the formation of a limited liability company. Our South Carolina business organization attorneys provide the legal counsel for entrepreneurs and executives to properly follow establish their limited liability company.

A few facts of the case:

Email Correspondence

In support of its claim, Robl (contributing member) pointed to email correspondence between Vera Robl, the Company’s accountant, and Homoly (non-contributing member). In mid-2006, Vera emailed Homoly to notify him that the Company needed “to make a capital call or increase loans on existing inventory” and told Homoly that Robl had “put in $71,500 so if you go the route of capital call, your share to get caught up would be $47,666.” Vera asked Homoly to “let [her] know what to do.” Homoly responded asking whether the $47,666 included $34,900 he previously contributed. In her next email, Vera explained to Homoly: “No, the 71,000 is new money we’ve put in to cover all the carrying costs of the inventory. To match it, you would need to put in 47,666. . . . I’ve been treating the 71,000 like a loan from Robl Const, but I need to known what the plans are – will it be capital and you will match it, or will it be a loan and be repaid?”

A few days later, Homoly responded to Vera by email letting her know that contributing the requested $47,666 “would be a good sized hit for [his] liquidity” and that he “would prefer the money from Robl to be considered a loan and then [Robl] get[s] repaid with interest.” Homoly concluded his email by saying, “If Steve would rather me put in a capital call, however, I will go ahead and write the check.”

Vera’s email reply stated that there was no money in the Company so she advanced money from Robl Construction, thinking they’ll “get caught up” later. She then told Homoly she would not make any journal entries until Homoly and Steve talked it over. Robl claimed the parties later agreed to treat the advances as a loan personally guaranteed by Homoly, while Homoly argued that the advances may have been a loan, but that Homoly never personally guaranteed to repay it. In March, 2011, Robl formally demanded that Homoly repay his share of the unpaid loan, and when Homoly refused, Robl sued for breach of contract.

LLC’s Operating Agreement and standalone Buy-Sell Agreement Provisions

In addition to the email correspondence, the parties’ dispute also turns on the interpretation of their written agreements. The Operating Agreement provided that no member is authorized to create “any obligation or commitment of the Company, including the borrowing of funds, in excess of $10,000.00” or to commit “any act which would cause a Member, absent such Member’s written consent, to become personally liable for any debt or obligation of the Company.” The Buy-Sell Agreement provided that if the “Company actively seeks and needs a loan (otherwise a personal guarantee is irrelevant and not necessary),” then prior to making any loan, “both the lender and borrower make separate requests that the respective LLC members personally guaranty the Company’s debt.”

On appeal following the lower court’s summary judgment in favor of the non-contributing member, the 8th Circuit reversed and remanded for further proceedings, ruling that the evidence was not so one-sided that the non-contributing member must prevail as a matter of law, and that a reasonable jury could return a verdict for the contributing member on his breach of contract claim.

Conclusion

Although nothing in the 8th Circuit’s or the lower court’s opinions confirms this, we can reasonably assume that the two members were good friends looking to join forces, leverage their talents, and operate a profitable real estate development company. After many years of operating at a loss, they all started losing patience with each other. Unmet expectations resulted in frustration and resentment, and the parties found themselves in court fighting over money.

While parties rarely enter into a business relationship expecting failure as an outcome, unfortunately the scenario above is far too common. Our Charleston corporate attorneys offer the following counsel to all new and existing business owners prior to LLC formation:

  • Expect the best, but assume the worst. Ensure all LLC documents, specifically the LLC operating agreement, provisions for worst-case scenarios.
  • Formalize all LLC agreements. Resist the temptation to make “gentleman’s agreements” with business partners for the sake of time or convenience
  • Keep in mind that email is discoverable and may be relied upon to determine the parties’ intent should a dispute arise
  • Read and understand agreements before signing them and realize that ignorance of the law (or the terms of the contract) is no defense
  • Comply with the terms of an entity’s governing documents at all stages of a proposed action or transaction
  • Consider amending the terms of an entity’s governing documents if they no longer meet the needs of the entity or serve the intent of its owners.  In other words, maintenance is critical to keep all LLC documents up-to-date so that they reflect the appropriate operating structure and governing provisions