In a recent opinion, the Washington Court of Appeals reminds litigants and their counsel that the provisions of the parties’ LLC Agreement remains of paramount importance. In Newcomer v. Est. of Cohen, No. 86612-5-I, 2024 Wash. App. LEXIS 2169, (Ct. App. Oct. 28, 2024), the Court addressed a rarely reviewed issue: What remedies do LLC managers and members have upon the failure of a member to make a capital contribution. The answer? Check your LLC agreement.
Newcomer’s Facts
In Newcomer, the plaintiff, Newcomer, invested in real estate development LLCs managed by Cohen. Newcomer loaned $600,000 to entities controlled by Cohen, secured by a promissory note with a 20% interest rate. After the loan, Cohen again made a capital call for the real estate development, but Newcomer refused. After Newcomer refused, Cohen attempted to unilaterally offset Newcomer’s $600,000 loan amount against Newcomer’s alleged outstanding capital call obligations in a backdoor attempt to force a capital contribution from Newcomer. However, nothing in the LLC agreement between the parties granted Cohen authority to make this offset.
Court of Appeals Addresses Remedies for Failure to Contribute Capital
The Court of Appeals was then posed with the question of whether Cohen could make the offset when the LLC agreement fails to provide such rights. In short, the Court of Appeals ruled Cohen had no authority to make such an offset. In its analysis, the Court of Appeals started with the bedrock rule on remedies for capital contribution failures found in RCW 25.15.196(3), which allows an LLC agreement to, upon failure to contribute capital, (i) reduce or eliminate a member’s interest, (ii) subordinate a member’s interest to other non-defaulting members, (iii) force a sale of the defaulting member’s interest, or (iv) require a defaulting member forfeit their interest. Notably, this list is not exhaustive, but certainly illustrative. Based on this, according to the Court of Appeals, “an LLC is free to specify in the LLC agreement what the penalty or consequence is for a member who fails to make any contribution.” Newcomer, Wash. App. LEXIS 2169 at *19.
In light of this, the Court of Appeals looked to whether the LLC agreement allowed Cohen to offset Newcomer’s $600,000 loan amount against Newcomer’s alleged outstanding capital call obligations. Unfortunately for Cohen, nothing in the LLC agreement allowed Cohen to do so, nor was there any other authority allowing Cohen to do so. As such, the Court of Appeals determined Cohen could not compel Newcomer to provide additional capital in a capital call.
Practical Considerations
First and foremost, practitioners drafting LLC agreements should consider including provisions addressing remedies upon a member’s failure to contribute capital. Drafters should consider whether the list of remedies should be exhaustive or merely demonstrative. Open-ended lists of remedies can be helpful for those in control, but may not necessarily provide certainty for members contributing capital.
Nevertheless, it is always nice to see Washington’s Court of Appeals reinforce the bedrock principle behind nearly all LLC law that the LLC agreement remains of paramount importance.
To learn more about Washington’s LLC Agreements, please contact Beresford Booth at info@beresfordlaw.com or by phone at (425) 776-4100.