Code Transferable_Interest CodeDistribution
JayNote: The boldface emphasis found in the Reporter's Comments were not found in the original, but was added by me because I found those particular passages to be of special importance. Note that the Reporter might disagree.
JayNote: The "general rule"* is that anything, whether cash or other assets, that is transferred to a member will be considered to be in the nature of a distribution, but with the caveat that whatever is received must be "on account of a transferable interest or in the person's capacity as a member", i.e., the member would receive that amount of money simply because of the member's equity ownership in the LLC and nothing more.
The language used here gives rise to myriad unanswered questions, such as whether management fees or or other compensation in the nature of salary or wages would be considered "on account of a transferable interest or in the person's capacity as a member." Look down to ¶ (B) below, and you will see that the answer is "no, negative." Although LLC planners naturally detest analogies to stock corporations, the analogy here to distributions from an LLC as being very similar to a stock distribution seems appropriate. Thus, Jim can own shares in Microsoft and earn dividends from those shares, while also acting as an employee of Microsoft and earning a salary that has utterly nothing to do with his distributions.
It is for this reason that the "best practice" for creditor rights attorneys is to serve, concurrently with a charging order, a garnishment, wage levy, assignment order (and/or whatever else is appropriate in a given jurisdiction) so as to pick up any non-distribution income received by the debtor/member.
Thus, once again illustrating the legal cynicism that "general rules are generally inapplicable".
JayNote: The use of the term "includes" of course denotes that the following two items are not the only things that would be considered distributions, but instead are exemplary.
JayNote: If the member is bought out, the buy out (at least to the extent that value is given by the company for the member's interest) would be a distribution as to the member. Likewise, if the LLC were wound up, the value paid by the member for her share of the assets in the LLC would likewise be considered a distribution.
Reporter's Comment to § 102(4)(A) ¶ 1.
“Distribution” [(4)(A)—redemptions included]—
This provision specifically refers to transactions between a limited liability company and one of its members, which in the corporate context would be labeled a “redemption.”
The paragraph has subparts because ownership interests in an LLC are conceptually bifurcated into economic rights (“transferable interest”) and governance and information rights.
Reporter's Comment to § 102(4)(A) ¶ 2.
Under Section 404(a), “[a]ny distribution made by a limited liability company before its dissolution and winding up must be in equal shares among members and persons dissociated as members . . . .”
Since a redemption is a distribution, absent authorization in the operating agreement an LLC may not redeem the interest of one member or transferee without redeeming (or at least offering to redeem) the interests of all other members and transferees to a comparable extent.
Reporter's Comment to § 102(4)(A) ¶ 3.
The law of close corporations has flirted with a similar notion.
See, e.g., Donahue v. Rodd Electrotype Co. of New England, Inc., 367 Mass. 578, 598, 328 N.E.2d 505, 518 (1975) (stating, with regard to closely held corporations, “if the stockholder whose shares were purchased was a member of the controlling group, the controlling stockholders must cause the corporation to offer each stockholder an equal opportunity to sell a ratable number of his shares to the corporation at an identical price”); Toner v. Baltimore Envelope Co., 304 Md. 256, 273, 498 A.2d 642, 650 (1985) (rejecting the “per se breach of duty” approach); Wilkes v. Springside Nursing Home, Inc., 370 Mass. 842, 850, 353 N.E.2d 657, 663 (1976) (stating that “untempered application of the strict good faith standard enunciated in Donahue to . . . will result in the imposition of limitations on legitimate action by the controlling group in a close corporation which will unduly hamper its effectiveness in managing the corporation in the best interests of all concerned”).
Reporter's Comment to § 102(4)(A) ¶ 4.
An operating agreement can override Section 404(a)’s equal treatment requirement without specifically mentioning redemptions.
Reporter's Comment to § 102(4)(A) ¶ 5.
EXAMPLE:
Ryan, LLC is a manager-managed limited liability company whose operating agreement:
(i) includes a list (the “protected list”) of decisions or actions that may be taken only with the consent of all members; and
(ii) provides that all other decisions and acts may be taken as the manager determines.
The protected list does not include redemptions.
The operating agreement overrides the Section 404(a)’s equal treatment requirement.
JayNote: If the member gives up some right under the operating agreement in return for payment, such would be considered to be in the nature of a partial redemption of the member's interest, and thus a distribution.
Reporter's Comment § 102(4)(B).
[(4)(B)—exclusion]—
This exclusion affects the reach of:
(i) the charging order remedy under Section 503; and
(ii) Section 405’s clawback provision.
The effect on the clawback provision reflects the law in several states, see, e.g., DEL. CODE ANN., tit. 6, § 18-607(b) (2012) and VA. CODE ANN. § 13.1-1036 (2012), and makes sense conceptually and as a matter of policy.
See In re Tri-River Trading, LLC, 329 B.R. 252, 266 (B.A.P. 8th Cir. 2005), aff’d, 452 F.3d 756 (8th Cir. 2006) (“We know of no principle of law which suggests that a manager of a company is required to give up agreed upon salary to pay creditors when business turns bad.”).
JayNote: Broken down, ¶ (B) states that the term "distribution" does not include:
(1) Compensation for present services;
(2) Compensation for past services; or
(3) Normal payments make pursuant to a retirement plan or program.
See also, comment to (4) above.