Contributions, Capital Accounts and Member Loans

Scope of the chapter. An LLC is financed by its members in two ways. Members contribute capital in exchange for their interests, and members lend money to the company on terms that make them creditors. The two forms of finance carry different rights. A contribution buys an equity interest whose value depends on the success of the venture and whose return is subordinate to the claims of creditors. A loan creates a debt that is repayable on stated terms and ranks, at least by default, with the company's other unsecured obligations. This chapter examines both. It describes the forms a contribution may take and the rules that make a promise to contribute enforceable, the capital call and the remedies available against a member who fails to meet one, the capital account that records each member's equity investment, and the treatment of member loans under state law and in bankruptcy. It closes with the issuance of new interests and a drafting checklist.

Why the subject matters. Disputes about capital arise at the two moments when money is scarcest: when the LLC needs more of it and a member will not pay, and when the LLC fails and the members and creditors compete for what remains. The operating agreement written at formation determines the outcome in both cases. An agreement that states each member's contribution obligation clearly, sets out a procedure for calls and a schedule of remedies for default, maintains capital accounts in a form the tax regulations recognize, and documents member loans as loans will usually resolve those disputes without litigation. An agreement that leaves these matters to the statutory defaults will often produce results the members did not expect.

Organization. The chapter proceeds in nine parts:

1. the forms of contribution (¶ 1310);
2. enforcement of the promise to contribute (¶ 1320);
3. capital calls and remedies for default (¶ 1330);
4. capital accounts and their maintenance (¶ 1340);
5. revaluations, deficit restoration obligations and the qualified income offset (¶ 1350);
6. contributions of property and services (¶ 1360);
7. member loans under state law (¶ 1370);
8. member loans in bankruptcy and member guaranties (¶ 1380); and
9. new issuances, preemptive rights and drafting (¶ 1390).

Relation to other chapters. Allocations of profit and loss and the making of distributions are examined infra ch. 14, and preferred interests, distribution waterfalls and third-party financing infra ch. 16. Profits interests issued for services are examined infra ch. 15. The federal income tax rules governing contributions, capital accounts and allocations are examined in detail infra ch. 40, and the treatment of member claims in the LLC's bankruptcy infra ch. 49. This chapter addresses the tax rules only to the extent they shape the drafting of the operating agreement.