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Business Law Update: Why Your Operating Agreement Matters.

Business Owners and Entrepreneurs: Let me paint you a picture:

You decide to go into business. You’ve identified a business partner. You and your business partner decide the details of who is going to contribute what (capital, finances, “sweat equity”, etc..).

Your startup is now off and running!2015-11-26-13-04-02

Your business does not go as expected.

You have a few “hiccups” that were unanticipated.

Your business needs some emergency cash flow.

You and your business partner agree (verbally) that you will contribute some extra funds out of your savings, and your partner will do the same.

Your partner does not contribute what you verbally agreed to….

Unfortunately, these scenarios can oftentimes find themselves in Court.

The Michigan Court of appeals issued a  recent business law opinion on September 20, 2016.

The Case is Copacia v Ginzinger (on reconsideration of its prior decision.)

This case illustrates very important reasons why you want your LLC to have a fully executed Operating Agreement in place.

The Facts:

Plaintiff and Defendant formed an LLC in 1998 as equal members. 50/50.

The purpose of the LLC was to own a parcel of undeveloped land to develop site condos.

side bar- 

An initial question you may be asking yourself: Why should I form an LLC? 

The primary reason – limit your personal liability.

“Once a limited liability company comes into existence, limited liability applies, and a member or manager is not liable for the acts, debts, or obligations of the company. “Duray Dev., LLC v. Perrin, 288 Mich. App. 143, 151 (2010)

Ok, now going back to the facts…

As the Court tells us in its opinion,

“the development did not go as planned by the parties.” Cocacia, Id. at page 1.

The financing of the development had to be restructured – Plaintiff and at times his spouse provided additional funds. Copacia, Id at page 1.

Thereafter, Plaintiff sued his business partner for “50% of the operating expenses and costs pursuant to a purported oral agreement between the parties.” Id. pg 1-2.

Defendant counter-sued, he asked the court to declare that $135,000 held in escrow should be disbursed according to the proper adjustment of the parties’ membership in the LLC (50/50). Id.

 

Law: The Business Partners’ Operating Agreement Controlled.

An Operating Agreement is a contract between the owners of the LLC.

“The LLC operating agreement is the written agreement regulating the parties conduct in this matter. See MCL 450.4102(2)(r)(footnote omitted). An operating agreement is a contract between the members of a limited liability company and is interpreted according to principles of contract interpretation.” Copacia, Id. at pg 2.

The Court went on to hold that the parties’ operating agreement is a contract that is analyzed under ordinary contract principles, citing Holmes v Holmes, 281 Mich App 575, 594; 760 NW2d 300 (2008). “The language of a contract should be given its ordinary and plain meaning.”

As the Court noted, analyzing under the plain meaning,  the signed operating agreement indicated that no interest accrues on any capital contribution and no member shall have any right to withdraw or to be repaid any capital contributions except as provided in the operating agreement. Id. pg 3.

Plaintiff’s argument is essentially:  Ginzinger verbally agreed to compensate me for the additional funds that me and my wife contributed!

Michigan law is clear, MCL 450.4302 “a promise by a member to contribute to the [LLC] is not enforceable unless..in writing and signed by the member.” See Copacia, Id. at pg 4.

The Court found that the parties’ business relationship was governed by the Operating Agreement. Period.

If Copacia expected to be repaid the funds he contributed, a few things he could have done:

  1. loaned the funds under an executed promissory note; or
  2. have the parties’ Operating Agreement revised and signed by him and his business partner.

 

A few take aways:

If you are going into business with a business partner there are a few things you want to do:

  1. Limit your Liability – form an LLC.
  2. Execute an Operating Agreement (all parties need to sign it); and
  3. Any revision to that relationship must be signed in writing.

 

Questions? Comments?

e-mail: Jeshua@dwlawpc.com

http://www.dwlawpc.com

Twitter: @JeshuaTLauka

 

 

 

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