This post explains what a “distribution” is with a limited liability company, how distributions are determined, and what the legal limits are to one’s right to distributions.
The North Carolina Limited Liability Act, G.S. § 57D, et seq. (the LLC Act), sets forth the rules for LLCs formed under North Carolina law. The LLC Act is similar to other LLC acts across the country. If you are a member of an LLC or you otherwise have an economic interest in an LLC then you are what the LLC Act calls an “interest owner.”
An LLC’s interest owners may be entitled to what are called “distributions.” A distribution is defined in the LLC Act at G.S. § 57D-1-03 as follows:
Distribution - Except as provided in the last sentence of this definition of distribution with respect to G.S. 57D-4-05, 57D-4-06, and 57D-6-12, the direct or indirect transfer of money or other property to, or incurrence of indebtedness by, an LLC for the benefit of an interest owner in respect of the interest owner's ownership interest. The amount of a distribution is the fair market value of the property distributed, net of liabilities assumed, or other consideration paid by the interest owner (or to which any property distributed to the interest owner is subject, but not in excess of the fair market value of the property that is subject to the liability), determined as of the time the distribution is made. As used in G.S. 57D-4-05, 57D-4-06, and 57D-6-12, “distribution” does not include payments made to, or an account of, an interest owner that constitutes compensation for services and does not include payments made in the ordinary course of business under a bona fide retirement plan or other benefits program.
This definition of “distribution” is comprehensive, but a plain English explanation is certainly called for. A distribution should simply be thought of as a transfer of money or property for the benefit of the LLC’s interest owners. That is, any time the LLC has paid the LLC’s owners, or taken on a liability on their behalf, a distribution has occurred.
An LLC can make two types of distributions: (1) interim distributions, and (2) liquidating distributions. Interim distributions are simply the normal payments that an LLC would make to the interest owners during the company’s existence. The LLC can be set up to require distributions at regular intervals, or yearly, or simply at the discretion of the members and managers. These are interim distributions.
Liquidating distributions, on the other hand, are distributions made when the company is be dissolved. When an LLC closes, its assets are liquidated (i.e., sold) and the proceeds must be used to pay back third parties to whom money is owed. If anything is left over, those funds may be used to repay the LLC’s owners for their investments in the company and as distributions of all remaining amounts.
Interim distributions are typically made in proportion to the members’ “aggregate contribution amounts,” or capital contributions. For instance, if one member contributed $100,000 to start the company and a second member contributed $50,000, and if the LLC were going to make a total distribution of $900, the first member would receive $600 and the second member would receive $300.
The amounts of interim distributions need not be proportionate to capital contributions, however. It is not uncommon for an LLC’s members to decide that regardless of the amount of their capital contributions, the members should always be paid in proportion to the percentage of their ownership interests. Capital accounts might be out of proportion to ownership interests if, for example, other members made additional contributions of capital but one of the members was unable to do so. Thus, the LLC Act allows the distributions to be made in any manner the parties agree on.
An LLC allows for flexibility when making distributions and when defining ownership interests. An LLC can make distributions in a variety of ways – preferred distributions among different classes of economic interests, distributions related to specific events (e.g., upon a sale of property) or circumstances (e.g., for holders to pay taxes on LLC income), distributions attributable to specific assets or operations, and distributions not based on capital contributions (e.g., for “profits-only” economic interests).
One thing to be aware of with regard to an LLC’s distributions is that – unlike distributions from a corporation – an LLC’s members do not have a statutory right to force the company to make distributions. The only distributions a company must make are those set forth in the operating agreement. This is consistent with LLC’s providing their members a maximum amount of flexibility to contract for their terms of operation. It also means, however, that before starting or joining an LLC, members should carefully review the operating agreement’s provisions regarding distributions.
If you are starting or buying into an LLC, it is imperative that you understand its provisions related to distributions. Doing so beforehand can reduce the issues you might otherwise have to confront later.
Dye Culik PC is a Charlotte, North Carolina business law firm that represents LLCs, corporations, and their owners in all matters related to corporate law. If you have a question about your company, contact us to see how we can help.