Lesson in Caution: Capital Call Provisions in Operating Agreements
On August 26, 2010, the Supreme Court of Kentucky issued its decision in Racing Investment Fund 2000, LLC v. Clay Ward Agency, Inc. (Case No. 2007-CA-002282-MR). The decision addressed the question of whether a trial court has authority to use its contempt power to compel satisfaction of a judgment against a Kentucky LLC by forcing the LLC’s manager to make a capital call on its members. The court's ruling is important because it clearly supports the limitation on personal liability of members of a Kentucky LLC for the LLC’s obligations. This litigation, however, illustrates that clients and their lawyers should carefully consider capital call provisions in LLC operating agreements.
Relevant Kentucky law, KRS 275.150, outlines the standard for immunity for personal liability of the debts of an LLC on its members. The statute provides that, generally, members of LLCs are not personally liable for the debts of the LLC. Members may, however, agree to become personally obligated on LLC debt in an LLC operating agreement or other written agreement. KRS 275.150(b).
Racing Investment Fund 2000, LLC (the “Company”) was a manager-managed Kentucky LLC formed to purchase, train and race thoroughbred horses. Clay Ward Agency, Inc. insured the Company’s horses and, when the Company failed to pay its insurance premiums, Clay Ward brought suit and the parties entered into an agreed judgment pursuant to which the Company agreed to pay the premiums. The Company paid Clay Ward its remaining cash, only a portion of the judgment, and then dissolved, leaving the remainder of the judgment unpaid. Clay Ward successfully moved the trial court to hold the Company in contempt for failing to pay the entire judgment. The trial court ruled that a provision in the Company’s operating agreement authorizing the Company’s manager to make a call for additional capital for “operating, administrative or other business expenses” provided a means of satisfying the judgment. The trial court ordered the Company to make a capital call on its members, a ruling upheld by the Kentucky Court of Appeals. The Supreme Court reversed the lower courts’ decisions and issued a decision that strongly supports the fundamental concept of limited liability of members of Kentucky LLCs.
The Supreme Court ruled that the provision in the Company’s operating agreement allowing the manager to make capital calls to pay for business expenses did not constitute an agreement by the members to be personally liable for the debts of the Company. The Court stated that any assumption of personal liability “must be stated clearly in unequivocal language which leaves no room for doubt about the party’s intent.”
Based on the ruling, we suggest that members of LLCs and their lawyers carefully consider capital call provisions in LLC operating agreements or other LLC documentation to confirm that no language unintentionally creates personal liability for LLC debts.