TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Saturday, January 5, 2019

Interest Dilution And Damages As Contribution-Default Remedies In Failing LLCs And Partnerships

Bradley T. Borden (Brooklyn) & Thomas E. Rutledge (Stoll Keenon Ogden, Louisville, KY), Interest Dilution and Damages as Contribution-Default Remedies in Failing LLCs and Partnerships:

Interest dilution often appears as a contribution-default remedy in LLC operating agreements and limited partnership agreements. Entities adopt interest-dilution remedies to create a financial incentive for members to fulfill their contribution obligations. That incentive generally would not exist in a failing arrangement because members will hesitate to throw good money after bad, so, if the only contribution-default remedy is interest dilution, members of a failing LLC or partnership may be able to avoid making additional contributions to the entity. To enforce a contribution obligation, the entity agreement must allow for damages as a remedy. This article discusses three recent cases (two from Kansas and one from Delaware) that identify situations in which the entity agreement limits contribution-default remedies to interest dilution and those that provide for damages as a possible remedy.

The cases show that careful drafting is necessary to ensure the arrangement achieves the parties’ objectives, and the article discusses steps drafters may take to properly document those objectives.

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