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Recent Example Demonstrates Danger of New Idaho LLC Act

Added by Hawley Troxell in Articles & Publications, Business Law, News on January 1, 2011

Caution: When owning and operating an Idaho LLC, the members must be careful to establish and follow an Operating Agreement that exactly matches their intent. Under Idaho Code 30-6-102, an ‘Operating Agreement’ can be any agreement, written, oral, or implied, and does not have to be defined as an Operating Agreement. This means that, even when members sign a formal Operating Agreement, they may unintentionally amend that Operating Agreement through another writing, an oral agreement, or an implied agreement by course of conduct. This danger of the new Idaho LLC Act was on full display in a recent case that came to us. As a teachable moment, here is a summary using hypothetical terms.

Al, Bob, and Chris are members in ABC Lawn Care, LLC; an Idaho LLC they formed to run their lawn care business. When they initially formed the business, they hired a lawyer to prepare their Operating Agreement. Al provided all the cash and equipment to start the business and Bob and Chris agreed to provide their services to operate the business. Therefore, the Operating Agreement provides that Al owns 60% of the business, with Bob and Chris owning 20% each. The Operating Agreement also provides that, upon liquidation of the company, Al will be repaid his initial investment, and any remaining assets will be distributed 60% to Al and 20% each to Bob and Chris.

Five years later, the business is doing really well, but Chris wants out. Al and Bob are okay with buying Chris out of the business, but only Al has the money to do so. Accordingly, they prepare an Assignment of Membership Interest Agreement whereby (1) Chris sells his 20% interest in the business to Al; and (2) Al and Bob agree that, after buying Chris out, they are 50/50 owners of the business. Wanting to avoid attorneys’ fees, they prepare this agreement on their own and decide not to hire an attorney to draft or review any documents.

A year later the business is not doing well, and Al and Bob decide to liquidate the company. Al pulls out a copy of the attorney-drafted Operating Agreement and argues that the liquidated assets should be distributed 80% to him and 20% to Bob. Al’s theory is according to the Operating Agreement, he was originally a 60% owner, but then bought Chris’ 20% interest and therefore owns an 80% interest in the company. However, Bob pulls out a copy of the written Assignment of Membership Interest Agreement and argues that it shows Al and Bob as each owning 50% of the company. Al and Bob consult the company’s attorney to resolve their disagreement. The attorney advises them that, under Idaho Code 30-6-102, the written assignment of membership interest agreement is an amendment to the Operating Agreement that supersedes the original version of the Operating Agreement. Therefore, after Al is repaid his initial capital contribution, Al and Bob are each entitled to 50% of the distributions of the remaining assets from the liquidation of the company.

Is your Operating Agreement accurate and current? Have you entered into any other written, oral, or implied agreements that modify your Operating Agreement? If you would like more information or have questions regarding this topic, please contact a member of our Corporate group at 208.344.6000.