Small Business Owners Beware: Get That Agreement to Share Expenses in Writing
On September 20, 2016, the Michigan Court of Appeals issued its ruling in Copacia v. Ginzinger, Case No. 323924, a case that shows why small business owners should be careful in drafting their organizational documents, especially as it relates to whether funds the parties provide will be treated as capital contributions or expenses to be equally shared.
The plaintiff and the defendant in this case were 50-50 owners of a two-member limited liability company that they formed to own and develop a parcel of land in Oakland Township into a residential condominium site. When the development needed to restructure its financing, the plaintiff, along with his wife, provided additional funds to assist that process. The plaintiff, contending that the defendant failed to pay his fair share of the additional funds, filed suit to collect half of the money and his wife had provided. The complaint, which alleged claims for breach of contract, unjust enrichment, implied contract/quasi-contract, fraud, and breach of fiduciary duty, was based on allegations that the defendant failed to honor an oral agreement to pay half of the funds. The defendant moved to dismiss all of plaintiff’s claims, but the trial court dismissed only the breach of contract cause of action. On appeal, and after reconsideration, the Court of Appeals held that the trial court should have granted defendant’s motion for summary disposition and dismissed all of plaintiff’s claims.
The Court of Appeals rejected the plaintiff’s arguments for two main reasons. First, the Michigan limited liability company act, MCL 450.4101 et seq., defines capital contributions as essentially anything of value a person contributes to the company in connection with membership, and the operating agreement for the parties’ limited liability company specifically addressed the handling of member capital contributions and adjustments to sharing ratios based on those contributions, if necessary. In addition, and no less important, the operating agreement contained a merger clause providing that it was the only agreement between the parties and could only be modified in writing. Because the agreement to share the additional funds as expenses was not in the contract, the Court of Appeals concluded that the funds could only be properly viewed as capital contributions for which the plaintiff's sole remedy was an adjustment of his sharing ratio, not repayment of half of the funds he contributed to assist in the restructuring of the company's finances.
Second, the Court of Appeals noted that the statute of frauds contained in the limited liability act, MCL 450.4302(1), barred plaintiff’s claims for unjust enrichment, implied contract/quasi-contract, fraud, and breach of fiduciary duty. That is, these claims failed because they were based on an alleged oral promise to contribute that was not reduced to a writing signed by the defendant. Further, the Court of Appeals noted that the trial court should have dismissed the fraud and breach of fiduciary duty claims should as a matter of law because they were based on a breach of the operating agreement, rather than duties separate and distinct from that document.
The moral of this story is a familiar one: make sure you get it in writing. As the Court of Appeals noted, an operating agreement for a limited liability company is a contract that controls the rights and responsibilities of the parties. As this case demonstrates, the operating agreement should cover not only contributions to the company and sharing ratios, but also the handling of expenses. If the operating agreement does not specifically provide how either are to be treated, the members would be well advised to reduce their new agreement to writing.