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LLC’s Members Waived Limited Liability, Held Liable on LLC’s Debts and Obligations

In a decision rendered on August 24, 2018, the Kentucky Court of Appeals affirmed a determination that, consequent to the wording of a particular operating agreement, the members in the LLC assumed and are liable to satisfy the LLC’s debts and obligations. VanWinkle v. Walker, No. 2016-CA-000097-MR, 2018 WL 404-3388 (Ky. App. August 24, 2018).

VanWinkle, Walker and Crawford formed TLC Developers, LLC in 2004, executing an operating agreement in connection therewith. That operating agreement provided, in part:

The profits and liabilities of the Company shall be divided as follows: Carl David Crawford = thirty-three and one 3rd  (33 1/3%), Lyle A. Walker = thirty-three and one 3rd (33 1/3%) percent and Troy Van Winkle [sic] thirty-three and one 3rd (33 1/3%).

When the company fell upon hard times, Walker and Crawford contributed additional amounts in order that the company could meet its business expenses. As recited by the court, “in their view, in the event TLC did not have the cash on hand to pay the liabilities itself, the operating agreement mandated that the three members would pay the liabilities of TLC equally.” VanWinkle did not make those contributions, apparently of the belief that the operating agreement did not require him to do so. He did, however, on two occasions contribute one-3rd of the amount necessary to satisfy TLC’s property taxes.

Ultimately, Walker and Crawford filed a complaint seeking a declaration of rights with respect to the obligation to satisfy TLC’s liabilities and the interpretation of the operating agreement. After a bench trial, the circuit court held that “the operating agreement unambiguously stated that the three members agreed to split the liabilities of the company in 3rds,” and ultimately ordered VanWinkle to pay $87,300 has his share of the company’s liabilities. This appeal followed.

VanWinkle had essentially two arguments. First, the operating agreement, and the LLC Act, protected him from liability for the LLC’s debts and obligations. Second, he would argue that personal liability for the LLC’s debts and obligations is antithetical to the very notion of an LLC and for that reason could not be enforced. Both arguments would fail.

While the operating agreement recited that the members enjoyed limited liability from the debts and obligations of the LLC, essentially repeating the language of KRS § 275.150(1), the court went on to note, however, that while not recited in the operating agreement, the LLC Act continues with KRS § 275.150(2), which provides:

Notwithstanding the provisions of subsection (1) of this section, under a written operating agreement or under another written agreement, a member or manager may agree to be obligated personally for any of the debts, obligations, and liabilities of the limited liability company.

Applying this language, the court found that “that is exactly what TLC’s members did when they agreed to split the liabilities of the company in the ‘Division of Profits and Liabilities’ provision.” of the operating agreement.

As for the argument that imposition of liability for company obligations is  antithetical to the very notion of an LLC, the court noted as well KRS § 275.003(1), it providing that it is the public policy to give maximum effective principle of freedom of contract and the enforcement of operating agreements. As to this point, the court wrote:

While holding the members personally liable for the TLC’s liabilities may seem contrary to the very point of establishing an LLC, it adheres to the intent of the General Assembly: namely, to allow business partners the freedom to contract and establish an LLC that fits the needs of the respective members. Here, following a meeting of the minds, TLC’s three members each decided to split the liabilities of the company in equal shares.