Warnings Regarding Cash Distributions from California Limited Liability Companies
Do you own or operate a California limited liability company?
Take care when making cash distributions from the company! Undercapitalization is commonly found in alter-ego cases, which allow creditors and claimants to "pierce the company veil". Making improper cash distributions which cause an LLC to become undercapitalized may put the members' personal assets in jeopardy.
Members and managers of an LLC should be aware that LLC's may not distribute cash to its members if, after making the distribution (a) the LLC would be unable to pay its debts as they become due in the usual course of business or (b) the LLC’s total assets would be less than its total liabilities (plus the amount that would be needed if the LLC were dissolved, to pay other members whose rights on dissolution are superior to the rights of the member receiving the distribution). Managers or members may be held personally liable for improper distributions. If the LLC is too thinly capitalized, the members may be potentially held liable for the debt of the company or the claims of the company's creditors.
If the LLC members have made a debt or equity investment, or provided other sources of funding for the company's initial operations sufficient to permit it to operate as a viable business entity, the adequacy of funding requirement is ordinarily considered met. A key test is whether the company had funds available for a sufficient period of time to enable it to begin its business and develop it to the point of economic viability.
If the company has sufficient funds, but otherwise made improper distributions, members are obligated to return distributions from the LLC if (1) the member had actual knowledge of facts indicating the impropriety of the distribution and (2) immediately after the distribution, all liabilities of the LLC exceed the fair market value of the LLC's assets. Corporations Code section 17254(e). An action to enforce an obligation to return a distribution must be brought within 4 years after the distribution is made. Corporations Code section 17254(e). This is especially important to remember because creditors have the right to enfoce the obligations of members to return improper distributions!