The members of a profitable limited liability company are entitled to receive periodic distributions from the business’s earnings. Most jurisdictions provide the framework for the types of distributions that may not occur. However, LLC members are free to stipulate the terms and eligibility requirements for distributions that do not inherently violate state regulations.
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The LLC has no obligation to provide distributions to individuals who are not owners, who are known as members. If at the time you create the LLC, no members yet exist, you can stipulate the conditions to which all prospective members must adhere prior to granting admittance to the LLC. After the formation of the LLC is complete, an individual can become a new member if he meets the requirements in the operating agreement, or obtains unanimous support from all existing members. There is no requirement that a prospective member make a contribution as a precondition to joining the LLC or obtaining a right to receive distributions.
State laws impose restrictions on the amount an LLC can distribute to the members. The LLC may not provide a distribution in an amount that leaves the LLC unable to pay debts as they come due in the ordinary course of business. However, members need not prohibit a distribution for a speculative liability that is uncertain or contingent on the occurrence of a future event. A distribution that creates an excess of liabilities over assets immediately upon its payment is also prohibited. In making this determination, members or managers of the LLC can rely on balance sheets that are prepared using generally accepted accounting principles.
The portion of a distribution payment that violates state law is an improper distribution. A manager or member who makes an improper distribution to other members is personally liable to the LLC for the improper distribution. However, no personal liability attaches if the operating agreement of the LLC specifically imposes the sole responsibility on a different member. Additionally, any member who receives a distribution with knowledge that it is improper is personally liable to the LLC. Either the LLC or its members must commence a legal action against the manager or member who is personally liable within two years of the distribution payment.
When members agree to dissolve the LLC and cease all business activities, the assets and liabilities of the business must undergo a winding up process. Winding up requires a distribution of all remaining profits and assets. Outstanding creditors of the LLC receive first priority in receiving distributions from the LLC. This includes members who are bona-fide creditors of the LLC. Once all creditors receive payment, the LLC must distribute the remaining assets to all current and former members who are owed a prior distribution. Current members are then able to recover all contributions to the LLC, unless they agree otherwise. If assets still remain, all current members receive the assets in a proportion that the operating agreement requires. In the event that an operating agreement does not exist or is silent, a distribution is made in proportion to prior contributions.
References & Resources
- University of Pennsylvania Law School: Revised Uniform Limited Liability Company Act 2006
- “Wiley CPA Exam Review Volume 1”; O. Ray Whittington, PhD.; 2010