Business and Legal Insights

More than one business owner this week has wondered aloud: “Why is my lawyer spending so much time (and, therefore, money) on the minutiae of the Operating Agreement? Does any of that matter, anyway?”  In response to that question, Florida’s Third District Court of Appeal (Third DCA) reminds us that the rights granted by an Operating Agreement will be enforced as they are written.  GG Investment Realty, Inc. v. South Beach Resort Development, LLC, --- So. 3d ---, 2022 WL 39085, Case No. 3D20-1033 (Fla. 3d DCA Jan. 5, 2022).

This case involving a Miami hotel investment has its roots back during the 2008 financial crisis, which negatively impacted the hotel and caused the original investors (“Seller”) to sell most of their equity interests to others (“Buyer”). The deal was finalized during September 2008 and it included a new Operating Agreement for the new ownership entity (“New LLC”), which relegated the Seller to a minority owner in the New LLC. As part of the deal, the Seller provided the Buyer with written representations and warranties regarding certain financial matters, which turned out to be false.

The Buyer, who controlled the New LLC through majority ownership, made several capital calls between the years 2008 and 2010.  The Seller did not contribute.  As a result, the Buyer funded the full amount of the capital calls and, thereafter, foreclosed on the membership interests owned by the Seller.

Lengthy litigation began during 2012, ultimately resulting in a 4-day bench trial and a 29-page written order by the trial court finding in favor of the Buyer on multiple claims and issues, including the issue of whether the Buyer had the right to fund the capital calls and foreclose on the Seller’s membership interests.

Pointing to the specific terms and conditions of the Operating Agreement for the New LLC, both the trial court and the Third DCA concluded that the following language allowed the Seller to self-fund the capital call, and later pursue the foreclosure of the Seller’s membership interests, rather than being required to obtain a third-party loan to cover the amount sought through the capital call:

As to Additional Capital Contributions referred to in Section V of the Operating Agreement, Gene [i.e. Seller] and SBH [i.e. Buyer] agree as follows: (a) Additional Capital Contributions. If, at any time or from time to time, Managing Member [i.e. Buyer] determines in its reasonable discretion, that the Company requires additional funds, whether for capital improvements, to defray losses, or resulting from either party’s failure to satisfy its indemnification obligations set forth in the Purchase Agreement, or otherwise for the benefit of the Company, the Managing Member shall first attempt to borrow any funds needed for such purpose from third-party lenders on commercially reasonable terms. If the Managing Member is unable or does not desire to borrow such funds, then the Managing Member shall request an Additional Capital Contribution from each Member.

Id. at fn 6.  Thus, the relevant language provided that the managing member “shall first attempt” to borrow funds, but was not required to borrow such funds if the managing member “is unable or does not desire to borrow such funds.”

In rejecting the Buyer’s argument that this provision required the Seller to borrow any needed funds from a third-party lender before making any capital call, the Third DCA explained:

Under paragraph 10(a) of this [New LLC] Agreement, SBH [i.e. Buyer], as managing member, could demand, in its reasonable discretion, additional capital contributions from each member. If a member failed to make the required capital call, the Agreement provided that “the other Members shall make the Additional Capital Contribution which the ‘Non-Contributing Members’ failed to make and to treat the Additional Capital Contributions made by such members as a loan by the Contributing Members to the Non-Contributing Members.” The Agreement also specified the conditions for the non-payment of such loan including dilution of the Non-Contributing Member’s percentage interest under paragraph10(d) and the grant of a security interest on the Non-Contributing Member’s entire percentage interest with the right to conduct a UCC sale of the security interest under subsection (e).

*      *      *

The trial court rejected the Grabarnicks’ [i.e. Seller’s] argument that SBH [i.e. Buyer], as managing member, was required to borrow the money from a third-party lender prior to making a capital call. Instead, the trial court found that the Agreement “expressly allows” SBH to request additional capital contributions from the other members if it “does not desire to borrow such funds.” Indeed, despite the seeming inconsistency under paragraph 10(a) of the Agreement, the managing member was vested with broad powers including making “any and all business and non business decisions concerning the property ... as well as the decisions concerning [the Company].” These broad powers included the discretion to decline to seek a third-party loan given the pre-existing loan obligation and the troubled financial state of the Company.

The Grabarnicks similarly take issue with the trial court’s ruling upholding the UCC sale of their minority interest in the Company. They assert that, under paragraph 10(d) of the Agreement, SBH was required to dilute their membership interest before proceeding with the UCC sale. The trial court also rejected this argument by pointing to paragraph 10(e) in which each member “grants to the other Members a security interest (within the meaning of the Uniform Commercial Code in effect in the jurisdiction in which the Company is located) in the Grantor’s entire Percentage Interest as security for the Grantor’s obligations” under the loan. This subsection further provides that if a Non-Contributing Member defaults in repayment of the loan, the Contributing Member “shall also have the right to exercise all of the rights and remedies of secured parties” under the UCC, including the “sale of the Non-Contributing Member’s Percentage Interest pursuant to Article 9” of the UCC.

We find the trial court’s interpretation of these provisions in the Agreement legally sound, and that it properly concluded the UCC sale was valid and commercially reasonable.

Id. at 2 and 5.

The motto of this story: It really is worthwhile for the business client’s lawyer to spend time negotiating the minutiae of an Operating Agreement.  That minutiae may be important someday.