Edited by Robert W. Hillman and Mark J. Loewenstein
Chapter 11: Capital accounts in LLCs and in partnerships
A lawyer drafting either an operating agreement for a limited liability company or a partnership agreement will be attempting to tease out, and reduce to writing, the basic economic understanding of the co-owners. Core matters include: the contributions each owner will make; how much credit each will be given for those contributions, be they of property or of services; how the owners will share in profits; how they will share in losses; how they will share in operating distributions; the price to be paid in the event of a buyout; and the right to any liquidating distributions, including the right to require another owner to “pony up” a final amount on liquidation. Dealing with the client can be sensitive, particularly when it comes to reducing to writing exactly what happens if things do not go as well as expected. Sometimes consciously and sometimes unconsciously, the drafter also will be interacting with: (1) the organization’s accountant, who may not yet be identified but who is likely to create a separate “capital account” for each owner; (2) statutory default rules that may give economic significance to those capital accounts; and (3) provisions of standard form agreements that contain impenetrable language designed to assuage federal income tax authorities who, in an audit, are likely to scrutinize the significance of capital accounts to determine the propriety of special allocations of tax benefits.
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