Allocating Distributions Under Utah’s 2014 Revised Uniform Liability Company Act
For reference, it is estimated that at least 60% of all LLCs formed in Utah do not involve attorneys. Some of these persons who form Utah LLCs on their own – especially small business people and other entrepreneurs – may be very surprised with the results of what they created without the guidance of an attorney. Even though attorneys may be involved in 40% of all Utah LLCs, it is estimated that only 10% of all new LLCs have operating agreements. For 90% of all Utah LLCs subject to the 2014 Utah Revised Uniform Limited Liability Company Act, Utah Code Ann. § 48-3a-101, et seq., (the “2014 LLC Act”), the default rules on distributions will shock them.
Investors of all kinds expect a return of their investment at some point in time and, in the interim, they often expect a return on their investment. Historically, a return on investment was called dividends and that term is still in vogue in financial circles today.
In business entity statutes, however, these two types of return — of investment and on investment — are both now called “distributions.” Yet, other terms are usually added to distinguish a periodic distribution of profits from a liquidating distribution. For example, in LLC statutes, periodic distributions are called “current distributions” or “interim distributions” to distinguish them from distributions of LLC capital or distributions due to dissolution and winding up of the LLC.
The pre-2014 version of the Utah LLC Act, titled the “Utah Revised Limited Liability Company Act,” Utah Code Ann. § 48-2c-100, et seq., (the “Prior LLC Act”) refers to current distributions as “distributions of profits and gain.” Utah Code Ann. § 48-2c-1001. It set the default rule for sharing current distributions to be “in proportion to the members’ capital account balances as of the beginning of the company’s current fiscal year.” Id.
The Prior LLC Act defines “capital account” to mean:
[U]nless otherwise provided in the operating agreement, . . . the account, as adjusted from time to time, maintained by the company for each member to reflect: (a) the value of all contributions by that member; (b) the amount of all distributions to that member or the member’s assignee; (c) the member’s share of profits, gains, and losses of the company; and (d) the member’s share of the net assets of the company upon dissolution and winding up that are distributable to the member or the member’s assignee.
Utah Code Ann. § 48-2c-102(3).
The 2014 LLC Act adopts an entirely different default rule for interim (current) distributions. That new rule is a “per capita” or head-count rule: “Any distribution made by a limited liability company before its dissolution and winding up must be in equal shares among members and persons dissociated as members. . . .” Utah Code Ann. § 48-3a-404(1). That means all LLC members, regardless of the existence of profits, or the value of their respective contributions, or the amount of prior distributions, will receive equal distributions from the LLC before the LLC is dissolved and wound up. There is no requirement that such distributions be limited to profits or that the LLC have any profits as the source for such distributions. That default rule will come as a complete surprise or shock to most investors who do not override that rule in their LLC operating agreements.
There’s more. The per capita rule extends in part to liquidating distributions. The 2014 LLC Act provides that the “surplus” left after paying all LLC debts on winding up be distributed in two steps:
(a) to each person owning a transferable interest that reflects contributions made and not previously returned, an amount equal to the value of the unreturned contributions; and
(b) in equal shares [per capita] among members and dissociated members.
Utah Code Ann. § 48-3a-711(2). Capital accounts therefore are regularly adjusted in the ordinary course of the LLC’s business to reflect each member’s true financial interest in the LLC. The members’ capital accounts could be compared to determine each member’s percentage interest in the remaining assets when the LLC is dissolved and wound up. Yet, under the 2014 LLC Act, there is mention of capital accounts, there is no default rule for how to allocate profits and losses, and no reference to profits or losses.
© 2014 Mark A. Larsen & Brent R. Armstrong