In Oneiric Holdings LLC v. Leonelli, No. 655833/16, 2018 WL 1672753 (N.Y. Sup. Ct. April 6, 2018), the New York Supreme Court confronted a matter of first impression under Delaware law.  The court held that where an LLC operating agreement provides exclusively for diminution of a member’s interest in the LLC in the event of a missed a capital call, other common law remedies for addressing a missed capital call are unavailable.

Cenk Fikri and defendant Jean Baptiste Leonelli were fifty percent members in Oneiric Holdings, LLC, a Delaware limited liability company, which they formed to own and operate hotels, restaurants, night clubs, and bars.  The operating agreement for Oneiric provided that Fikri, the managing member, could make subsequent capital calls to Leonelli for up to $23,000,000.  It further provided that in the event those capital calls were not met, “the Percentage Interests of Mr. Leonelli shall be decreased by One Percentage Interest (1%) for each Four Hundred Sixty Thousand Dollars ($460,000) of Subsequent Contributions not yet made by Mr. Leonelli at such time” and Fikri’s interest would be correspondingly increased.  Id. at *1 (emphasis added).

Fikri made two capital calls to Leonelli for $300,000 and $23,000,000.  Leonelli failed to respond to both of them.  Then, Fikri and Oneiric brought a lawsuit alleging breach of contract and seeking to recover the amount of the capital calls.  The court granted Leonelli’s motion to dismiss.  

The key dispute was whether the language compelling the diminution of Leonelli’s interest if a capital call was not met meant that the operating agreement excluded other common law remedies, such as the money damages sought by Oneiric.  

Section 18-502 of the Delaware Limited Liability Company Act (Act), Del. Code. tit. 6 § 18-502, provides, in relevant part: 

(a) Except as provided in a limited liability company agreement, a member is obligated to perform any promise to contribute cash . . . .  If a member does not make the required contribution . . . the member is obligated at the option of the limited liability company to contribute cash equal to that portion of the agreed value . . . of the contribution that has not been made.  The foregoing option shall be in addition to, and not in lieu of any other rights, including the right to specific performance, that the limited liability company may have against such member under the limited liability company agreement or applicable law.

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(c) A limited liability company agreement may provide that the interest of any member who fails to make any contribution that the member is obligated to make shall be subject to specified penalties for, or specified consequences of, such failure.  Such penalty or consequence may take the form of reducing or eliminating the defaulting member’s proportionate interest in a limited liability company, . . . forfeiture of the defaulting member’s limited liability company interest, . . . or other penalty or consequence.

The court noted that Delaware courts had not addressed whether, if an operating agreement provides for diminution where a member fails to meet a capital call, diminution is the exclusive remedy or whether damages in the amount of the capital call are also available.  Oneiric Holdings, 2018 WL 1672753, at *3.

The court held that the Oneiric operating agreement unambiguously limited the remedy for Leonelli’s failure to meet capital calls to diminution of his interest.  The court reasoned that Section 18-502(c), quoted above, permits operating agreements to specify a penalty for failure to make a capital contribution, including diminution.  Meanwhile, Section 18-502 (a) provides that “except as provided in the operating agreement, other remedies, including a right to compel the required contribution, will be available.”  Id. *3.  Because the Oneiric operating agreement specifies diminution, “[ot]her common law remedies are accordingly unavailable.”  Id.  

The court noted that its interpretation is consistent with Section 18-1101(b) of the Act, which provides:  “It is the policy of this chapter to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements.”  Id. at *4.  Also consistent is Delaware case law holding that, “Once members exercise their contractual freedom in their limited liability company agreement, they can be virtually certain that the agreement will be enforced in accordance with its terms.”  Id. (quoting Walker v. Resource Dev. Co., 791 A.2d 799, 813 (Del. Ch. 2000.)  “An interpretation that would permit a non-defaulting member to obtain a remedy that is not the penalty to which the members specifically agreed would ignore the terms of the Operating Agreement.”  Oneiric Holdings, 2018 WL 1672753, at *4.

The court rejected plaintiffs’ argument that all remedies were available because the operating agreement did not explicitly state that diminution was the exclusive remedy.  The Court cited Gotham Partners, L.P. v Hallwood Realty Partners, L.P., 817 A.2d 160, 176 (Del. 2002), which held that Delaware courts “will not construe a contract as taking away a common law remedy unless that result is imperatively required . . . .  [E]ven if a contract specifies a remedy for breach of that contract, a contractual remedy cannot be read as exclusive of all other remedies if it lacks the requisite expression of exclusivity.”  The court found that the operating agreement had the requisite expression of exclusivity by electing “to eliminate other remedies by providing expressly for the diminution penalty.”  Oneiric Holdings, 2018 WL 1672753, at *4.

At Novack and Macey, we have extensive experience advising shareholders involved in closely held company disputes, as well as advising companies on how to avoid disputes in the first place. For more information about our services, please contact John Haarlow at 312.419.6900 or jhaarlow@novackmacey.com.