The Business Divorce Law Report
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Advances or capital contributions made to a limited liability company without authorization may be a source of conflict.
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Using unauthorized advances or capital contributions as a means to exert control may be a breach of fiduciary duty.
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A well-drawn operating agreement addresses how and when the owners put additional money into a limited liability company.
Advances made by a member to a limited liability company can lead to disputes among the owners. Is the payment a capital contribution, an advance, or an interest-bearing loan? Was it authorized?
Payments made by one member in a three-brother limited liability company were at the core of a dispute over control of the finances of two LLCs that led to the expulsion of one brother and forfeiture of nearly $300,000 in unilateral payments made by the dissociated member.
Cropped image of lawyer showing evidence he found in papers to coworker
The payments were not the subject of any agreement, the court held, and therefore were neither capital contributions nor loans or advances. And therefore, the court held there was no basis to find that the companies simply keeping the money was inequitable.
The court applied much the same approach to approximately $125,000 that was claimed by the dissociated member for unpaid compensation, again reasoning that there was no contract in force and that the dissociated member was not entitled to be paid during the time that he was in breach of his fiduciary duties.
Member Who Made Unauthorized Advances is Expelled from LLC
This case, decided by the Vermont Supreme Court, is interesting not so much for its take on the law of limited liability governance—it breaks no new ground here—but for the way in which it applied basic principles of contract and agency law.
It’s a cautionary tale for any member that puts money into a jointly owned business. Make sure there is agreement among the owners on how it is to be treated—preferably in writing—and do not act unilaterally.
The dispute in Hirchak v. Hirchak grew out of the conflicts among the three Hirchak brothers—Garret, Toby, and Tyler—over their two limited liability companies. The LLCs initially were formed in connection with their family’s auctioneering business, Thomas Hirchak Company. The three brothers purchased the assets and real estate of the original company from their father, Tom, creating Hirchak Brothers LLC (for the auction business) and Hirchak Group LLC (for the real estate holdings). Each brother held an equal ownership share and agreed to specific management responsibilities for different divisions of the business.
Garret assumed control over the LLCs’ finances with his brothers acquiescence rather than by formal agreement. They were provided by his separate companies, Manufacturing Solutions, Inc. (MSI) and Sunrise Development LLC, which provided administrative and property management services to the LLCs.
The financial records were kept at Garret’s office, and the records were only available to the other members there during business hours. For a reason that is not clear from the opinion, Garret unilaterally paid a $300,000 down payment for the purchase of real estate. Toby and Tyler offered to contribute their shares, but Garrett ignored them.
LLC Experiences Cash Shortfall
The LLCs ran into financial difficulties, and Toby and Tyler began to question Garret’s financial management. Their attempts to access financial records and hold meetings were met with resistance. Garret proposed a buyout or division of the business, but no resolution was reached.
Garrett also made a number of payments to cover business expenses, again without consulting his brothers. His response to the complaints of his brothers was a request that he be bought out or that the businesses be divided.
Garret Hirchak first initiated legal action against his brothers, Toby and Tyler, and the companies over the money he claimed he was owed and requested that Hirschak Brother be dissolved. He contended that his exclusion from key decision-making processes and financial oversight rendered the company’s operations untenable. He alleged that he was being frozen out of the financial affairs of the company.
Toby and Tyler counterclaimed, seeking Garret’s expulsion (judicial dissociation) from both LLCs. They alleged that Garret had breached his fiduciary duties by engaging in self-dealing, managing the companies’ finances unilaterally, making payments to his own businesses without transparency, and withholding financial records from the other members. They challenged certain expenses and payments authorized by Garret, arguing that these transactions were unauthorized and did not benefit the companies.
If you’re facing a dispute, involving your limited liability company, partnership or closely held corporation, Jay McDaniel and the Business Divorce Practice Group at Weiner Law Group can help. With decades of experience handling disputes in New Jersey and New York, we provide the legal guidance and advocacy you need to achieve a favorable resolution.
Contact Jay McDaniel today to schedule a consultation and take the first step toward resolving your shareholder dispute.
Toby and Tyler Hirchak accused their brother Garret of breaching his fiduciary duties as a member and manager of Hirchak Brothers LLC and Hirchak Group LLC. These allegations focused on self-dealing, a lack of transparency, and actions taken unilaterally that undermined the interests of the companies and the other members.
Failure to Provide Access to Financial Records is Cause for Expulsion
A central issue was Garrett’s refusal to provide his brothers with access to financial records to understand the company’s financial condition. Garret resisted, refusing to produce the records unless they presented an alternative financial plan. This refusal persisted even after the majority of the members demanded access, and Toby and Tyler had to file suit to recover the financial documentation.
Toby and Tyler argued that these breaches—self-dealing, withholding financial records, and unilateral financial decisions—violated Garret’s fiduciary duties of loyalty, good faith, and fair dealing, justifying his dissociation from the LLCs.
The Supreme Court affirmed the trial court’s finding that Garret had breached his fiduciary duties and engaged in self-dealing by unilaterally managing the LLCs’ financial operations through his personal companies and benefited personally from these transactions, in violation of his duty of loyalty to act in the LLCs’ best interests. He further breached his duties by refusing access to records and refusing to attend meetings.
The court had found that Garret unilaterally made critical financial decisions, such as paying a $300,000 down payment for a real estate purchase on behalf of Hirchak Group LLC. By doing so without consulting Toby and Tyler or allowing them to contribute their shares, Garret excluded them from participating in key decisions and violated the principle of equal management responsibilities outlined in their agreement.
Garret’s conduct thus caused material harm to the LLCs, destabilizing operations and damaging relationships among the members. His actions, including self-dealing, withholding records, and unilateral decision-making, violated his duties of loyalty, good faith, and fair dealing. To protect the companies and restore functional governance, the court ordered Garret’s dissociation from both LLCs. It also required the companies to buy out Garret’s equity interest.
No Right to be Repaid for Advances or Unauthorized Services
The court emphasized that there was no mutual agreement between Garret and the other members, Toby and Tyler, that the $300,000 payment would be treated as a loan or a reimbursable expense. Under the LLC’s operating agreement, additional capital contributions required unanimous consent, which was not obtained. The court found that Garret made the payment unilaterally, without consulting or involving Toby and Tyler, even when they expressed willingness to contributdid not mutually agree
Without a formal or implied agreement to treat the payment as a loan or capital contribution, the court held that Garret could not claim reimbursement as a matter of contractual or statutory right. Instead, the payment was characterized as a voluntary act made without clear terms or conditions.
A well-drawn operating agreement will include provisions that explicitly address additional capital or advances made to the company, avoiding such disputes. It will also address the consequences of failing to add capital when required by the operating agreement.
It was surprising to me that the court did not find that the company had an obligation to repay the money Garrett had paid to the LLCs, even on a purely equitable basis. The analysis, however, is quite compelling. The court begins by stating that the companies plainly received a benefit.
However, the court ultimately determined that it was “not inequitable” for the companies to keep the money. The principal elements of the analysis were:
- Garret’s Exclusion of His Brothers: Garret unilaterally made the payment without consulting Toby and Tyler or allowing them to contribute their proportional shares. The court noted that this exclusion contradicted the principles of equal management and decision-making in the LLC.
- Garret’s Breach of Fiduciary Duties: The court found that Garret violated his duties of loyalty and good faith by acting in a self-serving manner. His refusal to involve his brothers in the decision-making process and his later demand for repayment, including interest, highlighted this breach.
- Unilateral Action: Garret’s unilateral payment was characterized as a voluntary act, made without any agreement or expectation of repayment. The court found that any belief of entitlement to reimbursement existed solely in Garret’s mind and was unsupported by the actions or agreements of the other members.
- Broader Context of Misconduct: The court emphasized that unjust enrichment must be evaluated within the broader context of the parties’ relationships and actions. Garret’s self-dealing and obstruction of financial transparency contributed to the dysfunction within the LLC. Allowing repayment would reward conduct that undermined the collaborative governance of the business.
The Supreme Court also affirmed the trial court’s finding that Garrett was not entitled to be paid for services that he rendered after he had breached his duty of loyalty and that the majority members had not engaged in oppressive behavior in denying his employment because their denial was based on Garrett’s own behavior.
There is no reasonable expectation of continued employment by one who is engaged in wrongful conduct, the court held. Beyond that, the court affirmed that a member that is in breach of a fiduciary duty of loyalty has no right to compensation.