Statutory Fraud Limits on Withdrawals for the LLC

April 13, 2006

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In the case of limited liability companies (LLCs), restrictions on withdrawals imposed by state LLC statutes are usually identical to the Uniform Fraudulent Transfers Act's (UFTA) constructive fraud restrictions. This is consistent with the theme of simplicity that applies to the LLC.

Thus, in the LLC, distributions to owners on account of their ownership interests (i.e., distributions of LLC income or redemption of an owner's interest) will automatically be deemed fraudulent if both:

the LLC receives nothing (or less than full value) in return for a transfer
the LLC is insolvent at the time of, or because of, the transfer under either a cash flow test (unable to pay debts as they come due) or a balance sheet test (liabilities exceed assets).

The constructive fraud restrictions imposed by the LLC statutes are limited to distributions of LLC income or redemptions of an owner's interest, and thus do not apply to payments by the LLC to the owners for salary, loans and leases. So in this way, they differ from the UFTA's constructive fraud provisions.

Note that, by definition, a distribution of LLC income or the redemption of an owner's interest will be for no return consideration. Thus, the first criterion under the constructive fraud test is really irrelevant, and the only issue involves the solvency of the LLC under the cash flow test and the balance sheet test.