Member distribution rights, profit allocation disputes, management fee conflicts, and capital account reconciliation under 6 Del. C. §§ 18-503 & 18-504
Distribution disputes are among the most common conflicts in Delaware LLCs. Members contribute capital expecting returns, but managers may withhold distributions for improper reasons, pay themselves excessive компенсация, or misallocate profits among members.
"The profits and losses of a limited ответственность company shall be allocated among the members, and among classes or groups of members, in the manner provided in a limited ответственность company agreement. If the limited ответственность company agreement does not so provide, profits and losses shall be allocated on the basis of the agreed value (as stated in the records of the limited ответственность company) of the contributions made by each member..."
"Distributions of cash or other assets of a limited ответственность company shall be allocated among the members, and among classes or groups of members, in the manner provided in a limited ответственность company agreement. If the limited ответственность company agreement does not so provide, distributions shall be made on the basis of the agreed value (as stated in the records of the limited ответственность company) of the contributions made by each member..."
Consider sending a formal требование when:
I personally draft and sign требованиеs for Delaware LLC distribution disputes, including Суд of Chancery enforcement actions.
Email owner@terms.lawSection 18-503 provides the default allocation formula when the operating agreement is silent: profits and losses are allocated based on the agreed value of contributions made by each member as stated in the LLC's records.
Three members form an LLC. Member A contributes $500,000, Member B contributes $300,000, Member C contributes $200,000. Итого contributions: $1,000,000.
Default allocation percentages:
Most Delaware LLC operating agreements modify the Section 18-503 default with custom allocation provisions:
Operating agreement states profits will be allocated "fairly" or "as determined by the manager" - such vague language leads to disputes when manager's interpretation favors themselves.
Member contributes services rather than cash. Disputes arise over the "agreed value" of those service contributions for allocation purposes.
When losses exceed a member's capital contributions, their capital account goes negative. Operating agreements must specify whether members with negative capital accounts still receive profit allocations.
IRS may challenge special allocations that lack "substantial economic effect" under Treas. Reg. § 1.704-1(b). Reallocation by IRS can create disputes among members.
For Recipients: If you receive a требование claiming profit misallocation, immediately review: (1) the operating agreement's allocation provisions, (2) capital account statements, (3) tax returns showing actual allocations, and (4) any member resolutions modifying allocation percentages. Consult a Delaware адвокат before responding.
Critical distinction under Delaware law:
You can have profit allocations without distributions. LLC may allocate $100,000 profit to you (taxable income) but distribute $0 cash (no money received). This creates "phantom income" tax ответственность.
Like Section 18-503, distributions follow agreed value of contributions unless the operating agreement specifies otherwise. Most operating agreements modify this extensively.
Section 18-504 prohibits distributions that would violate solvency. A distribution is improper if, after giving effect to the distribution:
Member Ответственность: Members who receive distributions in нарушение of Section 18-504's solvency requirements may be required to return them to the LLC. Operating agreements can expand or limit this ответственность.
| Discretionary Distributions | Mandatory Distributions |
|---|---|
| Operating agreement gives manager authority to decide "if and when" to make distributions | Operating agreement requires distributions in specific circumstances (e.g., "LLC shall distribute 90% of net cash flow quarterly") |
| Manager has broad discretion but must exercise it in добросовестность | Manager has no discretion - must make distributions per agreement |
| Challenging withheld distributions requires showing недобросовестность or breach of fiduciary duty | Failure to make mandatory distribution is contract breach |
| Manager can retain cash for business needs, reserves, future investments | Operating agreement defines limited exceptions (solvency, loan covenants) |
Managers often cite these reasons for withholding distributions:
"Section 4.3 of the Operating Agreement requires the LLC to distribute 'all available cash flow' to members quarterly. 'Available cash flow' is defined as net cash from operations minus necessary reserves for working capital. For Q1-Q3 2025, the LLC generated $850,000 in net cash from operations. Financial statements show current assets of $1.2 million and current liabilities of only $400,000, demonstrating more than adequate working capital. Despite this strong cash position and the mandatory distribution requirement, you have distributed $0 to members. This withholding violates Section 4.3 of the Operating Agreement and constitutes a breach of your fiduciary duty. I demand immediate distribution of my pro-rata share of the withheld cash flow totaling $212,500 (25% of $850,000)."
One of the most common tactics for reducing member distributions: the manager pays themselves excessive "management fees" or "consulting fees," depleting cash that would otherwise be distributed.
Delaware courts analyze management компенсация under fiduciary duty standards:
Суд held that manager's authority to set its own компенсация must be exercised consistent with the implied covenant of добросовестность and fair dealing. Even if operating agreement grants broad authority, manager cannot set компенсация in a manner that unfairly prejudices minority members.
To prove компенсация is excessive, compare to:
"According to the LLC's 2025 financial statements, you paid yourself $400,000 in 'management fees' - an increase from $120,000 in 2024. This $280,000 increase was never approved by members and is not authorized by the Operating Agreement. For comparison, third-party property management companies charge 1-2% of gross revenue for similar services. The LLC's gross revenue was $2.8 million, meaning market-rate management fees would be $28,000-$56,000, not $400,000. Your self-dealing компенсация is 14x market rates. This excessive компенсация depleted cash available for member distributions and constitutes a breach of your fiduciary duties. I demand: (1) immediate возмещение to the LLC of $344,000 (the amount exceeding reasonable market-rate компенсация of $56,000), and (2) distribution of my pro-rata share of the reimbursed amount."
Managers who pay fees to related entities must disclose the relationship and obtain member approval or demonstrate entire fairness:
For Recipients: If accused of excessive компенсация, gather: (1) operating agreement provisions authorizing fees, (2) member approvals/consents, (3) market comparables showing your fees are reasonable, (4) time records documenting services, and (5) доказательства of value created (LLC performance under your management). Be prepared to justify each component of компенсация.
Capital accounts track each member's economic interest in the LLC. Disputes often arise when capital accounts are incorrectly calculated, affecting distribution priorities and tax basis.
A capital account is a ledger showing:
| Purpose | Impact |
|---|---|
| Distribution Priorities | Operating agreements often provide that distributions are made pro-rata based on positive capital account balances, or that capital must be returned before profit distributions |
| Tax Basis | A member's tax basis (used to calculate gain/loss on sale or distributions) is closely tied to capital account balance |
| Liquidation Rights | Upon dissolution, assets are typically distributed according to positive capital account balances under Section 18-804 |
| Ответственность for Distributions | Distributions that cause negative capital accounts may create return obligations |
Member makes capital contribution but LLC records fail to credit their capital account. This understates member's economic interest and tax basis.
LLC allocates profits/losses differently than operating agreement requires, distorting capital accounts.
Capital accounts should be maintained on a "book" basis using fair market values, not tax basis. Errors occur when these are conflated.
Manager receives disguised distributions (inflated компенсация, personal expenses paid by LLC) that aren't properly recorded as reducing capital account.
When property is contributed with built-in gain/loss, special allocations under IRC Section 704(c) are required. Failure to make these allocations creates capital account discrepancies.
"I received the LLC's capital account statement dated December 31, 2025, showing my capital account balance as $450,000. This is incorrect. According to my records: (1) I made an initial capital contribution of $500,000 on January 15, 2023 (wire transfer confirmation attached); (2) I made an additional capital contribution of $250,000 on March 3, 2024 (check copy attached); (3) My profit allocations for 2023-2025 totaled $180,000 per my K-1s; (4) I received distributions totaling $100,000. The correct capital account balance should be $830,000, not $450,000 - a $380,000 discrepancy. This error affects my distribution rights under Section 5.2 of the Operating Agreement, which provides that liquidation proceeds are distributed according to positive capital account balances. I demand: (1) immediate correction of my capital account to reflect the accurate $830,000 balance, (2) corrected capital account statements for all periods since formation, (3) explanation of how this error occurred, and (4) confirmation that future distributions will be calculated based on corrected balances."
When требованиеs fail, Delaware Суд of Chancery provides several remedies for distribution disputes.
File исковое заявление seeking суд declaration of ваши права under operating agreement:
Operating agreement is a contract. Failure to make mandatory distributions or properly allocate profits is нарушение договора.
Remedies: Убытки equal to withheld distributions plus pre-judgment interest (Delaware statutory rate)
Manager's wrongful withholding of distributions or excessive self-компенсация breaches fiduciary duties.
Remedies: Disgorgement of improper компенсация, compensatory убытки, in egregious cases punitive убытки
When LLC financial records are unreliable or inaccessible, request formal accounting:
Request preliminary injunction to:
| Stage | Typical Timeline |
|---|---|
| File Исковое Заявление | День 1 |
| Ответчик's Answer/Motion to Dismiss | 20 days after service |
| Preliminary Injunction Hearing (if requested) | 2-4 weeks |
| Discovery | 4-8 months |
| Summary Judgment Motions | After discovery closes |
| Trial | 12-18 months from filing |
Forum Selection Clauses: Most Delaware LLC operating agreements contain forum selection clauses requiring all disputes to be litigated in Delaware Суд of Chancery. Even if you're located in California, you'll likely have to litigate in Delaware.
Delaware follows the "American Rule" - each party pays their own адвокат's fees unless:
Review your operating agreement's fee provision carefully before filing.
[Your Name]
[Address]
[City, State ZIP]
[Email]
[Phone]
[Date]
[Manager Name]
[LLC Name]
[Address]
[City, State ZIP]
Re: Demand for Distributions Under Operating Agreement and 6 Del. C. § 18-504
I am a member of [LLC Name], a Delaware limited ответственность company, holding a [X]% membership interest. I have been a member since [date] and have contributed $[amount] in capital to the LLC. This letter constitutes a formal demand for distributions that have been improperly withheld in нарушение of the Operating Agreement and your fiduciary duties.
The Operating Agreement, Section [X], provides: "[Quote exact language requiring distributions]." [Alternatively: "The Operating Agreement grants you discretion regarding distributions, but such discretion must be exercised in добросовестность and consistent with fiduciary duties."]
According to the LLC's financial statements for [time period], the LLC generated net income of $[amount] and maintains cash reserves of $[amount], with current liabilities of only $[amount]. The LLC is solvent and has more than adequate cash to make distributions while maintaining prudent working capital reserves.
Despite the LLC's strong financial position and [the Operating Agreement's mandatory distribution requirement / your fiduciary duty to act in добросовестность], you have distributed only $[amount or $0] to members during this period. [If applicable: Meanwhile, you have paid yourself $[amount] in management fees, an increase of [X]% from prior years without member approval.]
Your withholding of distributions constitutes:
1. Нарушение Договора: Section [X] of the Operating Agreement requires distributions of available cash flow. The LLC has $[amount] in available cash flow that should have been distributed.
2. Breach of Fiduciary Duty: As manager, you owe fiduciary duties of loyalty and care to members. Withholding distributions while [paying yourself excessive компенсация / diverting cash to related entities / providing no legitimate business justification] violates these duties.
3. Нарушение of Implied Covenant of добросовестность and Fair Dealing: Even if the Operating Agreement grants you discretion, Delaware law requires that discretion be exercised in добросовестность. Your actions demonstrate недобросовестность and unfair dealing toward minority members.
I demand the following в течение 21 дней of the date of this letter:
1. Immediate Distribution: Payment of $[amount], representing my [X]% pro-rata share of withheld available cash flow for [time period].
2. Complete Financial Disclosure: Provide complete and accurate financial statements, capital account statements, and records of all distributions made to any members for [time period].
3. Explanation of Withholding: Provide a detailed written explanation of the business justification for withholding distributions, including any loan covenant restrictions, anticipated capital needs, or other legitimate reasons.
4. [If applicable:] Возмещение of Excessive Компенсация: Reimburse the LLC for $[amount] representing management fees exceeding reasonable market rates, and distribute my pro-rata share of the reimbursed amount.
5. [If applicable:] Capital Account Correction: Correct my capital account balance to reflect [correct amount] and provide documentation supporting the corrected calculation.
If you fail to comply with these demands в течение 21 дней, I will have no choice but to file a исковое заявление in the Delaware Суд of Chancery seeking:
Судебный Процесс will be expensive and time-consuming for all parties. I prefer to resolve this matter cooperatively, but I am fully prepared to enforce my rights through the Суд of Chancery if necessary.
Please direct all communications regarding this matter to me at [email] or [phone]. I expect your written response в течение 21 дней.
С уважением,
[Your Signature]
[Your Printed Name]
Customization Required: This is a template. You must customize it with specific facts, operating agreement provisions, financial data, and applicable legal claims. Generic требованиеs are less effective than those tailored to your specific dispute.
I personally draft, customize, and sign требованиеs for Delaware LLC distribution disputes. Фиксированная оплата $575 includes research of your operating agreement, analysis of Delaware law, and адвокат signature.
Email owner@terms.lawGenerate a professional требование, CA суд исковое заявление, or арбитраж demand
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