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Commercial Division Holds That Agreement That Specifies Dilution as Remedy for Failure to Make Capital Call Prohibits Plaintiff from Seeking Monetary Damages

Operating agreements often specify dilution as the remedy for a failure to make a capital contribution.  But what if your business partner fails to make a contribution and you’d rather have the capital than an increased ownership share? If the agreement only provides for dilution as a remedy, can you still sue for monetary damages? In Oneiric Holdings LLC v. Leonelli,[1] Justice Marcy Friedman held that under Delaware law, the answer to this question is an unambiguous “no.”

In Oneiric, Cenk Fikri and Jean Baptiste Leonelli formed Oneiric, a Delaware limited liability company (“LLC”) that owned and operated hotels, restaurants, nightclubs, and bars. Fikri and Leonelli each held a 50% interest in the LLC. Oneiric’s Operating Agreement, which was governed by Delaware law, obligated Leonelli to make up to $23 million in contributions whenever Fikri, as the managing member of the LLC, made a capital call. The Operating Agreement provided that if at any time Leonelli failed to meet a capital call, his percentage interest in the LLC would be reduced 1% for each $460,000 he failed to contribute, and Fikri’s percentage interest would correspondingly increase. After Leonelli failed to meet a capital call in the amount of $300,000 and another in the amount of $23 million, Fikri sued for monetary damages in the amount of the capital calls. Leonelli moved to dismiss.[2]

Justice Friedman granted the motion.  Justice Friedman began by explaining that it was an open question under Delaware law whether “if the parties' operating agreement does provide for the penalty of diminution in the event a member fails to meet a capital call, the non-defaulting member will be limited to diminution as its exclusive remedy or may still seek damages in the amount of the capital call.”[3] Applying general principles of contract interpretation, Justice Friedman concluded that because the Operating Agreement unambiguously limited the remedy for Leonelli's failure to meet a capital call to dilution, and because Delaware LLC Act § 18‑502(a) allowed the parties to limit the remedies available for a failure to make a capital contribution, any “[o]ther common law remedies” were “accordingly unavailable,” and Fikri therefore could not sue for monetary damages.[4] Justice Friedman concluded by explaining this interpretation was supported by the principle of freedom of contract, which undergirds the Delaware LLC Act.[5]

Oneiric holds that Delaware law does not provide for monetary damages as a remedy for a member’s failure to make a capital contribution when the operating agreement only specifies dilution as a remedy. As Justice Friedman noted in her decision, this issue remains open under New York law. [6] Parties may therefore want to be mindful of the lessons of Oneiric when drafting LLC Operating Agreements, and may wish to think carefully about what remedies they would wish to seek in the event of a failure to make a capital contribution.

By Benjamin F. Jackson and Muhammad U. Faridi

[1] No. 655833/16, 2018 BL 126107 (Sup. Ct. Apr. 06, 2018).

[2] Id. at *1-2.

[3] Id. at *3.

[4] Id. at *4.

[5] See id. at *4-5.

[6] See id. at *5.