Long before I was regretting my decision to have recently stocked up on frozen chicken, future U.S. Supreme Court Justice Oliver Wendell Holmes, Jr. observed that “[t]he life of the law not been logic[,] it has been experience.” Such experience often comes at a heavy cost, and some of us pay more than our fair share. Recently, in Kilpatrick v. White Hall on MS River, LLC, the Mississippi Supreme Court underscored, to the tune of almost $200,000, both that simple truth and the potential perils of a “gentleman’s deal” gone awry.
In that case, five investors, who were apparently less friendly with each other than they initially thought, decided to each pony up $500,000 to collectively purchase a hunting camp. Because they were experienced with such matters, they would buy the land through a soon-to-be-formed limited liability company. The terms of the deal would be memorialized with a handshake and a promise because they were such long-time friends. Unfortunately, when it came time to close, two of the investors were unable to come up with the necessary funds, and one had to drop out of the venture completely. The other gentleman, Mr. Kilpatrick, pitched in $100,000 as a deposit, and assured his counterparts he would come through with the remaining $400,000 shortly.
Because the group wanted to capitalize on the time-sensitive pricing of the property, the group decided to go ahead and close on the purchase. The property was sold to White Hall on MS River, LLC (“White Hall”), which had not yet filed a certificate of formation with the Mississippi Secretary of State and did not have an operating agreement. After the sale, having now purchased a significant piece of property with perhaps even more significant debt, the outfit of investors decided that they should formalize their “gentlemen’s agreement.” The group soon circulated an operating agreement, which included a provision requiring a minimum $500,000 contribution to be admitted as a member. Although only the three $500,000 contributors signed the agreement, Kilpatrick’s name appeared on the capital accounts schedule, indicating he had pitched in $100,000 toward their cause.
Undeterred, Kilpatrick continued to chip-in toward the debt owed by White Hall, paying an additional $87,500 toward the company’s loan obligations. The members of the company were, for the time being, content to let him continue to hunt the land and reflected him as a member and part-owner on their Mississippi and federal income tax returns. Not too long thereafter, however, things went south. White Hall needed more money, Kilpatrick continued to shirk his obligations to contribute the full $500,000 and White Hall accordingly informed him he should find somewhere else to hunt until he made good on the $500,000 commitment.
Peeved, Kilpatrick packed his bags and bought his own hunting camp. White Hall, under financial distress, determined it would have to sell part of the land. In an attempt to divorce themselves completely of Kilpatrick, White Hall offered to refund the $43,225 of his contributions that had gone toward the principal of the debt. Kilpatrick refused, presumably insisting he would get it all back in court, in what was clearly a soon-to-be lawsuit.
At trial, however, a curious thing happened, at least from the perspective of Kilpatrick. Although Kilpatrick, armed primarily with his recollection of the gentleman’s agreement, argued that the operating agreement was not binding because not all members had signed it. He had an extremely difficult time establishing that he was, in fact, a member of White Hall and the trial court ultimately found just the opposite. The court found there was a minimum contribution requirement (Kilpatrick had been aware of the requirement) and that he had assured the company, to White Hall’s detriment, that he was imminently going to make such a contribution. According to the court, because Kilpatrick never came through on that promise, his claim to a membership interest in the company, much like his contribution, was a day late and a dollar short.
On appeal, the Mississippi Supreme Court largely agreed. The Court held that “the clear language of the operating agreement requires a $500,000 contribution to become a member” and, having failed to meet that requirement, Kilpatrick’s “membership interest is nonexistent under the agreement.” Further, although White Hall listed Kilpatrick as a member on the company’s tax return, the company did so only because the members believed their long-time friend when he assured them he would come through with the remaining funds.
Accordingly, the Court flatly rejected Kilpatrick’s claim he was a member of the company, and further found he was not even entitled to a return of his contributions, having largely created his plight by falsely assuring the company he intended to deliver on the remaining $400,000.
Kilpatrick’s experience should be an important reminder for us all. No one ever needs a contract when things are going well, but we’re not nearly as good at gauging how well things will continue to go as we think we are. This isn’t a novel idea, but neither is locking your shed. Experience can be a costly and necessary teacher, but here’s to hoping we can all borrow from Mr. Kilpatrick’s expense account for this refresher on the potential perils of the “gentleman’s deal” when things go downhill.
» J. Andrew Mauldin is an attorney at Phelps Dunbar LLP.
BEFORE YOU GO…
… we’d like to ask for your support. More people are reading the Mississippi Business Journal than ever before, but advertising revenues for all conventional media are falling fast. Unlike many, we do not use a pay wall, because we want to continue providing Mississippi’s most comprehensive business news each and every day. But that takes time, money and hard work. We do it because it is important to us … and equally important to you, if you value the flow of trustworthy news and information which have always kept America strong and free for more than 200 years.
If those who read our content will help fund it, we can continue to bring you the very best in news and information. Please consider joining us as a valued member, or if you prefer, make a one-time contribution.Click for more info