Expert: Ed McFarland - 3/24/2007

Question
QUESTION: My question is about capital accounts... in our llc business 1 of 3 partners wants to retire.. he want to sell his shares for x amount.. we did not know his capital account was negative 250,000... After we purchased his shares, 1 year later we find the account ( a good friend of the partner retired) Took the negative capital account and divided it among the remaining 2 partners capital accounts-- so our cap accounts went in the red... when we brought this up to the accountant... he said it was a way to sell the shares for what they were really worth that we did creative-- we had NO IDEA this was part of the deal--We went buy the buyout contract sale price only-- here is my question.. is the selling partner responsible -- can we MAKE him pay pack that neg cap account amount?
ANSWER: Let me see if I got this, a partner wants out, you have a buy/sell agreement in place and execute it to acquire his share.

After some very late due diligence, you find out that his share was not what it was suppose to be.

Based on what you've told me hear it is either very sloppy on your part or fraud. If it is the later, you may have recourse, but it'll have to go to court to be settled. If it is the former and the 2 remaining shareholders didn't properly check everything out and the retiring partner didn't hide anything, you are more than likely out of luck.

---------- FOLLOW-UP ----------

QUESTION: I know its a weird one- Ill try to explain how we are in this situation.. 3rd GENERATION FAMILY BUSINESS... that may help explain.. older generation is VERY CONTROLLING, manipulative etc.. FINALLY he wants to retire.. The co. accountant thats also a atty-- for 30 years with the co, that ONLY communicated with the retiring partner.. as he was told years ago.. So, yes, we were trained long ago to shut up and wait your turn... They prepared a buyout contract.. he wanted 12 million for his 50%..  we gave 650,000.,he was to stay on until the he gets the remaining 350,000.. When we DO get the nerve to ask the accountant for our files & taxes etc.. & the retiring partner  account act WACKED and avoid giving us our files-- we finally go to our banker for our financial ( the retiring partner still signed all returns- we never saw or discussed them...) We take to another accountant the explains to us what a capital account is and shows how he the retiring partner had a NEG 250,000 cap account 12/30/04 and on 1/1/05  his neg cap account was zero and our were up 250,000 we asked the accountant why-- he said " oh well, his shares were really worth more then 1 mill.. thats why we put it on your cap account.. The question is.. IF SOMEONE has a accountant put their NEG cap account on your cap account and tries to keep it from you-- & you find out.. Can we make him pay it back or prove he has received a additional 250,000 for his buyout balance? I know, Its complicated-- we are now trying to straighten things out-- this cap account is difficult to understand-- we want to know if we can PROVE he has been paid in full usng the neg cap account we took on his behalf unknowingly

Answer
If I understand the situation, the capital account is the equal to shareholder equity. There is some gamesmanship going on here and I can't sort it out for you.

It may be more about taxes than valuation. The best you can do without going to court is play a little hardball. There should be things that need to be signed, don't do it without counsel.

Your other option is pay him off and get him out of there and build the business.

Good luck