Frost Brown Todd Prevails on Novel Issue of Kentucky Business Law

July 3, 2012
Legal Updates

A three-member panel of the Kentucky Court of Appeals has unanimously affirmed a verdict in favor of Regional Radiology Associates, PLLC (RRA) on an issue of first impression involving the Kentucky Limited Liability Company Act.  The Supreme Court of Kentucky denied discretionary review, and the ruling in favor of RRA will stand.

The Court of Appeals affirmed a trial court judgment denying a departing physician's claim for additional compensation or distributions from RRA's professional practice after he had voluntarily left.  Joseph L. Ardery of Frost Brown Todd represented RRA.

RRA is a professional limited liability company (PLLC) that operates a radiology medical practice in western Kentucky. RRA employed the physician and, after a grace period, began discussions with him about becoming a 40% member of the PLLC.  Negotiations over the terms of an operating agreement—the legal document governing the rights of the company's owners—failed.  But despite the lack of an operating agreement, RRA began treating the physician as a 40% member in 2003.

Three years later, the physician gave notice that he was leaving to work for another professional practice in a different community. He demanded either additional distributions equal to 40% of RRA's accounts receivable or a payment equal to 40% of RRA's value as a going concern. He argued that he was entitled to these amounts because he had been a 40% member of the PLLC.

RRA pointed out that there was no written operating agreement governing RRA's operations or the economic relationship between the physician and the senior physician who had founded the practice.  As a result, default rules provided by the Kentucky Limited Liability Company Act were controlling. RRA was a "manager-managed" LLC. In the absence of a written operating agreement, distributions to current and prior members were at the sole discretion of the PLLC's manager—here, the senior founding physician.  Kentucky's LLC Act does not provide a departing member with a right to receive additional compensation or distributions simply because she might have received them if she remained a member. Instead, under the default rule, the manager has the exclusive power to decide whether a departing member will receive any additional compensation or distributions.

The RRA case illustrates the importance of having a written operating agreement to address important governance and economic issues.  The case further illustrates the importance of understanding the Kentucky Limited Liability Company Act default provisions that will operate in the absence of a written operating agreement.