Also known as: distributions of profits · profit distribution · profit distributions · profit sharing
Written by attorneys — see sources below.
An allocation of a business entity's earnings to its owners or participants according to the governing agreement or default statutory rules. The allocation determines each recipient's share and the timing of any payment.
Decker Electronics earned substantial net income last quarter. Its board adopted a plan under which a portion of those earnings would fund annual bonuses for long-serving employees and officers. The plan credited each eligible participant with a share calculated from overall profits rather than individual performance. Payments were made directly from corporate funds without impairing capital.
Dominic Drake and Delilah Duran advanced funds to a struggling firm under an agreement that fixed each member's allowable draw and barred any other distribution of realized profits until the lenders approved. The firm later generated earnings but could not pay them out to the members. The lenders invoked the restriction to keep capital inside the business.
In the spring of 1921, the firm of Knauth, Nachod & Kuhne found itself in financial difficulties after its partners engaged in unwise speculations. John R. Hall, a partner and friend of Mr. Peyton, obtained a loan of almost $500,000 of Liberty bonds from Peyton which the firm could use as collateral to secure bank advances. Negotiations followed involving Hall, Peyton, Perkins, and Freeman, during which a proposal that some of them become partners was refused. The parties instead executed three documents on June 4, 1921, as part of one transaction: the agreement, the indenture, and the option. Under these documents the respondents agreed to loan $2,500,000 worth of liquid securities to be returned by April 15, 1923, which the firm could hypothecate for up to $2,000,000, in exchange for compensation measured as forty percent of the firm's profits, not less than $100,000 nor more than $500,000. The documents named Peyton and Freeman as trustees who were to receive income from the securities, remain informed of transactions, and could substitute or deal with the securities under the conditions set forth to protect their interests as lenders. The firm was to insure Hall's life for $1,000,000 with the policies assigned to the trustees. The trustees could inspect the books, receive information, and veto speculative business. The option permitted the respondents to join the firm later by purchasing interests at a stated price or to form a corporation. Firm members placed resignations with Hall that could be accepted if Hall and the trustees agreed.
View caseSection 405(a) requires any distribution a partnership makes before dissolution and winding up to occur in equal shares among the partners unless a charging order or transfer under section 503 applies. The statutory command of equal shares governs pre-dissolution distributions regardless of any profit-sharing understanding the partners reached at formation.
Supporting sources
In most cases where dividends have been compelled, it has been shown that the directors willfully abused their discretion by withholding distributions because of an adverse interest, a wrongful purpose, or bad faith. A business corporation is organized and carried on primarily for the profit of the stockholders, and directors' discretion does not extend to the non-distribution of profits among stockholders in order to devote them to other purposes.
As a default rule, in many states members receive distributions pro rata based on the contributions they have made to the LLC. ULLCA § 405 adopts the partnership approach, prescribing distribution in equal shares and explaining this as a simple default rule that assumes profits will be divided equally.
…their interest in the firm. No loan by the firm to any member is permitted and the amount each may draw is fixed. No other distribution of profits is to be made. So that realized profits may be calculated the existing capital is stated to be $700,000, and profits are to be realized as promptly as good business practice will permit. In…