Monday, September 29, 2014
In recent blog posts, two of my favorite bloggers, Keith Paul Bishop and Steve Bainbridge, have highlighted for our attention Delaware and California statutes providing (differently in each case) that an LLC and, at least in Delaware, its managers and members, are bound by the LLC's operating agreement even if they do not sign that agreement. Bishop notes in his post that the California "RULLCA creates an odd situation in which LLCs are bound by contracts that they did not execute and to which they seemingly are not parties." In his post Bainbridge cites to the Bishop post and another post by Francis Pileggi. Certainly, they all have a point. For students of contract law, the conclusion that a non-party is bound by a contract does not seem to be an obvious result . . . .
The flap in the blogosphere has its genesis in a recent Delaware Chancery Court decision, Seaport Village Ltd. v. Seaport Village Operating Company, LLC, et al. C.A. No. 8841-VCL. The limited liability company defendant in that case raised as its only defense that it was not a party to the limited liability company agreement and therefore was not bound. Unsurprisingly in light of applicable Delaware law, Chancellor Laster found the defense wanting as a matter of law.
This issue has more history than my brother bloggers point out, some of which is included in the brief Seaport Village opinion. I probably don't have all the details, but set forth below is some additional background information that may be useful in thinking about the binding nature of LLC operating agreements. Others may care to fill in any missing information by leaving comments to this post.
First. it seems fair to comment that Delaware legislators have been busy little bees on the issue of non-signatories to LLC operating agreements (known as limited liability company agreements under current Delaware law) over the past 10-15 years. The relevant Delaware statute, Section 18-101(7) of the Delaware Code Annotated, is a definitional section--providing the definition of a limited liability company agreement. The definition was amended in 2002 to add this relevant text: "A limited liability company is not required to execute its limited liability company agreement. A limited liability company is bound by its limited liability company agreement whether or not the limited liability company executes the limited liability company agreement." A later amendment, in 2004, added more to the definition: "A limited liability company agreement may provide rights to any person, including a person who is not a party to the limited liability company agreement, to the extent set forth therein." Finally, in 2005, the following text also was added: "A member or manager of a limited liability company or an assignee of a limited liability company interest is bound by the limited liability company agreement whether or not the member or manager or assignee executes the limited liability company agreement." The definition has been amended in other ways over the years, but these are the most relevant amendments on the rights and responsibilities of non-signatories.
All of this statutory madness may have at its root an important 1999 Delaware LLC case still taught by many of us: Elf Atochem North America, Inc. v. Jaffari. In Elf Atochem, the Delaware Supreme Court found that an LLC was a party to its LLC operating agreement even though it was a non-signatory. At issue in the case was whether the LLC was bound by arbitration and forum selection clauses in the operating agreement, which it had not signed.
The Elf Atochem court found that the predecessor version of Section 18-101(7)--which defined an operating agreement as an agreement of the members that governed the affairs and conduct of the business of an LLC--intended to bind the LLC. How else, the court seems to say, other than by binding the LLC to the terms and provisions of its operating agreement, could the agreement govern the affairs and conduct of the business of the LLC? The court followed on with this commentary (footnotes omitted):
The Act is a statute designed to permit members maximum flexibility in entering into an agreement to govern their relationship. It is the members who are the real parties in interest. The LLC is simply their joint business vehicle. This is the contemplation of the statute in prescribing the outlines of a limited liability company agreement.
The statutory amendment in 2002 confirms that the legislature holds that same view and makes Delaware law express on the point.
Not every state has followed Delaware's lead in finding a non-signatory LLC to be bound by its operating agreement, however. For example, in Trover v. 419 OCR, Inc., 921 N.E. 2d 1249 (Ill. App. 2010), in factual circumstances similar to those at issue in Elf Atochem, the Appellate Court of Illinois came to a result different from that in Elf Atochem. Specifically, the Ilinois court refused to find that either of the two LLC defendants was bound by an arbitration clause in its respective operating agreement (because, in each case, the LLC did not sign the operating agreement).
[W]e find that neither FODG nor the Golf Club was a party to the operating agreements and that they are therefore not bound by the arbitration clauses therein. Accordingly, the trial court did not err in denying the motion to compel arbitration . . . .
More analysis on the Trover opinion and commentary on another earlier case, Bubbles & Bleach, LLC v. Becker, No. 97 C 1320, 1997 WL 285938 (N.D. IL May 23, 1997), decided under Wisconsin law, can be found here and here.
All in, legal counsel would be wise to arrange for the LLC to sign the operating agreement ab initio. Although Delaware law provides clarity on what happens by default if the LLC does not sign the operating agreement, that same clarity does not necessarily exist in other jurisdictions. Please let me know if you are aware of states other than Delaware that find an LLC is bound to an operating agreement it did not sign. . . .