Cooked or raw? Enforceability of partially signed operating agreements | Farrell Fritz, PC

The harsh realities of modern life are such that organizational documents of business entities, such as LLC operating agreements, are sometimes not drafted or executed until long after the entity was initially formed with the filing of articles of association.

In other cases, such as where an LLC has many members, the operating agreement may not even reach a state of full execution, with some members signing, others not, but the parties behaving as if they had accepted the written document.

In Abraham 2008 Family Trust v 391 Broadway LLC, Decision and Ordinance, Index n ° 653460/2021 [Sup Ct, NY County Oct. 5, 2021]Manhattan Supreme Court Judge Arthur F. Engoron considered a challenge to the enforceability of a written operating agreement raising two issues related to the proper execution of an operating agreement:

  • Can a court find potentially enforceable a written operating agreement signed by only a handful of the entity’s large roster of members?
  • Made Section 417 (c) of the Limited Liability Companies Act (the “LLC Act”), which states that an operating agreement “may be entered into. . . within ninety days after the filing of the articles of association ”, render unenforceable operating agreements dating from several months or years after the filing of the articles of association?

Facts

391 Broadway LLC (the “Company”) was formed with organization statutes own and manage a five story commercial and residential building in Tribeca. About six months later, the members of the Company – 14 individuals and entities – reportedly entered into a written agreement operating agreement.

The operating agreement was apparently only signed by three of the 14 members: plaintiff Abraham 2008 Family Trust (the “Trust”), defendant Erez Itzhaki (“Itzhaki”) and defendant Gil Boosidian (“Boosidian” ). According to a timetable in the operating agreement, Itzhaki and Boosidian each acquired 25% of the stakes, the largest stakes. The Trust has acquired a 2% interest among the members.

Section 8.2 provided for a “put option”, under which members were entitled to resell their interests to the Company, an obligation “guaranteed personally (jointly and severally)” by Itzhaki and Boosidian.

The complaint

According to complaint, more than five years ago, the Trust exercised in writing the put option, but the company, Itzhaki and Boosidian refused to buy out the trust’s stake. The Trust alleged two claims: (i) breach of the operating agreement against the Company; and (ii) violation of the warranty clause of the Operating Agreement against Itzhaki and Boosidian.

The motion for nonsuit

The Company, Itzhaki and Boosidian have decided to lay off. As the Court framed the questions:

[D]the defendants submit that: (1) the copy of the operating agreement provided by the plaintiff is signed only by three of the 14 members of the defendant 391 Broadway LLC and is therefore unenforceable; [and] (2) the operating agreement was entered into more than six months after 391 Broadway LLC filed its Articles of Association and is therefore invalid under § 417 (c) of the New York Limited Liability Act .

You can read the submissions of the parties on these issues. here, here, and here.

Enforceability of partially signed or unsigned operating agreements

We have written several times on whether courts can enforce operating agreements even if they are not signed. In an article, Peter Mahler wrote of a rule of law that some courts apply to this particular pattern of facts:

[W]here all the substantial terms of a contract have been agreed, and there is nothing left for future settlement, the mere fact that it was understood that the contract should be formally drawn up and put in writing, did not leave the incomplete and non-legally binding transaction, in the absence of a positive agreement that it should not be binding until it is so recorded in writing and formally executed.

In Abraham Trust, there did not appear to be a “positive agreement” that the operating agreement would be unenforceable unless signed by all parties. The closest provision – a standard oral no-modification provision – read: “This Agreement may not be changed, modified, amended, rescinded, abandoned or terminated orally, but only by written agreement, signed by all members.

Moreover, as alleged in the complaint itself, the operating agreement in Abraham Trust was executed by a majority of interests of the Company, that is to say, the Trust (2%), Itzhaki, (25%) and Boosidian (25%).

In a comparable factual situation, in Shapiro vs. Ettison, 146 AD3d 650 [1st Dept 2017], a Manhattan appeals court dismissed a minority member’s challenge to its co-members’ unwittingly adopting an operating agreement as allegedly “invalid because its adoption was not unanimous “. The Court ruled that the operating agreement was valid and enforceable, even though the minority member had not signed it and was not even aware of its existence at the time of its execution, because “The Companies Act limited liability § 402 (c) provides that the operating agreement may be adopted by “majority vote in the interest of the members entitled to vote.” By this same reasoning, one could certainly argue that the operating agreement Abraham Trust adopted by a majority of the Company’s interests would also be enforceable.

In Abraham Trust, however, the parties did not set out these rules, so the Court naturally did not take them into account. Nevertheless, the Court ruled:

[D]The defendants’ argument that the complaint should be dismissed at this stage because the plaintiff failed to include a copy of the agreement signed by the 14 members is not convincing. The applicant has produced a copy of the operating agreement that was in its possession, and the applicant has the right to be discovered to see what other copies might exist.

Enforceability of late signed operating agreements

On the second issue – the timing of the performance of the operating agreement and the effect, if any, on its validity – we are aware of only one prior written decision to consider this issue. It turned out to be the lower court decision in Shapiro vs. Ettison, 2015 NY Slip Op 31670 [U] [Sup Ct, NY County 2015]. In that opinion, the court ruled: “[W]While section 417 allows for an operating agreement to be entered into within 90 days of the articles being filed, it does not require the operating agreement to be entered into within 90 days.

Although the Court of Appeal of Shapiro did not explicitly take into account this lower court ruling, it implicitly affirmed it in ruling that the operating contract in this case was fully enforceable despite its execution almost two years after the filing of the articles of association.

As with the previous argument, the parties did not inform Shapiro. Nonetheless, Engoron J. ruled:

[T]The Court finds that the defendants’ argument that the agreement is invalid under § 417 (c) of the New York Limited Liability Act is ineffective. While the fact that the operating agreement was executed more than six months after the organization’s statutes were filed may have other legal implications, it clearly would not invalidate an otherwise enforceable contract.

To take with

Lay people often assume that for a multi-party legal document to be enforceable, it must be signed by all or it is unenforceable. Abraham Trust It is yet another reminder that in the particular field of operating agreements for limited liability companies, a growing case law considers that contracts not performed or partially performed can nonetheless be potentially enforceable.

To prevent the courts from enforcing such unsigned or partially signed agreements, the parties should carefully and explicitly document their understanding – whether in the written operating agreement or in the negotiating documents preceding it – only they cannot and will in no way be bound unless their agreement is formally executed by all parties to the agreement.

And on the question of whether operating agreements should be executed at some point, it now seems clear that an operating agreement can be executed at any time during the existence of an LLC. All the more reason, then, to avoid partnering with others or investing in a limited liability company without requiring a written agreement upfront.

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