Cooked or Raw? Enforceability of Partly Signed Operating Agreements
November 08, 2021
The harried realities of modern life are such that business entity organizational documents, like LLC operating agreements, sometimes do not get drafted or executed until long after the entity’s initial formation with the filing of articles of organization.
In other cases, particularly where an LLC has many members, the operating agreement may not even reach a state of total execution, with some members signing, others not, but the parties behaving as if they had agreed to the written document.
In Abraham 2008 Family Trust v 391 Broadway LLC, Decision and Order, Index No. 653460/2021 [Sup Ct, NY County Oct. 5, 2021], Manhattan Supreme Court Justice Arthur F. Engoron considered a challenge to enforceability of a written operating agreement raising two related issues of due execution of an operating agreement:
- Can a court find potentially enforceable a written operating agreement signed by just a handful of the entity’s large roster of members?
- Does Section 417 (c) of the Limited Liability Company Law (the “LLC Law”), which states that an operating agreement “may be entered into . . . within ninety days after the filing of the articles of organization,” render unenforceable operating agreements dating many months or years after filing of the articles?
The Facts
391 Broadway LLC (the “Company”) was formed with articles of organization to 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 – allegedly entered into a written operating agreement.
The operating agreement apparently was signed by just three of the 14 members: Plaintiff Abraham 2008 Family Trust (the “Trust”), Defendant Erez Itzhaki (“Itzhaki”), and Defendant Gil Boosidian (“Boosidian”). According to a schedule to the operating agreement, Itzhaki and Boosidian each acquired 25% membership interests, the largest stakes. The Trust acquired a 2% membership interest.
Section 8.2 provided a “Put Option,” pursuant to which members were entitled to sell their interests back the Company, an obligation “personally guaranteed (jointly and severally)” by Itzhaki and Boosidian.
The Complaint
According to the complaint, more than five years ago, the Trust exercised in writing the Put Option, but the Company, Itzhaki, and Boosidian declined to repurchase the Trust’s interest. The Trust alleged two claims: (i) breach of the operating agreement against the Company; and (ii) breach of the guaranty provision in the Operating Agreement against Itzhaki and Boosidian.
The Dismissal Motion
The Company, Itzhaki, and Boosidian moved to dismiss. As the Court framed the issues:
[D]efendants argue that: (1) the copy of the operating agreement plaintiff provided is only signed by three of the 14 members of defendant 391 Broadway LLC and therefore unenforceable; [and] (2) the operating agreement was entered into more than six months after 391 Broadway LLC filed its Articles of Organization and is therefore invalid under § 417 (c) of New York Limited Liability Law.
You can read the parties’ briefs on these issues here, here, and here.
Enforceability of Partially Signed, or Unsigned, Operating Agreements
We’ve written multiple times about the subject of whether courts can enforce operating agreements even if they are unsigned. In one article, Peter Mahler wrote about a rule of law some courts apply to this particular fact pattern:
[W]here all the substantial terms of a contract have been agreed on, and there is nothing left for future settlement, the fact, alone, that it was the understanding that the contract should be formally drawn up and put in writing, did not leave the transaction incomplete and without binding force, in the absence of a positive agreement that it should not be binding until so reduced to writing and formally executed.
In Abraham Trust, there seemed to be no “positive agreement” that the operating agreement would be unenforceable unless executed by all parties. The closest provision – a standard no-oral-modification provision – stated, “This Agreement may not be changed, modified, amended, discharged, abandoned or terminated orally, but only by an agreement in writing, signed by all of the Members.”
Moreover, as alleged in the complaint itself, the operating agreement in Abraham Trust was executed by a majority-in-interest of the Company, i.e., the Trust (2%), Itzhaki, (25%) and Boosidian (25%).
In a comparable factual situation, in Shapiro v Ettison, 146 AD3d 650 [1st Dept 2017], a Manhattan-based appeals court rejected a minority member’s challenge to his co-members’ adoption of an operating agreement without his knowledge 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 did not sign it, and did not even know of its existence when executed, because “Limited Liability Company Law § 402 (c) provides that the operating agreement may be adopted by ‘the vote of a majority in interest of the members entitled to vote thereon.’” By this same reasoning, one certainly could argue that the operating agreement in Abraham Trust adopted by a majority-in-interest of the Company would similarly be enforceable.
In Abraham Trust, the parties did not brief these rules, however, so the Court understandably did not consider them. Nonetheless, the Court ruled:
[D]efendants’ argument that the complaint must be dismissed at this juncture because plaintiff failed to include a copy of the agreement signed by all 14 members is unpersuasive. Plaintiff produced a copy of the operating agreement that was in its possession, and plaintiff is entitled to discovery to see what other copies might exist.
Enforceability of Belatedly Signed Operating Agreements
On the second issue – the timing of the operating agreement’s execution and the effect, if any, upon its validity – we are aware of just one prior written decision to consider this question. It happened to be the lower court’s ruling in Shapiro v Ettison, 2015 NY Slip Op 31670 [U] [Sup Ct, NY County 2015]. In that opinion, the court ruled: “[W]hile section 417 permits an operating agreement to be entered into within 90 days after filing the articles of organization, it does not mandate that the operating agreement be entered into within 90 days.”
Though the appeals court in Shapiro did not explicitly consider this ruling by the lower court, it affirmed it implicitly by finding the operating agreement in that case to be fully enforceable despite being executed nearly two years after filing of the articles of organization.
As with the prior argument, the parties did not brief Shapiro. Nonetheless, Justice Engoron ruled:
[T]he Court finds defendants’ argument that the agreement is invalid under § 417 (c) of New York Limited Liability Law unavailing. While the fact that the operating agreement was executed more than six months after the filing of Articles of Organization may have other legal implications, this clearly would not invalidate an otherwise enforceable contract.
Takeaway
Laypeople often assume that for a multi-party legal document to be enforceable, it must be signed by all or it is unenforceable. Abraham Trust is yet another reminder that in the particularized area of limited liability company operating agreements, a growing body of case law holds that unexecuted, or partially executed contracts, may nonetheless be potentially enforceable.
To avoid courts enforcing such unsigned, or partially signed agreements, the parties should carefully and explicitly document their understanding – either in the written operating agreement or in the negotiation transmittals preceding it – that they cannot, and will not, under any circumstances be bound unless their agreement is formally executed by all parties to the agreement.
And on the issue of whether operating agreements must be executed at a particular time, it now seems clear that an operating agreement can be executed at any time during an LLC’s existence. All the more reason, then, to avoid partnering with others or investing in a limited liability company without insisting upon a written agreement from the outset.