Unsigned, Non-Final Operating Agreement Trumps Conflicting Testamentary Bequest of LLC Interest

April 12, 2021

Ten months ago, we wrote about an unusual case involving an LLC member who documented two irreconcilable membership interest transfers upon death. In Harris v Harris, 2020 NY Slip Op 31570(U) [Sup Ct, NY County Apr. 23, 2020], the deceased LLC member, Steven, had a written operating agreement conveying a life estate of his membership interest to his wife and, upon her death, to their daughter (hereinafter “Family Number One”).

Symmetrically at odds with the operating agreement (which happened to be unsigned, some provisions internally inconsistent, and loaded from front to back with handwritten comments), the deceased LLC member left an executed last will and testament conveying a life estate of his membership interest to another woman (referred to in the will as his “loving partner”), and upon her death, to their alleged out-of-wedlock daughter (hereinafter “Family Number Two”).

Last week, in Harris v Harris, ___ AD3d ___, 2021 NY Slip Op 02105 [1st Dept Apr. 6, 2021], a Manhattan-based appeals court reversed the lower court’s decision in Harris, which denied both sides’ motions for summary judgment, and granted summary judgment to Family Number One. Harris is a fascinating take on two important legal issues for closely-held business owners.

The “Doctrine of Definiteness” and “Agreements to Agree”

In the original Harris decision, the lower court ruled that the presence of “significant handwritten modifications and marginalia” in the operating agreement, “including portions of which are illegible,” as well as a sentence in the operating agreement that it “shall be retyped and redrawn and prepared in a proper and final fashion,” raised “issues of fact as to whether a formalized agreement . . . exists and whether the operating agreement is enforceable.”

As alluded to in our prior article, there is a fulsome body of New York case law addressing the concept of so-called “preliminary agreements” and “agreements to agree.” In these cases, one side argues that the parties did not intend the agreement to be enforceable unless every term was finalized and reduced to a signed writing, the other side arguing that the agreement should be enforced although some terms may have been left for future agreement or the document not signed.

We wrote about this phenomenon three years ago, noting that that courts on occasion will enforce written operating agreements – even though unsigned – where the material terms have been agreed upon and the parties demonstrate, either through conduct at the time of negotiation or subsequent performance, their intent to be bound by the unsigned writing. In the subject of that article, 223 Sam, LLC v 223 15th St., LLC, 161 AD3d 716 [2d Dept 2018], the Court ruled:

Where 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 (quotations omitted).

The basic rules of law on this subject – the so-called “doctrine of definiteness” – are simple in theory, but difficult in practice. One the one hand, under the “common law of contracts,” a “mere agreement to agree, in which a material term is left for future negotiations, is unenforceable” (Joseph Martin, Jr. Delicatessen v Schumacher, 52 NY2d 105 [1981]). On the other hand, “where it is clear from the language of an agreement that the parties intended to be bound and there exists an objective method for supplying a missing term, the court should endeavor to hold the parties to their bargain” (Matter of 166 Mamaroneck Ave. Corp. v 151 E. Post Rd. Corp., 78 NY2d 88 [1991]).

As one appeals court wrote just last week, “The doctrine of definiteness should not be applied with a heavy hand or allowed to defeat the reasonable expectations of the parties in entering into the contract,” so “the terms of a contract do not need to be fixed with absolute certainty to give rise to an enforceable agreement” (Toobian v Golzad, ___ AD3d ___, 2021 NY Slip Op 02185 [2d Dept Apr. 7, 2021] [quotations omitted]).

Under the principle, courts have the power to supply material terms missing from a contract by resort to extrinsic evidence. In a case where Peter Mahler and I represent the plaintiff, LMEG Wireless, LLC v Farro, 190 AD3d 716 [2d Dept. 2021], the Court held that an oral agreement among co-owners of an LLC to accept, at some future date, any “reasonable offer” from a third party to sell the business may be enforced despite the absence of an agreement on price. “There were objective criteria,” the Court ruled, “such as whether an offer comported with the company’s value as established by an analysis of its financial records, which could be used to determine whether a given offer was ‘reasonable’” (id.).

In the end, determining whether a non-final contract is nonetheless enforceable is fact intensive, “varying for example with the subject of the agreement, its complexity, the purpose for which the contract was made, the circumstances under which it was made, and the relation of the parties” (Cobble Hill Nursing Home, Inc. v Henry and Warren Corp., 74 NY2d 475 [1989]).

Based upon this case law, the primary task for the appeals court in Harris was to determine whether the parties agreed upon all of the material terms of the operating agreement. The Court held:

Plaintiffs correctly contend that there is no issue of fact as to whether the operating agreement is an unenforceable agreement to agree. The operating agreement did not leave material terms for future negotiations. On the contrary, it said, ‘This agreement shall be retyped and redrawn and prepared in a proper and formal fashion containing the text and substance of this agreement.’ The fact that the operating agreement referred to a ‘formal agreement’ and ‘a later time’ is not determinative (see e.g. Moshan v PBM, LLC, 141 AD3d 496 [1st Dept 2016] [citations omitted]).

Conflicting Pre- and Post-Death LLC Membership Interest Transfers

In the original Harris decision, the lower court ruled that there was an additional triable issue of fact whether the operating agreement could legally divest Steven of the ability to later bequeath in a last will and testament his LLC interest in a manner different than he agreed in the operating agreement. The lower court found that although the operating agreement “contemplate[s] [Steven’s wife] . . . acceding to Steven’s rights and ownership interests in the company,” it lacks “any language where Steven clearly and unambiguously renounces his future power of testamentary disposition.”

In Matter of Hillowitz’ Estate (22 NY2d 107 [1968]), New York’s highest court ruled, “A partnership agreement which provides that, upon the death of one partner, his interest shall pass to the surviving partner or partners, resting as it does in contract, is unquestionably valid and may not be defeated by labeling it a testamentary disposition.” The Court further held, “We are unable to perceive a difference in principle between an agreement of this character and one . . . providing for a deceased partner’s widow, rather than a surviving partner, to succeed to the decedent’s interest in the partnership” (id.).

Relying upon Hillowitz (which Family Number One previously briefed, but the lower court did not address in its opinion), the Appellate Division reversed the lower court, ruling that the operating agreement’s membership interest transfer provision – as a matter of law – trumped Steven’s conflicting will. The Court held that “plaintiffs are entitled to summary judgment because . . . the operating agreement, which is not an attempted testamentary disposition, prevails over the will” (citation and quotations omitted).

Thoughts on Harris

As we noted in our last article on Harris, a “contract to make a testamentary disposition” is governed by a statute of frauds, Section 13-2.1 (a) (2) of the New York Estates, Powers and Trusts Law, which requires any such contract to be “subscribed [i.e., signed] by the party to be charged.” The operating agreement in Harris was unsigned. Under Harris, an operating agreement (and presumably also a partnership or shareholders agreement) providing for transfer of a closely-held business interest upon death is “not an attempted testamentary disposition,” meaning it falls outside the statute of frauds and does not need to be executed to be enforceable.

Additionally, under Harris, courts may be inclined to enforce an operating agreement, even if it is not signed, so long as the agreement appears final in its material terms, and even though some other terms may be non-final. The lesson: if the parties intend for the contract not to be enforceable unless completely negotiated and signed, they should say so explicitly during the drafting process, in the communications discussing the document, in the drafts themselves, or both.

Harris also seems to express a hard-and-fast rule that a provision in an operating agreement providing for transfer of an LLC interest upon death will necessarily prevail over a conflicting estate plan. The lesson of this particular holding is clear: closely-held business owners and their estate planning counsel need to be extremely careful when planning an estate to read any applicable partnership, shareholder, or operating agreements before drafting a will. If the latter conflicts with the former, the former will prevail, to the disappointment of any would-be beneficiaries who hoped to become business owners, but instead saw their bequest fail due to a conflicting contract.