The statutory default rule for member-managed limited liability companies (LLCs), as codified in New York’s LLC Law § 402, gives decision-making authority to a “majority in interest of the members’ votes.” Members are free to vary the default rule however they wish in the operating agreement, including a requirement for super-majority consent of the members as to matters affecting the LLC’s business affairs.
In my experience with multi-member LLCs including minority-interest holders, when the operating agreement does depart from the default rule, usually it takes the form of a “Major Decisions” provision that defines specific types of decisions and transactions outside the ordinary course of business requiring either super-majority or unanimous member approval. Such decisions could include hiring, firing and compensation of key personnel; the selection of outside professionals; changes to banking authority; entering into contracts of a certain type or outside defined dollar or other metrics; leasing decisions; and any other matters the members agree are important enough to justify member consent greater than a “mere” majority.
It goes without saying that such provisions should be drafted with great care to avoid future disputes and litigation over whether a particular proposed action requires one or another level of member approval. An appellate ruling earlier this month in Herbert v. Schodack Exit Ten, LLC, 2013 NY Slip Op 04083 (3d Dept June 6, 2013), illustrates the potential for litigation even when, as the court ultimately found in that case, the agreement’s language unambiguously authorized the challenged management decision without requiring unanimous member consent as contended by the dissenting member.
Herbert involved a real estate joint venture formed in 2000 between Schodack Exit Ten, LLC (SET) and British American Development Corp. (BADC) to commercially develop a 106-acre parcel owned by SET. SET and BADC formed B.A. Capital Corporate Campus, LLC (BACCC) as the development entity, with SET agreeing to contribute land and improvements, and BADC agreeing to market and manage the development. BACCC’s operating agreement provided a procedure for transferring the property from SET to BACCC, including a provision requiring BADC to acquire 2 acres annually from SET if no development occurred.
SET had four members, including a 35% member named John Bayly who died in 2004. The following year, faced with a stalled development project and BADC’s failure to make annual land purchases, the remaining three SET members authorized and entered into an agreement with BADC whereby SET transferred its remaining acreage to BACCC in exchange for $2.7 million in the form of promissory notes from BADC. By doing so, SET also relieved itself of a portion of the real property tax burden.
The trustees of the trust established by Bayly to hold his SET membership interest subsequently brought suit against the other SET members, claiming that the 2005 transaction with BADC did not have the requisite unanimous authorization of SET’s membership. SET’s operating agreement provided that
all management decisions affecting [SET] must be approved by at least three (3) [m]embers and all decisions involving commitments in excess of $10,000.00 must be accompanied by three (3) competitive bids, and be approved by the unanimous consent of all [m]embers.
The trustees contended that the sale of the remaining acreage to BADC for $2.7 million was a “commitment” in excess of $10,000 as contemplated by the above provision requiring unanimous member consent. The lower court disagreed and granted summary judgment for the defendants dismissing the complaint.
The trustees appealed to the Albany-based Appellate Division, Third Department, whose decision earlier this month upheld the lower court’s order based, in part, on the dictionary definition of “commitment.” Here’s what the court said:
In the context of SET’s business purpose, defendants’ decision to transfer SET property to BACCC and receive BADC’s promissory notes clearly fell within the ordinary meaning of a management decision. The issue thus narrows to whether the additional language in the operating agreement regarding commitments in excess of $10,000 and competitive bids controlled, thereby imposing a requirement of unanimity. The term “commitment” in a business context involves an agreement to do something in the future, “esp[ecially] to assume a financial obligation” (Black’s Law Dictionary [9th ed 2009]; see Merriam-Webster On-line Dictionary, http://www.merriam-webster.com/ dictionary/commitment [accessed May 9, 2013]). Significantly, the operative language was also tied to a competitive bid requirement further reflecting that such provision was intended to apply to incurring monetary obligations. Nor was this a situation where the property could have been placed on the open market in light of SET’s commitment under the BACCC operating agreement. We agree with Supreme Court that the ordinary meaning of the relevant words, considered in the context of the entire agreement, unambiguously authorized defendants’ action as a management decision and the unanimity requirement was not implicated under these circumstances.
Might the controversy and litigation have been avoided with more concise drafting of the LLC agreement? It’s hard to say, but it certainly could have made suit less attractive to the trustees had the provision spoken of commitments “to purchase services or property real or personal” or similar language that would have more specifically excluded the sale of SET’s realty.
Would the result have been different if the provision used the word “contracts” instead of “commitments”? I ask the question because, although I can’t think of any examples I’ve seen other than the Herbert case using the term “commitments,” I’ve seen many shareholders and operating agreements with Major Decisions provisions requiring super-majority approval of “contracts” in excess of a stated dollar amount. Arguably it would have been a closer question in Herbert if “contracts” had been used, but then again, in light of the additional, competitive bidding requirement, the contractual restraint on SET’s ability to sell its realty to anyone other than BADC might have remained an insuperable obstacle for the trustees.