Transactional lawyers who assist clients in the formation and restructuring of business entities, and the litigators who clean up the transactional lawyers’ occasional messes, each have lessons to learn from last week’s appellate ruling in 223 Sam, LLC v 223 15th Street, LLC, 2018 NY Slip Op 03118 [2d Dept May 2, 2018].
The lesson for transactional lawyers is, when you go to the time, trouble and client expense of negotiating and preparing a shareholders or operating agreement, every time you transmit via email or other means a copy of the unsigned agreement, no matter how preliminary or advanced the draft, include a proviso that there is no binding agreement until the parties exchange fully signed copies. Or better yet, put the proviso in the body of the agreement. Or both.
For litigators, the lesson is twofold. First, litigation, like a prize fight, usually goes a number of rounds before there’s a victor (or, more likely, a settlement). An early round win, such as defeating the adverse party’s bid for a preliminary injunction, is no guaranty the other side won’t prevail, with or without an assist from a panel of appellate judges. Second, if you’re litigating a governance or ownership dispute between putative co-owners of a realty holding entity, it’s usually not a good idea to file a lis pendens against the real property unless you (or your client) are prepared to pay the other side’s legal fees to secure its cancellation.
The LLC Agreement
223 Sam involves a dispute over the ownership and control of a single-asset New York LLC that, in 2013, acquired a commercial real property in Brooklyn consisting of a residential loft building. At the time, the LLC’s sole member was a family trust. A simple, 3-page, single-member operating agreement accompanied the LLC’s formation.
According to the complaint, in July 2014, the trust and the plaintiff LLC entered into a written Amendment to the operating agreement making plaintiff a 50% member and designating it the sole managing member. The Amendment states, among other duties, that the plaintiff will manage, renovate, and legalize the building within three years, and will loan the LLC approximately $400,000 for building work.
The Amendment’s final provision addresses its execution in counterparts, stating,
This Amendment may be executed in multiple counterparts, each of which shall be an original, but all of which shall be and constitute one instrument. Facsimile/email/pdf signatures to this Amendment shall be deemed originals for purposes hereof.
Only one problem with the Amendment: it never was signed.
In April 2016, the plaintiff filed suit against the property-holding LLC and the trustees of the family trust, claiming that the defendants were wrongfully refusing to acknowledge plaintiff’s membership interest and had usurped plaintiff’s authority as sole manager. The complaint alleged that, in furtherance of the Amendment, the plaintiff undertook management of the property, retained counsel to pursue legalization proceedings before the New York City Loft Board, negotiated with tenants, and advanced the LLC $40,000 for expenses.
The plaintiff also filed a lis pendens a/k/a notice of pendency against the LLC’s realty, a device authorized by NY CPLR § 6501 that puts any prospective purchaser or mortgage lender of the property on constructive notice of a potential judgment that “would affect the title to, or the possession, use or enjoyment of, real property.”
The lis pendens effectively stymied any financing of the building, which the defendants apparently were in the process of arranging, prompting their counsel to send a notice to the plaintiff’s counsel, demanding cancellation of the lis pendens upon threat of a motion to the court requesting judicial cancellation along with an award of costs and legal fees.
The Lower Court Proceedings
The plaintiff rejected the demand and filed a motion for an interim injunction to prevent the defendants from mortgaging the property, and to stay all Loft Board proceedings. The motion was shot down in a ruling from the bench by Nassau County Supreme Court Justice Jerome C. Murphy, who commented, “I don’t know that [the Amendment has] been accepted,” and also asked, “How come it’s two years later and it’s not signed?”
The defendants then fired back with their own motion to cancel the lis pendens, on the ground that the plaintiff’s claims did not affect title to, or the possession, use or enjoyment of, real property, and for summary judgment dismissing the complaint on the ground that the plaintiff held no membership interest or managerial authority based on the unsigned Amendment. In support of the latter proposition, the defendants highlighted Justice Murphy’s above-quoted comments in connection with the failed injunction motion, casting doubt on the Amendment’s acceptance.
In opposition to the motion to cancel the lis pendens, the plaintiff argued that his alleged managerial rights and duties, and his claim for a constructive trust, fell within the statute’s requirement that the claims affect, if not title, at least the possession, use, or enjoyment of realty.
In opposition to the summary judgment motion, the plaintiff relied on a series of emails between the parties’ attorneys, on which the principals were copied, as follows:
Defendants’ attorney on 5/8/14: Looks good to me [referring to the last draft of the Amendment sent by the plaintiff’s attorney].
Plaintiff’s attorney on 5/16/14: Can we get this signed? I will have [plaintiff] sign today. I just need the amount you want me to put in para 6.
Defendants’ attorney on 6/3/14: I approve ☺
Plaintiff’s attorney on 7/1/14: Please confirm I can send the [Amendment] home with [defendant’s] son to have [defendant] sign tonight. Once he does we will get [plaintiff] to sign tonight or tomorrow.
Defendants’ attorney on 7/1/14: I spoke to [my client], and he is ready to sign and go forward. With mazel!!!
Plaintiff argued that the defendants’ attorney’s “With mazel!!!” indicated “congratulations at finalization of the Agreement” and that the totality of the emails constituted “an undeniable manifestation of assent to be bound by the Terms” of the Amendment. Plaintiff also argued that the email “signature” of defendants’ attorney constituted “execution of the agreement as a matter of law” and satisfied the Amendment’s provision for acceptance of “Facsimile/email/pdf signatures.”
Justice Murphy’s December 2016 Decision and Order (read here) focused solely on the lis pendens. He disposed of defendants’ summary judgment motion without comment, merely stating that “to the extent that requested relief has not been granted, it is specifically denied.”
As to the lis pendens, Justice Murphy concluded that the complaint’s claims to establish plaintiff’s 50% membership interest in the property-holding LLC and to validate his management authority “do not seek relief that would affect the title to, or the possession, use or enjoyment of real property” as required by the statute, and he therefore ordered cancellation of the lis pendens.
That’s not all. Justice Murphy also found that plaintiff’s filing of the lis pendens and subsequent refusal to withdraw it were “frivolous” and “completely without merit in law and could not be supported by a reasonable argument for an extension, modification, or reversal of existing law.” On that basis, he ordered the plaintiff to reimburse defendants’ expenses including counsel fees incurred as a result of the improper filing, to be determined at a hearing. The hearing never took place, however, after the plaintiff agreed to pay defendants $15,000.
The Appellate Court’s Affirmance
The defendants appealed the denial of their summary judgment motion, leading to last week’s decision by the Appellate Division, Second Department, affirming Justice Murphy’s order. The meat of the court’s opinion follows (citations and internal quotation marks omitted):
If the parties to an agreement do not intend it to be binding upon them until it is reduced to writing and signed by both of them, they are not bound and may not be held liable until it has been written out and signed. However, if the parties intended to be bound by an oral agreement, a mere failure to reduce their promises to writing would be immaterial. Further, 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. . . .
Contrary to the defendants’ contention, the agreement does not, on its face, demonstrate that the parties did not intend to be bound absent formal execution. Moreover, in support of their motion, the defendants submitted emails exchanged between the parties and their respective attorneys. The defendants failed to eliminate triable issues of fact as to whether the parties had agreed upon the major terms of the agreement and whether the parties began to perform the agreement. Accordingly, they failed to establish, prima facie, that the parties did not intend to be bound by the terms of the agreement.
Interestingly, nowhere does the court mention Sections 102 (u) and 417 (a) of the LLC Law. The former defines “operating agreement” as a “written agreement of the members” and the latter requires members “to adopt a written operating agreement”. In light of these statutes, query, what did the court have in mind when it wrote, “if parties intended to be bound by an oral agreement, a mere failure to reduce their promises to writing would be immaterial”?
Taken at face value, the court’s comment suggests the enforceability of oral operating agreements which, while recognized in many if not most states, is not the rule in New York where, in the absence of a written operating agreement as required by statute, courts deem the LLC to be governed by a “statutory operating agreement” consisting of the LLC Law’s default rules.
As I see it, however, the comment should be treated as dicta given the opinion’s explicit references to the attorney emails and the issue of plaintiff’s performance under the Amendment, both of which bear on the parties’ assent to the written Amendment rather than the enforcement of an oral agreement. Indeed, the plaintiff’s complaint nowhere alleges, much less seeks to enforce, an oral agreement.
Also worth noting is the court’s distinction between an “understanding” that the agreement should be “formally drawn up and put in writing” — which, the court states, is insufficient to preclude a binding agreement where “all substantial terms of a contract have been agreed on” — versus a “positive agreement that it should not be binding until so reduced to writing and formally executed.”
Apparently, the Amendment’s provision expressly contemplating its execution in counterparts and deeming “Facsimile/email/pdf signatures to this Amendment” as “originals for purposes hereof,” and the attorney emails about obtaining client signatures, did not constitute the type of “positive agreement” negating an intent to be bound absent the agreement’s formal execution.
I’ve written previously about cases in which the deal gets ahead of the documents, that is, where a party takes on operational or even financial responsibility for the business before there’s a finalized written agreement in place formalizing the party’s ownership and management rights. As mentioned at the top of this post, the best insurance against litigation of the sort is to include, in the communications transmitting the draft agreement, and in the agreement itself, a proviso that the parties are not bound absent the mutual execution and delivery of the agreement.