Corporate shareholder and LLC operating agreements routinely contain provisions addressing the transfer of equity interests upon the death of an owner of a closely-held business. Such provisions are vital for succession planning and multi-generational business continuity. But what happens if a contract provision governing distribution of an ownership interest upon death conflicts with the owner’s last will and testament?
In Harris v Harris, 2020 NY Slip Op 31570(U) [Supreme Court, New York County Apr. 23, 2020], Manhattan Supreme Court Justice Nanny M. Bannon considered this important question in the context of a dispute over the estate of a man who allegedly lived a double life.
The LLC, its Members, and the Competing Claimants
The decedent, Steven Harris, was one of two co-equal founders of TJ Montana Enterprises, LLC, an LLC formed in the 1990s that owned a five-story residential apartment building in Manhattan’s East Village.
Steven had a wife and daughter (“family number one”). Over his lifetime, Steven transferred various membership interests to his daughter, so that by the time of his death in 2017, Steven owned 19.35% and his daughter 30.65% of TJ Montana.
Steven also allegedly had a mistress who legally changed her last name to “Harris,” and an alleged daughter out of wedlock who also assumed the last named “Harris” (“alleged family number two”).
The Operating Agreement
TJ Montana had a written “Limited Liability Partnership Agreement.” The operating agreement – which said it was for an entity “to be formed” – was covered from start to finish with handwritten markups, cross-outs, and changes. The agreement stated above the signature block, “This agreement shall be retyped and redrawn and prepared in a proper and final fashion containing the text and substance of this agreement which shall be incorporated into the formal agreement at a later time.”
The agreement set forth the intended “succession” of each member’s LLC interest, providing as to Steven’s 19% interest a life estate to his wife with the remainder to their daughter, as follows:
Upon death, [wife] shall accede to Steven Harris’ full interest thereunder and [daughter] shall then get a power of attorney to sign for her mother and upon the death of [wife] and Steven Harris, [daughter] shall accede as heiress to all that right, title and interest that her father had in succession and shall as a 50% co-partner be entitled to all rights hereunder.
The Last Will and Testament
The estate plan in Steven’s Last Will and Testament was the polar opposite of the operating agreement, cutting out his wife and daughter, providing instead a life estate of Steven’s 19% LLC interest to his alleged mistress with a remainder to his alleged out-of-wedlock daughter:
To my loving partner [the alleged mistress] . . . I do hereby transfer all my right, title and interest to my 19.35% share in TJ Montana Enterprises LLC . . ., which holds the right, title and interest to real property located at 82 East 3rd Street New York, New York, for her life and, upon her death, to our [alleged] daughter.
In addition to the will, the alleged family number two purported to rely upon a practically-illegible, un-notarized, handwritten assignment.
The Prior Litigations
Shortly after Steven died, alleged family number two offered Steven’s will to probate in Bronx County Surrogate’s Court. A will contest between family number one and family number two ensued, which apparently remains ongoing.
Separately, alleged family number two filed a lawsuit in New York County Supreme Court over their claim to Steven’s former interest in various assets, including TJ Montana, a lawsuit which also remains ongoing.
In the action before Justice Bannon, family number one were the plaintiffs, filing a complaint, in response to which family number two filed their own counterclaims. In all three pleadings, the first cause of action sought a declaratory judgment as to who was legally entitled to Steven’s 19% membership interest in TJ Montana.
The Summary Judgment Motions
Prior to any discovery, family number one, on the one hand, and alleged family number two on the other, filed a dueling motion and cross-motion for summary judgment on their respective declaratory judgment claims, asking the court to rule, as a matter of law, on the issue of post-death ownership of Steven’s 19% interest in the real-estate holding LLC.
The Summary Judgment Decision
Ruling on the dueling motions for summary judgment, Justice Bannon issued three essential legal rulings.
Justice Bannon noted that family number one filed at least two different versions of the same operating agreement containing slight variations in the handwriting on various pages. The court held, “These submissions . . . rais[e] an issue of fact as to whether there are multiple versions of the operating agreement.”
Under New York law, there is well-developed body of case law holding that so-called “preliminary agreements” – sometimes synonymously called “agreements to agree” – are unenforceable until reduced to a final, written agreement.
Relying upon this case law, and based upon what the court called “significant handwritten modifications and marginalia” in the operating agreement, “including portions of which are illegible,” as well as the sentence in the operating agreement that the contract “shall be retyped and redrawn and prepared in a proper and final fashion,” the court ruled that there were “issues of fact as to whether a formalized agreement between Steven and Lichtenstein exists and whether the operating agreement is enforceable.”
In the most interesting passage of the court’s decision, the court ruled:
[A]ssuming arguendo that one of the submitted agreements was the operative agreement at the time of Steven’s death, there would still be a triable issue of fact as to whether it irrevocably conveys Steven’s membership to [his wife], such that Steven’s subsequent will and assignment transferring his membership interest are void. It is well established that because a testator has the right to freely revoke a will until death, an agreement not to revoke a prior will, or an agreement irrevocably making a testamentary bequest, ‘demands the most indisputable evidence of…agreement’ and must ‘unequivocally renounce [the] testator’s right to execute a will making other disposition of [the] property.’ Am. Comm. For Weizmann Inst, Of Sci, v Dunn, 10 NY3d 82, 92 (2008). . . Although the operating agreements submitted do contemplate [the wife] acceding to Steven’s rights and ownership interests in the company, the plaintiff fails to point to any language where Steven clearly and unambiguously renounces his future power of testamentary disposition such that summary judgment would be proper.
As a result of these holdings, Justice Bannon denied both sides’ motions for summary judgment. In doing so, the court said it “notes that the validity of both the will and assignment are being disputed by the plaintiffs in a related action before the Bronx Surrogate Court.”
Harris raises an important question closely-held business owners sometimes take for granted: how clear must a shareholders’ or operating agreement be to effectively restrict the shareholder or member from later conveying an ownership interest under a will in a manner inconsistent with the contract? It is a rare case where a decedent plans an estate inconsistent with a fundamental business contract, like an operating agreement but, as alleged in Harris, it can happen.
As noted in Dunn, the Court of Appeals decision Justice Bannon quoted in Harris, New York has a statute of frauds provision specifically addressing this subject. Section 13-2.1 (a) (2) of the New York Estates, Powers and Trusts Law provides that “a contract to make a testamentary provision of any kind” is enforceable only if “it or some note or memorandum thereof is in writing and subscribed by the party to be charged therewith, or by his lawful agent. . .” To satisfy the statute of frauds, New York case law holds that such an agreement must be “indisputable” and “unequivocal,” a high level proof indeed.
In Harris, the court found that evidentiary problems with the operating agreement – multiple version, extensive ambiguous, illegible handwritten changes, and express language that the agreement was intended to be reduced to a more formal “final” agreement – collectively rendered the contract insufficiently clear to prohibit Steven as a matter of law (at least in the pre-discovery procedural posture of Harris) from making a testamentary disposition of his LLC interest inconsistent with the operating agreement itself.
Update: Justice Bannon’s decision has been overturned on appeal, in favor of the family number one. On April 6, 2021, the Appellate Division, First Department reversed the denial of summary judgment to Steven’s wife and marital daughter, ruling that the operating agreement was binding and enforceable even though it was unsigned and in some respects non-final and internally inconsistent. The appeals court also ruled that the operating agreement prevailed as a matter of law over Steven’s later will.