One of the more attractive features of LLCs as a business organization is that they are, in large part, creatures of contract. Most provisions in the NY LLC Law are default rules, and members are free to adopt those or almost any other rules governing the ownership and management of the LLC. They can also agree to modify the rules, or they can make new agreements that affect the same interests as those covered by the LLC operating agreement.
With all the freedom of contract available to LLC members, it is not difficult to imagine how things can get messy quickly. Members sign an LLC operating agreement, then bury it in a file cabinet while they run the business. Years later and without consulting the operating agreement, they make another deal regarding their respective interests in the LLC. When a dispute arises, how do the operating agreement and the subsequent deal interact?
A recently filed case in the Manhattan Commercial Division promises to shed some light on the issue. In the first round—the plaintiff’s application for a preliminary injunction—a subsequent email buyout deal trumped any provisions in the parties’ operating agreement that might have given the defendant an out. At this stage, therefore, the case reminds us that the LLC operating agreement may give way to a subsequent, less formal agreement when both LLC members manifest their intent to be bound by the latter.
The dispute in Rosen v Triebenbacher arose between the two fifty-percent members of Barrier Island Enterprises LLC (“BIE”), which owns and operates several beachside restaurants and bars in Long Beach Island, New Jersey, including Kubel’s Too Restaurant and Bar.
The Shotgun Buy-Sell Agreement
According to Plaintiff’s complaint, the parties began their business relationship in 2017 by combining assets that they each owned separately under BIE LLC. They executed a detailed BIE operating agreement making Plaintiff and Defendant co-equal managers and 50% members, and the two shared plans to renovate at least one of the properties owned by BIE and to grow BIE’s portfolio.
Addressing potential differences of opinion between the two 50% managers, BIE’s operating agreement contained a decisive mechanism to break any deadlock: a shotgun buy-sell agreement. We’ve covered shotgun buy-sell agreements on this blog before. On paper, they are an elegant solution when business owners cannot get along. In practice, asymmetries in information or buying power between the members can lead to turmoil when the provision is invoked.
Here’s how the shotgun provision worked in the BIE operating agreement: if the members fail to reach agreement on an issue within 90 days, either member can pull the trigger, initiating the shotgun buy-sell process. The initiating member names a price, and the responding member has 30 days to elect to either (i) purchase the initiating member’s interest at that price or (ii) sell his interest to the initiating member at that price. This shotgun has an unorthodox add-on, however. After the process is triggered, both sides have a walkaway option: within 15 days after the price is set, either party can “cancel the Buy-Sell by giving written notice to the other Member/Manager that it agrees with the decision of the other Member/Manager” on the issue that initially caused the deadlock. Likewise, if the purchaser refuses to close, the seller can reverse the deal (with the seller becoming the purchaser), but he cannot force the purchaser to buy his interest.
BIE’s operating agreement further required that “[a]ll notices, demands, offers or other communications required or permitted by this agreement shall be in writing and shall be sent by overnight or international delivery service.” Any transfer “not made in accordance” with the shotgun buy-sell provision (or other provisions related to a member’s death or disability) would be void and invalid.
The Email Deal
By 2020, the members of BIE could not agree on the nature and extent of their contemplated renovations to BIE’s properties, and the two began to discuss how they might split up the assets of BIE.
When their plans to amicably split up the business fell through, Defendant extended an olive branch, emailing Plaintiff the following “settlement” proposal:
Jon, Ray has suggested that I present you with an offer in writing to settle our dispute concerning Barrier Island Enterprises (BIE). I am willing to purchase your ownership interest in BIE for $1,900,000.00 or sell you all my ownership interest in BIE for $1,800,000.00. This offer is made without prejudice to my rights and in the hope of amicably settling all issues pertaining to BIE.
Two hours later, Defendant responded by accepting the “settlement” and—relevant here—imposing the additional condition that the parties proceed to closing in accordance with the shotgun buy-sell provisions of BIE’s operating agreement:
George, thank you very much for your email. I appreciate your trying to resolve our dispute amicably. I accept your officer, and agree to purchase all of your interest in Barrier Island Enterprises for the purchase price of $1.8 million. We will proceed to closing using the procedures in the Buy-Sell provisions of the operating agreement (with $1.8 million being agreed upon buy-sell price). I am prepared to close within 30 days, and will ask [my attorney] to reach out to your attorney to get the process going.
Over the next week, the parties discussed and could not reach agreement upon additional terms and conditions. Although the parties now take sharply differing views as to whether those discussions were follow-up to an already-binding deal or ongoing pre-deal negotiations, it seems from the record that both parties anticipated formalizing their buyout deal in a signed agreement. When their discussions soured, Defendant stated that he no longer wished to sell his interest. In response, Plaintiff took the position that their email exchange was a binding contract, separate and apart from the operating agreement.
Calling this a classic case of “seller’s remorse,” Plaintiff sued to enforce the email agreement that the parties struck. He accompanied his complaint with an application for a preliminary injunction demanding all manner of interim relief, including access to books and records and an order precluding the defendant from causing BIE to incur any extraordinary expenses without his consent.
In response to the preliminary injunction application, Defendant argued that Plaintiff could not show likelihood of success on the merits because Defendant was not bound to sell his interest. The emails, Defendant argued, were not enough to evidence agreement on all material terms and an intent to be bound.
Do the Formality Requirements and Walkaway Rights of the Shotgun Buy-Sell Provision Apply to the Email Deal?
Defendant’s most interesting argument was that even if the emails might have been enough to constitute a binding contract under ordinary circumstances, the existing BIE operating agreement changed things. In essence, the Defendant treated Plaintiff’s “settlement” proposal as a formal initiation of the Operating Agreement’s buy-sell process, arguing that:
- The operating agreement set forth detailed formality requirements for all notices and offers, and it expressly stated that no transfer of interests would be valid unless it followed the formalities outlined in the operating agreement.
- The shotgun buy-sell provision does not obligate either party to proceed to closing; as discussed above, it had a mutual walkaway option. So if the shotgun buy-sell rules apply, Defendant was within his rights to terminate the sale.
- The shotgun buy-sell provision required agreement on terms that the email exchange did not include, such as lender permissions and release of guarantees. So the email deal was missing terms that the parties, per the operating agreement, considered essential.
By supposedly incorporating the operating agreement into their email deal, Defendant argued, the parties unmistakably manifested their intent that the email exchange could not be binding.
In a decision dated January 19, Justice Borrok of the New York County Commercial Division granted Plaintiff’s request for a preliminary injunction. Justice Borrok specifically found that Plaintiff’s claims had a likelihood of success on the merits based on the email deal, finding that Plaintiff “sufficiently demonstrat[ed] that the parties entered into a binding agreement.” The formality requirements of the operating agreement and the walkaway rights in the shotgun buy-sell provision were not enough to defeat likelihood that the email deal would be enforced. Between the email deal and the buy-sell provisions in the operating agreement, the email deal wins round one.
Rosen v Treibenbacher is not the first case to consider the interaction between an LLC operating agreement and a subsequent buyout deal between the members. If the subsequent buyout deal is fairly considered an independent agreement (as opposed to an amendment to the operating agreement), the formality requirements of the original operating agreement will not foreclose enforceability of the new deal.
For instance, in Treeline 990 Stewart Partners, LLC v RAIT Atria, LLC, 107 AD3d 788, 790 [2d Dept 2013], the Court enforced an oral agreement for the sale of LLC interests because the terms of the operating agreement did not prohibit such a transfer, and “[a]s such, the alleged oral agreement was a separate additional agreement addressing a situation not covered by the terms of the operating agreement.”
While the Court’s preliminary injunction ruling is not law of the case, and neither party is precluded from asserting their respective positions with respect to the enforceability of the email deal on a more fully-developed evidentiary record, the Court’s injunction ruling presents a significant hurdle for the Defendant to overcome. As the case proceeds, it seems likely that the Court will soon be called to squarely decide on the ultimate merits whether the parties’ email exchange, as the Court preliminarily concluded, manifested their intent to make a new agreement and dispatch with the restrictions (and walkaway rights) of the BIE operating agreement. Accordingly, Rosen v Treibenbacher remains a case worth watching.