Binding LLC to Operating Agreement A Substantive Change in Illinois Law; No Retroactive Effect – IL Court

The summer of 2017 ushered in a slew of changes, to Illinois’ limited liability company statute, 805 ILCS 180/15-1 et seq. (the “Act”).  Some of the key Act amendments included clarifying LLC member rights to access company records, explaining if and when a member or manager’s fiduciary duties can be eliminated or reduced, tweaking the Act’s judgment creditor remedies section, and changing the Act’s conversion (e.g. partnership to LLC or vice versa) and domestication rules.

Q Restaurant Group Holdings, LLC v. Lapidus, 2017 IL App (2d) 170804-U, examines another statutory change – one that binds an LLC to an operating agreement (OA) even where the LLC doesn’t sign it. See 805 ILCS 180/15-5.

The OA is the LLC’s governing document that sets forth each member’s (or manager’s) respective rights and obligations concerning contribution, distribution, voting rights and the like. The OA’s signing parties are typically the LLC members/managers – not the LLC itself.  Legally, this is significant because under privity of contract principles – only a party to a written agreement can sue to enforce it.

2017’s LLC Act changes make it clear that the LLC entity has standing to sue and be sued under the OA regardless of whether or not the LLC signed it.

The plaintiff in Lapidus sued the defendant for various business torts including conversion and tortious interference with contract. The defendant moved to dismiss the suit based on mandatory arbitration language in the OA.  Denying defendant’s Section 2-619 motion, the Court held that since the amended Section 15-5 of the Act worked a substantive change to the former LLC Act section, it didn’t apply retroactively. (The OA in Lapidus preceded the 2017 amendments.)

Rules/reasoning:

Affirming the trial court, the First District examined the dichotomy between procedural and substantive changes to legislation.  Where a statutory amendment is enacted after a lawsuit is filed, the Court looks to whether the legislature specified the reach (i.e. does it apply retroactively?) of the amendment.  Where new legislation is silent on its scope, the Court determines whether a given amendment is procedural or substantive.  If procedural, the amendment has retroactive effect.  If the change is substantive, however, it will only apply prospectively.

A procedural change is one that “prescribes the method of enforcing rights or obtaining redress” such as pleadings, evidence and practice.  A substantive change, by contrast, is one that establishes, creates or defines legal rights.  (¶¶ 15-16; citing to Landgraf v. USI Film Products, 511 U.S. 244, 280 (1994); 5 ILCS 70/4 (Illinois’s Statute on Statutes))

In finding that amended Section 15-5 was a substantive change to Illinois’ LLC Act (and therefore couldn’t be applied retroactively) the court noted the amended statute “established a contractual right” by binding the LLC to an OA it never signed.

Since the plaintiff LLC in Lapidus never signed the OA, the Court couldn’t require the plaintiff to follow the OA’s arbitration clause without substantially altering the LLC’s contract rights.  As a result, the Court held that amended Section 15-5 did not apply to the pre-amendment OA and the plaintiff didn’t have to adhere to the arbitration clause.t have to adhere to the OA’s arbitration provisions. (¶¶ 18-19).

Afterwords:

I. To decide if a statutory amendment applies retroactively (as opposed to only being forward-looking), the court considers whether the change is procedural or substantive.

II. While the distinction between procedural and substantive isn’t always clear, Lapidus stands for proposition a change in the law that alters a parties basic contract rights (such as by making a non-party a party to an operating agreement) is substantive and will only apply in the future.

III.  And though the case is unpublished, Lapidus still makes for interesting reading in light of Illinois’ manifold LLC Act changes.  With so many recent statutory changes (see here_for example), this case likely augurs an uptick in cases interpreting the 2017 LLC Act amendments.

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PaulP

Litigation attorney at Fisher Kanaris, P.C. representing businesses and individuals in all types of commercial disputes.