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.

Apparent Agency Questions Defeat Summary Judgment in Guaranty Dispute – IL ND

The Northern District of Illinois recently examined the nature of apparent agency liability in the context of a breach of guaranty dispute involving related limited liability companies (LLCs).  The plaintiff in Hepp v. Ultra Green Energy Services, LLC, 2015 WL 1952685 (N.D.Ill. 2015) sued to enforce a written guaranty signed by the defendant company in connection with a $250K-plus promissory note signed by a company owned by the defendant’s managing member.

The court denied the plaintiff’s summary judgment motion.  It found there were material and triable fact issues as to whether the person signing the guaranty had legal authority to do so.

The court first addressed whether the guaranty was supported by consideration.  Consideration is “bargained-for exchange” where the promisor receives something of benefit (or the promisee suffers detriment) in exchange for the promise.  A guaranty’s boiler-plate provision that says “For Value Received” creates a presumption (but one that can be rebutted) of valid consideration.

Where the guaranty is signed at the same time as the underlying note, the consideration for the note transfers to the guaranty.  But where the guaranty is signed after the note, additional consideration (beyond the underlying loan) needs to flow to the guarantor.  A payee’s agreement to forbear from suing can be sufficient consideration.

Here, the plaintiff agreed to extend the deadline for repayment of the note by thirty days.  According to the court, this was sufficient consideration for the plaintiff to enforce the guaranty.  **3-4.

Next, the court shifted to its agency analysis and considered whether the LLC manager who signed the guaranty had authority to bind the LLC.  Answer – maybe not.

Apparent agency arises where (1) the principal or agent acts in a manner that would lead a reasonable person to believe the actor is an agent of the principal, (2) the principal knowingly acquiesces to the acts of the agent, and (3) the plaintiff reasonably relies on the acts of the purported agent.

When considering whether a plaintiff has shown apparent agency, the focus is on the acts of the principal (here, the LLC), and whether the principal took actions that could reasonably lead a third party to believe the agent is authorized to perform the act in question (here, signing the guaranty on the LLC’s behalf).

The scope of an apparent agent’s authority is determined by the authority that a reasonable person might believe the agent has based on the principal’s actions.  Also, a third party dealing with an agent has an obligation to verify the fact and extent of an agent’s authority.  **5-6.

The court found there material questions of disputed fact as to whether the plaintiff reasonably relied on the LLC manager’s representation that he had authority to sign the guaranty for the LLC.  The court noted that this was an unusual transaction that was beyond the ordinary course of the LLC’s business (since it implicated a possible conflict of interest (the manager who signed the guaranty was an officer of the corporate borrower) and it resulted in a pledge of the LLC’s assets), and culminated in the LLC taking on another $125,000 in debt in exchange for a short repayment time extension.  * 7.

The anomalous nature of the transaction coupled with the affidavit testimony of several LLC members who said they had no knowledge of the manager signing the guaranty, created too many unresolved facts to be decided on summary judgment.

Take-aways:

1/ A guaranty signed after the underlying note requires additional consideration running to the guarantor;

2/ Great care should go into drafting an Operating Agreement (OA).  Here, because the OA specifically catalogued numerous actions that required unanimous written consent of all members, the LLC defendant had ammunition to avoid the plaintiff’s summary judgment motion.