In Shapiro v. Ettenson, No. 2849, 2017 BL 19404 (App. Div. 1st Dep’t Jan. 24, 2017), the Appellate Division, First Department recently affirmed a decision by Supreme Court Justice Kelly O’Neill Levy upholding an LLC operating agreement that was adopted by two of the LLC’s three co-equal members without the consent of the third member. The Appellate Division rejected Shapiro’s argument that the operating agreement was unenforceable because it was not adopted unanimously. The panel affirmed the lower court’s decision that LLC Law § 402(c) “provides that the operating agreement may be adopted by ‘the vote of a majority in interest of the members entitled to vote thereon.’” Because the First Department agreed that the operating agreement was enforceable, the court further affirmed the lower court’s ruling upholding the majority members’ reliance on a provision of the agreement to issue a capital call and reduce the voting interest of any member who fails to make the requested capital contribution.
Shapiro involved a New York limited liability company called ENS Health, LLC which was formed in January 2012 by three individuals who each held a one-third ownership interest. The three members negotiated over but failed to agree on an operating agreement for ENS. Ultimately, in December 2013, two of the three LLC members adopted an operating agreement without the consent of the third member, Shapiro. The operating agreement provided for majority vote on any action requiring manager approval, including capital calls for additional contributions from members. In October 2014, the majority members notified Shapiro that his salary had been cut to $0 and requested a $10,000 capital contribution from each member, stating that a member’s failure to pay could result in a reduction in their participation interest in ENS. Shapiro objected to the $10,000 capital call and the reduction of his salary, and commenced a lawsuit challenging the action.
The key to this majority-friendly result is that the LLC had no operating agreement in place before the disputed agreement was adopted, leaving a void to be filled by statutory default provisions. As the First Department explained, “where there is no operating agreement or the operating agreement fails to address issues in dispute, the default provisions under the [LLC] Law govern.” In turn, the default statutory rule for adopting or amending an operating agreement, LLC Law § 402(c), requires only “the vote of a majority in interest of the members entitled to vote,” in order to “adopt, amend restate or revoke” an LLC operating agreement (with some specific exceptions not at issue in the case).
Shapiro argued unsuccessfully that the parties had “an oral agreement regarding unanimity on this issue.” As the First Department explained, LLC Law § 417 “requires a written operating agreement” and without one, the statutory rule governs. Shapiro also argued that LLC Law § 417 supported a unanimity requirement, pointing to language providing that “the members of a limited liability company shall adopt a written operating agreement . . . .” At the trial court, Justice Levy rejected this reading and found that “[n]othing contained in section 417 requires ‘all’ of the members of a limited liability company to enter into an operating agreement.” While the First Department did not comment on this portion of the opinion, the court’s result was affirmed. While not addressed by either court, Shapiro’s reading of LLC Law § 417 appears to be further contradicted by § 402(f). That provision sets forth the default rule that “[w]henever any action is to be taken under this chapter by the members or a class of members, it shall . . . be authorized by a majority in interest of the members’ votes cast at a meeting of members by members or such class of members entitled to vote thereon.”
Takeaways for Members of New York LLCs
The Shapiro decision carries important lessons for members of existing LLCs and those contemplating a new venture.
To start, Shapiro highlights the value to minority LLC members of entering into a written operating agreement with protections against adverse actions by the majority prior to joining the company. Once the company is formed, if no operating agreement is in place, there is apparently nothing to prevent the majority, as in Shapiro, from adopting an operating agreement without the input or consent of the minority.
In negotiating a written operating agreement before joining an LLC, a prospective minority member should also consider protections against the possibility of future amendments or revocation by the majority. LLC Law § 402(c) requires only a majority vote to “adopt, amend, restate or revoke” an operating agreement. As a result, without a provision in the operating agreement to override this default rule, the majority could later amend or revoke the original agreement under the same reasoning applied in Shapiro.
On the other hand, majority members of LLCs that currently operate without a written agreement, should be aware of their rights under the LLC Law to enter into a written operating agreement without the need for any consent by the minority. Further, for majority members of LLCs with operating agreements, such agreements may be amended or even revoked under LLC Law § 402(c) by a majority vote of the members if the existing agreement does not provide otherwise.
Finally, for LLCs that have operated without a written agreement for some time, Shapiro teaches that an operating agreement can be adopted long after a company’s formation. Although LLC Law § 417(c) states that “[a]n operating agreement may be entered into before, at the time of or within ninety days after the filing of the articles of organization,” Shapiro upheld an operating agreement that was adopted by the majority two years after the LLC’s formation. At the trial court, Justice Levy ruled that “section 417 . . . does not mandate that the operating agreement be entered into within 90 days.” While this point was not expressly addressed by the First Department, it was left undisturbed and the later-entered agreement was held to be enforceable.