C.A. No. 1884-VCL (Del. Ch. October 22, 2008)
Brian T. Olson (the “Plaintiff”), together with O. Andreas Halvorsen and David C. Ott (jointly, the “Defendants”) formed a Delaware limited liability company (the “Company”) in 1999. No shortform limited liability company agreement was ever prepared or executed, but a draft amended and restated limited liability company agreement was prepared but was never executed. The unsigned document provided for a multi-year earnout of a founder’s interest in the Company if he voluntarily or involuntarily left the Company. Upon returning from a sabbatical, the Defendants informed the Plaintiff that they had determined to remove him from his position with the Company. The two Defendants paid the Plaintiff the amount representing his capital account balance and the remainder of his annual salary, but did not pay him an earnout because they claimed that they had never agreed to do so. The Plaintiff sought a series of six yearly payments he claimed he was entitled to under the unsigned agreement. Both parties filed motions for summary judgment.
The Court’s opinion focused purely on the legal questions of whether the statute of frauds applies to LLC agreements. In this case of first impression, the court found that the statute of frauds does apply to LLC agreements, and that the exceptions to that doctrine that the Plaintiff argued were not available under the facts of the case. Summary judgment was ordered for the Defendants.
The Delaware LLC statute expressly allows oral operating agreements, but does not address whether the statute of frauds applies to such agreements. The court held that the statute of frauds applies to LLC agreements, noting that while few oral operating agreements will have provisions that will not be able to be performed within a year, those provisions that cannot possibly be performed within one year are unenforceable. Provisions that may possibly be performed within one year do not fall within the statute of frauds and remain enforceable.
In the case at hand, notwithstanding that the obligation to make a payment under the earnout provision could occur within one year, existing case law suggested that unless nothing remained to be done after one year other than the payment of money, the statute of frauds applied. Here, the agreement would have required the Defendants to maintain the Plaintiff’s economic interest in the company and to refrain from any actions that would reduce his economic interest for a period of time well beyond one year, and even if the Plaintiff were to die, the benefits would continue to the Plaintiff’s estate or successor-in-interest. No exceptions to the statute of fraud were applicable. Although multiple other writings existed to other entities formed at the same time as the Company, none of them mentioned the unsigned agreement or its earnout provision. One document made reference to the Company’s “limited liability company agreement…as amended from time to time,” that document did not clearly identify the unsigned agreement as the “limited liability company agreement” to which it was referring. Likewise, the past performance exception to the statute of frauds was inapplicable because that exception also requires the ability to perform the contract within one year.
The full opinion is available here.