Wednesday, July 7, 2010

LLC Operating Agreement Controls Assignment of Membership Interest in Colorado

In the case of Condo v. Conners, No. 09CA1130, from May 27, 2010, the Colorado Court of Appeals held that the provisions of the operating agreement for an LLC which prevented a member from assigning his membership interest without the unanimous written consent of the other members are valid, and the assignment is void.

In Condo, one of the members of an LLC assigned his membership interest (in the form of the right to receive distributions from the LLC) to his ex-spouse as a part of his divorce.  The Operating Agreement for the LLC required that any assignment be approved in writing by the other members.  The other members of the LLC refused to approve the assignment and instead purchased the assigning member’s interest from him.  The former member’s ex-spouse then brought an action against the remaining members for tortious interference with contract and civil conspiracy on the basis that their actions had resulted in the divestment of her contractual right to the monetary distributions from the LLC.  The Court affirmed the summary judgment of the ex-spouse’s claims.

In reaching its conclusion, the Court of Appeals for Colorado first noted that for a tortious interference with contract claim to succeed, there must be a valid contract.  In general, Colorado statutes provide that an LLC membership interest is personal property which can be assigned and transferred.  C.R.S. § 7-80-702(1).  Any person who receives a transfer or assignment has the same rights as the member.  C.R.S. § 7-80-702(3).  However, the Court also noted that LLC's are governed by operating agreements which control over provisions of the statutes contrary to the operating agreement terms, subject to exceptions certain inapplicable exceptions.  C.R.S. § 7-80-108(1).  The goal of the statutes governing LLCs in Colorado is to give maximum effect to freedom of contract in operating agreements.  C.R.S. § 7-80-108(4)

Accordingly, because the operating agreement at issue prohibited assignments without the consent of the other members, the Court found that the assignment was void.  The assignment was void because the member who made the assignment was limited by the terms of the operating agreement, and because the operating agreement governed over contrary statutes which otherwise might have allowed for the assignment. 

The Court went on to note that Colorado does not require any “magic words” in the operating agreement to make the assignment void such as a specific statement that the assignment would be void.  Rather, the language in the operating agreement that the assignment, without the written consent of the other members, was not effective for any purpose, was sufficient to void the assignment.  As a result, the ex-spouse assignee was never, and could never be, a member, or have any membership interest.

In the operating agreements we do for clients, as well as buy-sell agreements incorporated therein, we broach this and other similar issues with the members of the expected LLC asking them, for example, to determine whether, and how, they will allow the transfer or assignment of membership interests (whether voting rights, rights to distributions, or otherwise).  It is an important exercise that many potential members do not initially recognize, or realize, they should address.  But very often, when potential members consider the issues, they do not want to allow the membership interests to be freely transferable and they want to have some control over who can be, or become, a member of the LLC.  For example, even if a divorce does not come into play, none of the members will live forever, and the succession of the membership interests in the estate of a deceased member, for the stability and perpetuation of the business, must be considered.

The Condo case reinforces that operating agreements are valid and will be enforced by the courts under Colorado law.  The case shows that the members at the formation of the LLC have real power and their choices have real consequences which should be taken into consideration before there is a dispute.  Furthermore, LLCs which exist, but where the members have not addressed these issues, or do not even have an operating agreement, can, and should, spend the time and money to put something in place before a dispute arises.

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