Opinion: When forming a business partnership, give thought to its potential end
By Kathleen J. Smith
Business partners, seeking to make their fortunes, form their limited liability companies at a moment when they expect to work together indefinitely, with goodwill between them and nothing but cooperation as their modus operandi.
At this time in a business partnership, the idea of distrusting their business partner and needing to dissolve the LLC is furthest from their minds. Commerce demands their attention, and they may forget to sign their operating agreement after they register their LLC with the California Secretary of State.
What happens when dissension leads one partner to reject the terms of the unsigned operating agreement, simply because they never signed it? Answer: they probably have to honor it anyway.
LLC Operating Agreements (“OA”) are governed by the law of contracts. The National Conference of Commissioners on Uniform State Laws, Uniform Limited Liability Company Act. last amended in 2013, states in the discussion of the definition of “Operating Agreement” the following: “An operating agreement is a contract, and therefore all statutory language pertaining to the operating agreement must be understood in the context of the law of contracts.”
Every contract requires consenting parties. A party’s consent is gathered from the reasonable meaning of her words and acts, and not from any unexpressed intentions or understanding. For instance, your partner’s consent is demonstrated when they comply with a term in the OA — like asking the co-member to consent to a transfer of their membership to their trust. Or perhaps your partner will cite the OA in a legal document, like, when the LLC applies for a bank loan.
Such consent can also be evidence of ratification of the unsigned OA. Ratification arises when your partner benefits from the bank loan based on their signed certificate of incumbency. If your LLC stands to receive income as a result of a loan — perhaps enabling investment funds to be leveraged geometrically with borrowed funds — then ratification can arise.
California Civil Code section 2310 states: “A ratification can be made only in the manner that would have been necessary to confer an original authority for the act ratified, or where an oral authorization would suffice, by accepting or retaining the benefit of the act, with notice thereof.”
In Rakestraw v. Rodrigues (1972), ratification was found where the signer Rakestraw, whose signature was forged on a deed of trust, did nothing to repudiate the challenged signature because she anticipated receiving monetary benefits from the mortgaged property. In Rakestraw, the court found that the forger was acting as agent for principal Rakestraw. On that basis, the court held that any requirement that the ratification be done in writing was inapplicable. Written ratification required under California Civil Code section 2310 was not intended to apply to a ratification as between a principal and agent.
Consent and ratification are two classic contract principles that support validation of the unsigned OA. If your partner is repudiating your unsigned OA, look back over the years for indicia and evidence of consent and ratification. It’s probably there.
• Kathleen J. Smith is an experienced civil litigator and an attorney with Schneiders & Associates, LLP in Oxnard.