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Delaware Court of Chancery Holds Statute of Frauds Applies to LLC Agreements

By Harvard Law School Program on Corporate Governance

(This post is based on a memo by Robert Saunders and his colleagues Allison Land and Ron Brown of Skadden, Arps, Slate, Meagher & Flom LLP.)

On October 22, 2008, Vice Chancellor Lamb of the Delaware Court of Chancery issued an opinion in Olson v. Halvorsen with important implications for parties contemplating the formation of a Delaware limited liability company. Ruling on a question of first impression, the court held that the Delaware statute of frauds applies to limited liability company agreements.

The plaintiff sought enforcement of an unsigned operating agreement for an LLC formed by the plaintiff and two other individuals in connection with a newly formed hedge fund structure. The dispute arose after the other two founders voted to remove the plaintiff from the LLC. The LLC paid $100 million to the plaintiff, consisting of his capital account balance and the remainder of his compensation for the year. However, the plaintiff argued that he was entitled to an additional payment of more than $100 million because, under the terms of the unsigned operating agreement, the plaintiff would have been entitled to an ?earn out? over six years.

For purposes of summary judgment, the court?s decision turned on whether the Delaware statute of frauds applies to a Delaware LLC operating agreement. Neither the court nor the parties cited any case in any jurisdiction addressing the issue. Commentators were split as to whether the statute of frauds should apply. The Delaware Limited Liability Company Act expressly permits oral and implied LLC agreements, and provides that it is the policy of the Act ?to give maximum effect … to the enforceability of limited liability company agreements.? However, the court asserted that most oral LLC agreements would not contain a provision that cannot possibly be performed within one year, so that the statute of frauds would not limit the enforcement of such agreements. The court held ?that if an LLC agreement contains a provision or multiple provisions which cannot possibly be performed within one year, such provision or provisions are unenforceable.? The court went on to reject the plaintiff?s claim because the earn-out provision in the unsigned LLC operating agreement could not possibly be performed within a year and because the multiple writings or part performance exceptions to the statute of frauds did not apply.

The plaintiff now has thirty days to appeal this ruling to the Delaware Supreme Court.

Full post as published by The Harvard Law School Corporate Governance Blog on November 09, 2008 (boomark / email).