Section 489.102(15) of the new Iowa LLC Act contains a rather expansive definition of “operating agreement.” It says that an LLC operating agreement can be oral, written or implied. And a written operating agreement can be modified orally or by implication. Oral operating agreements or operating agreements implied by the conduct of the members are problematic, let alone a written operating implicitly modified by conduct or oral agreement. This is the reason the drafters of the Iowa LLC Act added a provision allowing written operating agreements to include a clause that only requires amendments to be in writing. See Iowa Code Section 489.111(4).
But what about written operating agreements that do not contain that provision or LLCs without a written operating agreement? Does the statute of frauds apply to them?
Iowa’s version of the statute of frauds is found at Iowa Code Section 622.32. It provides that evidence of a contract that is not to be performed within one year of its making is not valid, unless the contract is in writing and signed by the party against whom the contract is to be enforced.
All states have essentially the same statute of frauds and Delaware is no exception. The Delaware Supreme Court considered the application of the statute of frauds to operating agreements for Delaware LLCs in Olson v. Halvorsen, 986 A.2d 1150 (December 15, 2009). In that case Olson sought to enforce an unsigned operating agreement that would have paid him an earnout when he left a hedge fund he owned with two other individuals. When he departed the hedge fund the only signed operating agreement entitled him to his capital account and earned compensation, a paltry $100 million.
Olson argued that the Delaware statute of frauds did not apply because the Delaware LLC Act permitted operating agreements to be “written, oral or implied” and declared that an LLC is bound to an operating agreement whether or not it signs it. For similar Iowa provisions see Iowa Code Sections 489.102(15) and 111(1). Olson also noted that the Delaware LLC Act seeks “to give maximum effect to the principal of freedom of contract and to the enforceability of limited liability company agreements."
Olson attempted to convince the Delaware Supreme Court that these provisions of the LLC law overruled the statute of frauds and precluded its application to operating agreements. The Delaware Supreme Court disagreed. In the eyes of the court, the LLC law did not “guarantee enforcement of all oral or implied LLC agreements.” The law simply recognized that an LLC agreement could be oral or implied, but like all other contracts must comply with the statute of frauds.
It is reasonable to conclude that the Iowa Supreme Court would come to the same conclusion. Accordingly, except in the rare case that an LLC is designed to last less than a year (e.g., the voluntary withdrawal of a member terminates the LLC), even though an Iowa LLC operating agreement can be oral or implied it will only be enforceable if it is in writing.
So what rules apply to an LLC that does not have a written operating agreement? It stands to reason that the terms of the new Iowa LLC Act will apply to all oral or implied operating agreements. This has serious and potentially harsh consequences to the members because the default rules under the Iowa law require that (1) all income be distributed equally among the members of the LLC regardless of their relative investments, (2) the LLC will be member-managed, and (3) all members will participate equally in the management of the LLC regardless of their relative investments.
Put your deals in writing!
-Marc Ward
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