Getting into a new business venture with friends is exciting, but when the relationship heads south, the fallout is only “exciting” for the lawyers. Navigating a separation is stressful enough, but it can be especially so if you do not understand that certain provisions in a shareholder agreement (corporation) or operating agreement (limited liability company) are not enforceable under Florida law or not applied consistently with common sense.
- The first culprit, that even some attorneys fall for, is the “no oral modifications” clause.
“This agreement may only be amended, modified, or supplemented by an agreement in writing signed by each party hereto.”
This is standard boilerplate language, but depending on the facts of your case, you may not be able to rely on it. Oral modifications or amendments to an agreement will be enforced, despite a “no oral modifications” clause, when the following requirements are met:
- The parties agreed upon and accepted an oral modification (i.e., mutual assent); and
- Both parties (or at least the party seeking to enforce the amendment) performed consistent with the terms of the alleged oral modification (not merely consistent with their obligations under the original contract); and
- That due to one party’s performance under the contract as amended the other party received and accepted a benefit that it otherwise was not entitled to under the original contract (i.e., independent consideration).
Be careful of stipulating or agreeing to certain operational decisions relating to the company’s business either verbally or in writing via emails or texts. If you do and then act consistent with such an agreement, you may be unwittingly modifying material terms of your agreement with your fellow business partners to your substantial detriment. For example, many times a shareholder agreement will expressly state that all major decisions (as defined therein) shall be decided upon unanimously. However, if major decisions are routinely effectuated by the majority of the shareholders in control of the company without seeking unanimity of all shareholders, including you, and you have failed to avail yourself of your rights under the shareholder agreement by demanding unanimous consent, the “major decisions” clause may be modified such that unanimity is not required. Considering that major decisions oftentimes involve major monetary decisions, this can have dire consequences to your position down the road.
- Another clause that you really want to rely on, but cannot, is a “no fiduciary duties” provision.
This clause typically reads: “No owner shall have any fiduciary duties to any other owner or the Company.” The current LLC Act allows the courts to look to the terms of the operating agreement, as well as common law principles relating to the duties of care and loyalty. An operating agreement can “alter or eliminate” the duty of loyalty, but that power is limited. An operating agreement’s attempt to limit fiduciary duties will only be enforced if not “manifestly unreasonable.” If the agreement tries to completely invalidate the duties of care and loyalty that exist at common law, it will not be enforced. For corporations with 100 or fewer shareholders, the statute prohibits a shareholder agreement from including terms that are contrary to public policy, such as reducing the duties of care and loyalty prescribed by statute or exculpating directors from statutory liability. Bottom line, if you have an LLC you can only limit fiduciary duties so far and for a corporation you cannot vary the duties imposed by statute regardless of what your agreement says.
- Beware of clauses that modify the statutory rules on deadlock, dissolution, or derivative claims.
An age-old problem with the management of both corporations and LLCs is what to do when the people in control are at a deadlock. Deadlock occurs when no person or group has enough voting power to make a decision for the company without additional support, or one owner is allegedly harming the company. A classic example is when two partners own a company on a 50/50 basis and require a majority (or in practice a unanimous) vote to make company decisions, but one owner is unilaterally running the company. In trying to fashion a way to avoid lengthy litigation, the operating or shareholder agreement may try to alter the grounds for dissolution or prevent an owner from bringing suit against another owner for harm to the company.
The LLC Act prohibits an operating agreement from, among other things, varying the grounds for dissolution, which include deadlock, and from unreasonably restricting the rights of an owner from bringing a claim against another owner, either directly or derivatively on behalf of the company.
Similarly, the Corporation Act prohibits provisions that violate public policy, such as by including terms that adversely affect shareholders’ rights to bring derivative actions. Unlike the LLC Act, however, a shareholder agreement for a company with 100 or fewer shareholders is allowed to require dissolution of the corporation at the request of one or more of the shareholders or upon the occurrence of a specified event or contingency even if such terms are inconsistent with the Corporation Act. This difference between LLCs and corporations is a potential trap that leads to errors in the drafting of governance documents, and subsequently to a potential false sense of security when facing litigation.
If you find yourself in a dispute between owners of a company, you should seek an in depth legal analysis on the enforceability of your agreement in light of the facts rather than put too much faith in what your contract says.
Paul O. Lopez is a director and chief operating officer of Tripp Scott in Fort Lauderdale. and Megan L. Janes is an associate.