What happens when an LLC manager engages in “questionable conduct” with third parties, such as, binding the LLC to transactions and obligations that are potentially beyond the manager’s authority to enter into without the consent of the majority of the LLC’s members?
The Operating Agreement ordinarily contains some limits on the authority of a manager. Most such agreements grant the manager authority over the LLC’s day to day operations, but require LLC member approval for extraordinary transactions, such as the ability to sell or encumber the LLC’s property or dissolve the LLC.
California Corporations Code section 17703.1 provides guidance on the consequences and rights of the parties when an LLC manager makes an “unauthorized” deal with a third party. Section 17703.01, a part of the Revised Uniform Limited Liability Company Act (“RULLCA”), sets forth the rules for a manager acting as an “agent” for the LLC in the LLC’s dealings with third parties.
For manager-managed LLCs (as opposed to member-managed LLCs), the members are not agents of the LLC, and cannot “bind or execute any instrument on behalf of” the LLC. (Section 17703.01(b)(1).)
The manager, on the other hand, is an agent of the LLC “for the purpose of its business or affairs,” and the manager’s signature on any instrument on behalf of the LLC will bind the LLC “unless the manager so acting has, in fact, no authority to act for the limited liability company in the particular matter and the person with whom the manager is dealing has actual knowledge of the fact that the manager had no such authority.” (Section 17703.01(b)(2).)
Subdivisions (c) and (d) of the statute continue:
(c) No act of a manager … in contravention of a restriction on authority shall bind the limited liability company to persons having actual knowledge of the restriction.
(d) Notwithstanding the provisions of subdivision (c), any note, mortgage, evidence of indebtedness, contract, certificate, statement, conveyance, or other instrument in writing, and any assignment of endorsement thereof, executed or entered into between any limited liability company and any other person, when signed by [the manager], is not invalidated as to the limited liability company by any lack of authority of the signing [manager] in the absence of actual knowledge on the part of the other person that the signing … manager had no authority to execute the same. (Section 17703.01(c)-(d), emphasis added.)
A manager’s “unauthorized” acts cannot categorically be invalidated. Under the statute, if a manager engages in an “unauthorized” transaction the members must prove that the third-party buyer had “actual knowledge” that the manager lacked authority to sell the property to invalidate the transaction. This rule protects the rights of the third party dealing with an LLC’s manager.
Under California law “actual” knowledge or notice consists of “express information of a fact” (Civil Code section 18 and is distinguished from “constructive” or “imputed” knowledge, where someone is held to “know” something because their agent knows it or because the fact is contained in a recorded document. However, some Courts have held that knowledge that could be gleaned from a recorded document is “actual” knowledge.
Even if the members cannot unwind the transaction, they may have remedies against the manager for breach of fiduciary duties. However, such remedies may be of little comfort if the unauthorized act of the manager transferred away the LLC’s main assets or other rights.
If you are an LLC manager or member and are concerned with liability over a transaction, contact legal counsel since such transactions are not automatically invalidated and there are ways to protect the LLC from such conduct if it has not yet occurred.
The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.
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