California limited liability company disputes | Courtroom war stories and lessons learned

Does an Arbitration Clause Apply to Your LLC Dispute?

Suppose your LLC’s operating agreement contains a typical clause requiring all disputes to be resolved in binding arbitration instead of the court system.

Is it then safe to assume that all disputes among the LLC’s members and/or managers will be determined in arbitration?

Not entirely, according to a recent opinion filed by California’s Second Appellate District — Yao v. Pro-Management Consulting.  While the Yao opinion is not published (and therefore not binding precedent), it provides useful guidance as to how future courts might rule in similar situations.

Facts: LLC operating agreement left unsigned

Plaintiffs Yu-Jung Yao, Yuh-Yuan Sun, and Wen-Jye Yao sued Pro-Management Consulting and John Tu (collectively PMC) for breach of fiduciary duty, breach of contract, and other claims arising from their LLC relationship.

The plaintiffs alleged they were residents of Taiwan and became interested in seeking permanent residency for their family in the United States.  PMC offered to provide assistance with the immigration process through a series of written agreements with the plaintiffs, including investment agreements and an LLC operating agreement.  The LLC was formed for the purpose of managing and operating restaurants serving as investment targets for foreign nationals applying for U.S. residency through the EB-5 program.

Plaintiffs’ complaint alleged that PMC, after taking their initial $500,000 investment, mismanaged and botched the immigration application process.

The investment agreements, which were fully signed by all parties, required disputes to be submitted to any federal or state court within the county of Los Angeles.  The LLC operating agreement, in contrast, required arbitration of all disputes.  But the operating agreement was left unsigned.

After being served with summons in the court action, PMC filed a motion to compel arbitration based on the arbitration clause in the LLC operating agreement.

Trial court: no signature; no arbitration

The trial court denied PMC’s motion to compel arbitration based on the fact that the operating agreement was unsigned.

PMC appealed.

Court of Appeal: affirmed

The Court of Appeal affirmed the trial court’s ruling.

The court acknowledged the language in California Corporations Code section 17701.11(b), which provides that a “person that becomes a member of a limited liability company is deemed to assent to the operating agreement.”  Plaintiffs did not dispute that they became members of the LLC even though they didn’t sign the operating agreement.  PMC argued, based on that statute, that plaintiffs were bound by the arbitration provisions of the operating agreement.

However, the court held that PMC failed to show that plaintiffs’ “automatic assent to be bound by the general terms of the operating agreement, as related to the management of the entity and the rights among its members, translates to specific consent to arbitrate their claims.”  The court noted that in other settings, “courts have distinguished between a party’s consent to an entire agreement and an arbitration provision within it, where circumstances indicated a lack of consent to the latter.”

Here, the court noted the investment agreements that were signed by plaintiffs did not incorporate the operating agreement or reference arbitration in any way.  Instead, the investment agreements contained a provision requiring disputes to be filed in court.  Given those facts, PMC failed to meet its burden to show that plaintiffs specifically agreed to arbitrate their LLC-related claims.

Lesson

Although the Corporations Code provides that a member of an LLC “is deemed to assent to the operating agreement” even without a signature, that isn’t enough to show a party’s specific assent to an arbitration clause.

For an operating agreement’s arbitration clause to be fully enforceable, the operating agreement should be signed by the members.  As an extra precaution, the arbitration clause might be separately initialed.