The Perils of Buying Property from an LLC with Competing Claims to Managerial Authority
Prior LLC Jungle posts have addressed the tricky issue of LLC managerial authority in the context of the LLC’s dealings with third parties. See:
- LLC and Partnership Authority “Safe Harbors”
- LLC Managerial Authority and Dealings with Third Parties
As referenced in those posts, under Corporations Code section 17703.01, when an LLC’s true manager enters into an agreement with a third party, that agreement is generally binding — even if the manager lacked authority to act under the LLC’s operating agreement — unless the third party had “actual knowledge” of the manager’s lack of authority. This comes into play, for instance, where the manager needs (but fails to obtain) member approval to sell the LLC’s property.
But what about situations where the person acting as the LLC’s purported manager is not, in fact, the manager, or where there are at least competing claims to the manager role?
A case recently published by California’s Second Appellate District — Sam v. Kwan — tackles that situation.
Facts: LLC sells its property to a third party amidst disputes regarding the identity of its manager
According to the facts alleged in the complaint underling the appeal:
Anthony Sam and Renee Kwan formed an LLC referred to as “2013 LLC,” signed an operating agreement, and through the LLC purchased a parking lot in downtown Los Angeles for $1.6 million. The LLC had four members, each of which was a different LLC. Sam’s three separate LLCs owned a 51% interest in 2013 LLC, while Kwan’s separate LLC owned a 49% interest in 2013 LLC.
The operating agreement for 2013 LLC designated Sam as the manager, and Sam signed the operating agreement as the LLC’s manager. As manager, Sam obtained a bank loan for the LLC’s purchase of the parking lot, personally guaranteed the loan, and signed deed of trust and assignment of rents documents, which were both recorded in the chain of title.
By one year later, the relationship between Sam and Kwan had soured. Without Sam’s knowledge, Kwan orchestrated the sale of the LLC’s parking lot property to third party Board of Fire and Police Pension Commissioners for the City of Los Angeles (“Board”) for $3.8 million.
During the escrow, First American Title Insurance Company served as both title insurer and escrow officer. First American prepared a preliminary title report and sent it to the Board. The report contained hyperlinks to the recorded deed of trust and assignment of rents documents from the LLC’s purchase of the property, which were signed by Sam as the LLC’s manager. The Board’s attorney “looked at” but did not “review” those documents. The attorney also ignored “informational notes” in the title report highlighting the need to examine the operating agreement of any LLC involved in a transaction to confirm that the LLC was acting through its manager.
The Purchase and Sale Agreement and the Joint Escrow Instructions for the LLC’s sale of the parking lot to the Board were signed by Kwan as the purported manager of the LLC. At one point, First American raised questions regarding managerial authority. In response, Kwan provided a different version of the operating agreement that was signed by her as manager, but identical in all other respects. Kwan also provided a one-page “Corporate Resolution” document, signed only by Kwan, in which the LLC’s members purportedly authorized Kwan, as the LLC’s manager, to complete the sale. This apparently satisfied First American’s concerns, and the sale closed.
Upon discovering the sale, Sam sued, alleging claims on behalf of himself and the LLC. (While his lawsuit included multiple defendants as one would expect, this post focuses only on Sam’s claim against the Board as buyer.)
Trial court: summary judgment for Board; Board was a “bona fide purchaser”
The trial court granted the Board’s motion for summary judgment, holding the Board was a “bona fide purchaser” for value, and therefore took title to the parking lot property “free and clear” of Sam’s claims. The court held that the undisputed evidence showed the Board purchased “without notice” of Sam’s alleged interest in the parking lot.
Court of Appeal: reversed; factual disputes regarding managerial authority defeated summary judgment
The Court of Appeal reversed the trial court’s order granting summary judgment to the Board.
The court first described the relevant legal standards governing the bona fide purchaser doctrine. The doctrine enables a buyer to keep purchased property free and clear of competing claims if the purchase was for value and the buyer “lacked knowledge or notice of another’s claim. When the buyer has actual or constructive notice of a prior interest, however, the buyer takes the property subject to those other interests.”
A buyer “must demonstrate it conducted research with due diligence to see if the title it was planning to buy would be good.” “Due diligence requires prospective buyers to heed warning signs.” “The buyer is not entitled to interpret ambiguities in its own favor. Neither may it ignore reasonable warning signs in the recorded documents. … Nor is the buyer entitled to ignore information that comes to it from outside the recorded chain of title[.]”
The court concluded that based on the factual disputes in the record, the Board was not entitled to “bona fide purchaser” status on summary judgment. The court noted the preliminary title report, which linked to recorded documents featuring Sam’s signature as the LLC’s manager, and which contained “informational notes” stressing the need for the buyer to confirm the LLC manager’s authority.
The court held that “the Board’s inadequate diligence flunked the test.” The Board and its attorney “did not question why the 2013 LLC, when buying the lot, had one manager but, the next year when selling the lot, it had a different manager.” The Board failed to request relevant documents from the LLC, and failed to review the recorded documents in the chain of title indicating that Sam, not Kwan, was the manager. The court also noted that the “Corporate Resolution” document submitted to escrow by Kwan was “suspect on its face.” The court concluded that Kwan’s “suspect claim of authority would have caused a reasonable and prudent buyer to inquire further.”
Lesson
Under the Sam v. Kwan opinion, a third party buying property from a manager-managed LLC does not qualify as a “bona fide purchaser” on summary judgment if there are factual disputes regarding the identity of the LLC’s manager. Buyers have a duty to make a reasonable inquiry regarding the identity of the LLC’s manager.