Improper Assignment of an LLC Interest – Breach of Contract or Void Ab Initio?

Improper Assignment of an LLC Interest – Breach of Contract or Void Ab Initio?

         A recent decision of the Colorado Supreme Court provides helpful guidance with respect to the treatment of anti-assignment provisions in an LLC’s Operating Agreement. Condo v. Conners, 2011 WL 6318980 (Colo. Dec. 19, 2011).

      Banner was one of three members of a Colorado LLC. That LLC’s Operating Agreement provided that “a Member shall not sell, assign, pledge or otherwise transfer any portion of [the Member’s] interest in [the LLC] without the prior written approval of all of the Members.” This provision went beyond the statutory provision to the effect that, while the right to participate in management is not assignable, the right to the economic fruits of the venture is freely assignable. Colo. § 7-80-702(1). Accord KRS § 275.255(i)(a)-(c). Banner, in the course of his divorce, sought to transfer his interest in the LLC to Condo, his former spouse, agreeing as well to exercise his retained management rights under her direction. Both of the other Members objected to this proposed assignment, but Banner went ahead and did it. Ultimately, Banner sold his interest in the LLC to the other two Members, whereupon Condo sued them on theories of tortious interference with contract and conspiracy.

      The validity of Condo’s claims depended upon whether the assignment to her was of itself valid. The trial court rejected the validity of that assignment, and the Colorado Court of Appeals affirmed, but on other grounds.

      When the case came before the Colorado Supreme Court, it focused upon the alternative paradigms for the analysis of an anti-assignment clause. Classically, a violation of an anti-assignment clause was itself a nullity; no transfer took place in that the transferor lacked the capacity to accomplish that act. Under the modern approach, a violation of a limitation upon assignment is seen as a breach of contract pursuant to which the assignment is accomplished, but the assignor is liable for damages. Consequently, if the classic approach was applied, Condo’s interference of contract claim would fail in that she never received the purportedly assigned membership interest. Conversely, under the modern approach, the assignment would have taken place and Condo’s claims against the LLC’s two other members would at least survive summary judgment. 2011 WL 6318980,*7.

      The Colorado Supreme Court ultimately determined that the classical approach would be utilized, justifying that determination on a pair of grounds. First, the Colorado LLC Act contains a freedom of contract provision. Colo. § 7-80-108(4) (“It is the intent of this article to give maximum effect to the principle of freedom of contract and to the enforceability of operating agreements”). Kentucky utilizes the same rule in its LLC Act. See KRS § 275.003(1). This statutory directive was interpreted as sanctioning the capacity of the parties to an operating agreement to restrict, to the degree they determine appropriate, the assignability of any interest in an LLC. Second, utilizing the principles of in delectus personae, the Court thought it appropriate that the parties should be able to restrict the conveyance of any aspect of the interest in the LLC. As to this point, the Court cited with approval RIBSTEIN & KEATINGE ON LIMITED LIABILITY COMPANIES § 7:5 (2011) (“[A]n assignment of financial rights could injure the non-assigning Members by diluting the assignor’s incentives to maximize the welfare of the firm. Thus, the parties should be able to control assignment by agreement.”)

      Ultimately, there having been no conveyance of the interest by Banner to Condo, Condo had no claim against the other members of the LLC.

      While no Kentucky court has yet reviewed this issue, on a similar fact pattern it would appear appropriate to follow the guidance of the Colorado Supreme Court. Kentucky’s LLC Act embodies the same flexibilities as does that of Colorado with respect to the ability of a written operating agreement to restrict the assignability of the economic rights in the venture, the same principle of maximum enforcement of operating agreements and the same principles of in delectus personae.