Navigating the Enforceability of Oral LLC Ownership Percentages: A Legal Perspective
Limited Liability Companies (LLCs) have become a popular choice for business owners due to their flexible structure and limited liability protection. When forming an LLC, it is essential to establish the ownership percentages to define each member’s share of profits, losses, and decision-making authority. While written operating agreements are generally recommended to avoid disputes, questions may arise about the enforceability of an oral LLC ownership percentage if it is not documented in writing. In this article, we will explore the legal landscape surrounding oral LLC ownership percentages and discuss their enforceability.
Understanding LLC Ownership Percentages
LLC ownership percentages define the ownership interests of individual members within the company. These percentages determine the distribution of profits, losses, voting rights, and other benefits among the members. In many cases, LLC members create a written operating agreement that explicitly outlines the ownership percentages and other important provisions. However, some LLCs may lack a formal written agreement, leading to reliance on oral agreements or implied understandings.
The Importance of Written Operating Agreements
Written operating agreements are highly recommended for LLCs as they provide clarity, prevent misunderstandings, and serve as a legal reference in case of disputes. These agreements typically address important aspects such as ownership percentages, management responsibilities, capital contributions, profit-sharing, and dispute resolution procedures. When an LLC has a written operating agreement in place, it becomes the primary source of guidance for member rights and obligations.
Enforceability of Oral LLC Ownership Percentages
The enforceability of oral LLC ownership percentages can vary depending on the jurisdiction and specific circumstances. It is crucial to note that while some states allow oral operating agreements, others require written agreements. Furthermore, even in states that recognize oral agreements, proving the existence and terms of an oral agreement can be challenging. The absence of a written document may lead to disagreements, misunderstandings, and potential legal disputes.
Statute of Frauds
The Statute of Frauds is a legal principle present in many jurisdictions that requires certain contracts to be in writing to be enforceable. While the specifics of the Statute of Frauds vary by jurisdiction, it commonly applies to agreements involving the sale of land, contracts that cannot be performed within one year, and agreements related to the transfer of interests in a business entity. In some states, LLC ownership interests fall within the scope of the Statute of Frauds, thereby necessitating a written agreement.
Exceptions and Equitable Principles
Although the Statute of Frauds can pose challenges, there are situations where oral LLC ownership percentages may still be enforced. Courts may consider exceptions and equitable principles to protect the rights and interests of parties involved. For example, if one member can prove that they have significantly contributed to the LLC’s success or relied on the oral agreement to their detriment, a court may be more inclined to enforce the agreement.
Best Practices for LLC Owners
To avoid potential disputes and uncertainty regarding LLC ownership percentages, it is strongly advised to create a written operating agreement. This agreement should clearly outline the ownership percentages, rights, responsibilities, and dispute resolution mechanisms. By having a comprehensive written agreement, LLC members can minimize the risk of conflicts and ensure a solid legal foundation for their business.
Conclusion
While oral LLC ownership percentages may have some enforceability in certain situations, it is highly recommended to have a written operating agreement in place to avoid potential disputes. The absence of a written agreement can lead to uncertainties, misinterpretations, and legal challenges. By proactively documenting the ownership percentages and other essential provisions, LLC owners can protect their interests, promote transparency, and establish a solid foundation for their business venture.
Video Transcript
Is an Oral LLC Ownership Percentage Enforceable if It is Not in Writing?
So what do we have here? We have business owners, let’s say two of them. And they agreed to a ownership percentage split of the LLC. Let’s say it is 25% and 75%, but they never put it in writing. They never sign an operating agreement. They simply didn’t formalize any of this. You would be surprised. This is actually quite common. Because business owners will start out agreeing to something. And they say, “You know what, once we get going, we will put it in writing.” And then they get busy, and they have a lot of opportunity, or they have problems. And they are busy working on the business. And then finally they go, “We better put that in writing,” and usually, that comes up when there are some other problems and I can’t tell you how many times I have seen people have a different viewpoint on what the ownership percentage should be after they have been running the business for a while.
I have seen many many times where owners will start out with one percentage and then one owner wants to change it or argues that it should have been a different way. Or I saw one time where one owner said, “You could get 50% if you did X, Y, and Z, or if we achieved certain milestones.” And the other business owner said, “No, that wasn’t my understanding. My understanding was I get 50% and then we would work together to achieve those milestones.” So as you can see, this can be messy.
Is an Oral Agreement Enforceable?
Absolutely. In virtually all states, if not all of them, an oral agreement is enforceable related to the ownership percentage of a business started between two partners. It doesn’t matter if it is an LLC. It doesn’t matter if it is a corporation. If the owners agree on a percentage before they start the business, at the time they start the business, or at any other time after that. That oral agreement is enforceable. Proving it is a whole other issue.
How Do You Prove That?
Well, maybe there are some emails. Maybe there are some tax returns. Maybe there is a recording of some sort. Maybe there is a witness of conversations that occurred. Maybe the witness didn’t observe the two business owners talking about this issue, but the owners went home and talked to their spouses. And the spouse is at least a witness to what the business owner understood was the arrangement. And then finally, even if you don’t have any of that in litigation, you can do a deposition.
What is a Deposition?
A deposition is where you ask the other party some questions. It may be that a judge or jury finds one party more credible, trustworthy, and honest than the other party. And so, ultimately, it is very common that you can prove an oral agreement through other sorts of evidence. But even if you have no evidence at all, legally, an oral agreement for the ownership percentage of a business is fully enforceable.
Conclusion
If you found this video helpful and you would like more educational videos like this, feel free to subscribe to this channel. If you have other questions, put them in the comments below. I am Aaron Hall, an attorney for business owners and entrepreneurial companies. You can learn more about me at AaronHall.com. And if you would like to sign up for our free resources, go to AaronHall.com/free. It was great to be with you here today.