Proposed Bill Would Eliminate the Corporate and LLC Shield for Many Washington Contracts
The Washington legislature is currently considering a bill that would apparently require any contract that calls for the payment of money by an LLC or corporation, to include an extra signature by an authorized representative that would render the representative personally liable for any amounts due on the contract. HB 1535. In other words, under this bill any LLC or corporation making a contractual commitment that involves the payment of money would have to include a personal guarantee from a natural person.
This would be an extraordinary change to Washington law. No other state has anything comparable in its laws.
The Background. The bill would upend the familiar principle of the law that “when an agent makes a contract on behalf of a disclosed or partially disclosed principal whom he has power to bind, he does not thereby become liable for his principal’s nonperformance.” Griffiths & Sprague Stevedoring Co. v. Bayly, Martin & Fay, Inc., 71 Wn.2d 679 , 686, 430 P.2d 600 (1967). See Restatement (Second) of Agency § 320 (1958).
When an LLC manager (or a corporate officer) signs a contract on behalf of a company, the manager usually signs only as an agent of the company. The fact that the manager is signing as an agent is reflected in the typical signature block:
Acme Corporation
______________________
By: Wile E. Coyote
Vice President of Product Development
Under these well-accepted rules, LLC managers and corporate officers can sign contracts on behalf of their company without fear of becoming personally liable. If the rule were otherwise it would be exceedingly difficult to find a manager willing to sign for an LLC or corporation.
The Bill. The heart of the bill is a requirement that any “business payment contract” must contain an additional signature line, directly following and on the same page as any other signature line that the authorized business representative must sign. The additional signature line must be immediately preceded by the following legend in bold, 14-point or larger typeface:
By signing this contract you, the undersigned, agree to become PERSONALLY LIABLE for any sums due pursuant to this document, regardless of whether you are signing on behalf of a limited liability company, corporation, or nonprofit corporation.
This bill, if passed, will clearly make it difficult for LLCs to find managers willing to sign contracts for their LLC.
Drafting and Interpreting Statutes. The language of HB 1535 has some internal conflicts. I have described above the interpretation that I and other business lawyers that I have talked to have given to the bill. It is possible, however, that it was intended to simply require a warning legend on guarantee contracts, although that is a more difficult interpretation. In any event it needs to be clarified.
It is not an easy thing, to draft statutes so that they are clear, unambiguous and sufficiently detailed. This has repeatedly been driven home to me in my participation on a Bar committee that has reviewed proposed legislation.
HB 1535 is scheduled for public hearing in the Washington legislature’s House Committee on Business & Financial Services at 1:30 p.m. Tuesday, February 1, 2011, in Olympia, Washington. At the hearing I expect we will learn what is behind this bill and what the intent of its sponsors is. More information is available about the bill’s scheduled hearings here.
Washington Law Firms Organize as LLCs, Sometimes Unlawfully
Law firms traditionally have organized as partnerships, but in recent years many states have authorized law firms to organize as professional corporations or professional LLCs, subject to special requirements. You might expect lawyers to comply with the law when they form an entity for their law firm. If so, you could be disappointed. In Washington state, at least, many law firms are unlawfully organized.
I began to look into this last month, when I noticed a press release from a law firm in South Carolina that trumpeted the firm’s change from a partnership to a limited liability company. The press release indicated that the firm was “positioning ourselves to maximize our efficiencies so we can continue to achieve the most successful outcomes for our clients.” That sounded good. I started wondering about Washington state, where I practice.
Washington’s LLC Act authorizes professional limited liability companies (PLLCs) for licensed professionals such as attorneys. RCW 25.15.045. The LLC Act subjects PLLCs to the provisions of Washington’s Professional Service Corporation Act (PSCA), RCW chapter 18.100. The PSCA prohibits licensed professionals, such as attorneys and health care providers, among others, from operating as a corporation unless they use a “professional service corporation.” This form preserves the professional relationships between service providers and their clients or patients, and prohibits ownership of shares or member interests in the entity by persons not licensed to render the professional services for which the entity was formed. RCW 18.100.090.
A review of the Washington Secretary of State’s online business entity search page showed that there are hundreds of Washington law firms organized as limited liability companies. Roughly 15% of the law firms organized as LLCs are not PLLCs, but instead are standard LLCs. This is determinable from the names, because a PLLC must have the word “professional” or “PLLC” in its name. RCW 25.15.045(4). The Secretary of State’s records also show for each entity a category that distinguishes PLLCs from standard LLCs. The Secretary of State’s categorization is apparently determined from each LLC’s certificate of formation, which is filed with the Secretary of State. The certificate of formation for a PLLC is required to state that it is a professional LLC. RCW 25.15.005(10).
A large majority of those law firms that are non-professional LLCs appear to be solo practitioners. That is not a defense to the professional LLC requirement, because the PLLC statute applies even to single-member LLCs. RCW 25.15.045(1). There are also a number of Washington multi-lawyer firms organized as standard LLCs.
Why are there so many violations? I assume the lawyers that formed these entities did not intend to violate the law. That leaves two possible explanations: either inadvertence, or perhaps a difference of opinion as to whether the PLLC structure is optional or mandatory for law firm LLCs.
It is not obvious on the face of the LLC Act that the PLLC structure is mandatory: “A person or group of persons licensed or otherwise legally authorized to render professional services within this or any other state may organize and become a member or members of a professional limited liability company under the provisions of this chapter for the purposes of rendering professional service.” Id. (emphasis added). The word “may” suggests an alternative rather than a requirement.
Last year, however, the Washington Supreme Court removed any doubt on this issue. Columbia Physical Therapy, Inc., PS v. Benton Franklin Orthopedic Assocs., PLLC, 168 Wn.2d 421, 228 P.3d 1260 (2010). The court treated an LLC like a corporation, and held that licensed medical professionals practicing in an LLC would violate the rules against the corporate practice of medicine if the LLC were not organized as a PLLC. 168 Wn.2d at 438. The court’s analysis makes clear that the same result would hold for the other licensed professional services listed in the PSCA, including the practice of law. Washington law has long prohibited lawyers from practicing law as a corporation. State ex rel. Lundin v. Merchs.’ Protective Corp., 105 Wash. 12, 177 P. 694 (1919).
Law firms improperly organized as standard LLCs rather than PLLCs have apparently not drawn much attention from the Washington State Bar Association. That may change if law firms formed as non-professional LLCs begin conducting other businesses in addition to the practice of law, which RCW 18.100.080 prohibits for professional service corporations and PLLCs. RCW 18.100.080.
When Does a Manager's Signature Bind the LLC?
In the world of commerce, businesses routinely rely on the apparent authority of LLC managers to sign contracts on behalf of their LLCs. Generally that works well. But what happens if an LLC disavows an agreement, claiming the manager who signed the contract had neither actual nor apparent authority?
The Missouri Court of Appeals was recently faced with this scenario in Pitman Place Development, LLC v. Howard Investments, LLC, No. ED94456, 2010 Mo. App. LEXIS 1635 (Mo. Ct. App. Nov. 23, 2010).
Background. According to the court’s statement of the facts, the LLC was formed by three members, one of whom was the sole manager. The LLC’s operating agreement gave the manager authority to manage the LLC’s business, but the consent of the members was required for the manager to cause the LLC to encumber its property or to borrow more than $50,000. The manager, however, wanted to borrow $525,000, and at this point the facts get ugly.
The manager gave the bank a copy of the LLC’s operating agreement, but omitted the pages that limited his authority. On request of the bank’s loan processor, on the day of the loan closing the manager faxed the omitted pages to the bank, but only after fraudulently altering the key provisions. The alterations increased the limit of his authority from $50,000 to $750,000 and authorized him to encumber the LLC’s property. The $525,000 loan was closed, and portions of the loan proceeds were later used by the manager for his own purposes. When the other two members learned what had happened, the LLC sued the bank to set aside the loan and deed of trust.
The trial court found after a bench trial that the manager acted with apparent authority when he executed the loan documents, and enforced the note and deed of trust against the LLC. The LLC contended on appeal that apparent authority was lacking because neither of the other two LLC members took any action to create the appearance that the manager had authority.
Apparent Authority. The Missouri rule is that to establish apparent authority, it must be shown that a principal has either manifested consent to the agent’s exercise of authority or knowingly permitted the agent to assume the exercise of authority. Additionally, the party relying on the apparent authority must have known the facts and believed in good faith that the agent had authority, and must have changed its position in reliance on the appearance of authority. Id. at *12. The Missouri rule is consistent with the Restatement of Agency. Restatement (Second) of Agency § 27 (1958).
The court found that the lender relied on the express language of the LLC’s operating agreement. “Pitman cloaked Burghoff with apparent authority when it manifested its consent for Burghoff to act as ‘Manager’ of Pitman in the Operating Agreement, and gave the ‘Manager’ general authority to enter into transactions such as the Rockwood Bank loan transaction.” Pitman Place, 2010 Mo. App. LEXIS 1635, at *14. Although the manager lacked actual authority and acted to defraud the LLC, the court relied on prior rulings that the act of an agent with apparent authority, even if in furtherance of a fraud on the principal, will bind the principal. Id.
The LLC argued that the manager had no apparent authority here because he fraudulently created the appearance of authority. The court acknowledged that an agent cannot create its own authority and that it was troubled by the manager’s “fraudulent and dishonest conduct.” Id. at *11, 19. But in the end the court found that the LLC’s general statements of authority in the operating agreement vested the manager with the apparent authority to carry out the loan transaction. The LLC was therefore responsible for the manager’s acts and agreements with the bank as if the acts were the LLC’s own. Id. at *19.
The court glosses over the fact that by fraudulently deleting the operating agreement’s limits on his authority, the manager essentially was creating his own authority. The court implicitly treats the fraudulent pages of the operating agreement as a detail that does not impair the members’ broad grant of authority.
Statutory Defense. The LLC also contended that even if the manager did have apparent authority to bind the LLC under agency common law principles, the manager’s conduct did not bind the LLC because the execution of the loan documents was not apparently for carrying on in the usual way of business or affairs of the LLC, as required by the Missouri LLC Act. Id. at *20. The statute provides, in relevant part, that “the act of any manager for apparently carrying on in the usual way of the business or affairs of the limited liability company of which he is a manager binds the limited liability company,” and that an “act of a member or manager which is not apparently for the carrying on the usual way of the business or affairs of the limited liability company does not bind the limited liability company unless authorized in accordance with the terms of the operating agreement.” Mo. Rev. Stat. § 347.065.
The court did not address why the manager’s lack of authority under this statute, if it applied, would trump the manager’s apparent authority. Instead, the court found in the language of the operating agreement and in the LLC’s past practices sufficient evidence that the loan transaction was “carrying on in the usual way of business.” Pitman Place, 2010 Mo. App. LEXIS 1635, at *23-24. The court accordingly rejected the LLC’s argument, and after affirming the trial court’s other rulings, affirmed the lower court’s judgment. Id. at *42.
Protective Steps. What else could the Pitman members have done to prevent the manager from fraudulently having apparent authority in excess of the limits in the operating agreement? Perhaps they could have written their operating agreement so that the language granting broad authority to the manager had the limitations tightly woven into it. If the manager had provided altered versions of those pages, retaining only the broad granting language, what result? Or if the agreement had no broad grant of authority to the manager but instead simply granted certain enumerated, limited powers, what result if the altered pages added some additional powers?
In any event, there are other, practical steps that could be taken to forestall chicanery. For example, the Missouri LLC Act allows an LLC’s articles of organization, which must be filed to create the LLC, to optionally contain provisions from the LLC’s operating agreement. Mo. Rev. Stat. § 347.039.2. The organizers of an LLC could include in the articles of organization the limits on the manager’s authority. Articles of organization are publicly available, and banks and title companies can and often do obtain a copy from the Secretary of State prior to closing a real estate or loan transaction. That would make them aware of the limits on the manager’s authority expressed in the articles.
Alternatively, the LLC could file a memorandum with the county where its real estate is located, referencing the LLC’s real estate and describing the limits on the manager’s authority. Any transaction involving the LLC’s real estate would almost certainly involve a title company and a title search, which would then address the manager’s authority.
The LLC could also require signatures in addition to the manager’s on all checks, or all checks above a limit, in the banking resolutions when it sets up its bank accounts. Once in place, those resolutions would require additional signatures from members other than the manager to change the authorized account signatories. That would result in oversight of withdrawals from the LLC’s bank account.
A structural approach would be for the LLC to have two or more managers, and in their operating agreement’s grant of authority require that the managers act jointly.
These measures are often not adopted, frequently because they are inconsistent with the trust most LLC organizers have in their managers. LLC organizers won’t usually appoint someone to be their manager unless they have substantial trust in them. Lawyers, though, can’t assume that the other (non-client) parties will always act benevolently, and must write agreements to cover contingencies including bad acts. The Pitman Place case is a good example of why lawyers must try to anticipate unauthorized or improper acts by the other parties.
