Statute of Frauds and Partnership and Limited Liability Company Agreements

The scene:  three friends are sitting in an office.  Friends 1 and 2 outline in detail a proposal to buy certain property and quickly re-sell it for a profit.  Friend 3 has a remarkable memory, loves both friends equally, and has no interest in the deal.  With friend 3 listening carefully, friends 1 and 2 talk through and agree to all of the terms and turn to friend 3 and announce jointly “we just struck a deal - you are our witness.”  The oral agreement includes all material terms of the deal.  Miraculously, friends 1 and 2 agreed orally as to the type of legal relationship they will enter and the jurisdiction governing that relationship.  Is the deal enforceable:

a)      if they agreed to a New York partnership?
        Answer:  Yes, since the deal has the capacity to be performed within a year.

b)      if they agreed to a New York limited liability company?
        Answer:  No because New York’s Limited Liability Company Law requires operating agreements to be in writing.

c)      if they agreed to a Delaware partnership?
        Answer:  Yes

d)      if they agreed to a Delaware limited liability company?
        Answer:  Yes, under Section  18-101(7) of the Delaware Limited Liability Company Act.

Generally, the statute of frauds requires that a written contract be drafted to identify the contracting parties, recite the subject matter and provide the essential terms of the agreement but there are exceptions for oral agreements in certain circumstances.  This post compares the varying application of the statute of frauds to partnership and LLC agreements in New York and Delaware.

Oral partnership agreements are typically enforceable in New York.  Courts have held that a joint venture may be found by evidencing “a joint undertaking, a combination of the parties resources, and a provision for the sharing of profits and losses” even though there is an absence of a writing.  If the oral agreement does not specify a definite term of duration, a partnership at will has been created.  New York courts have held that a partnership at will has the capacity to be performed within one year and thus the statute of frauds would not apply. Mendelovitz v. Cohen, a recent decision by the Kings County Commercial Division, reaffirmed this principle.  Only those contracts that have absolutely no possibility of full performance within one year (such as a partnership for a definite term of two years) are subject to the application of statute of frauds.

On the other hand, the issue of whether the statute of frauds applies to New York LLC agreements is a relatively new one which has not been addressed by the courts. (Berman v. Sugo LLC, a federal case in the Southern District of New York, came close to addressing this issue but stopped short of doing so when the existence of an oral agreement could not be established.) Section 417(a) of New York’s Limited Liability Company Law, requires members to adopt a written operating agreement suggesting that all LLC agreements in New York are subject to the statute of frauds.  Therefore, if you orally agree with a friend to establish a New York LLC, that agreement may be voidable, on statute of frauds grounds, until it appears in writing.

Delaware takes an even less stringent stance with regards to the application of statute of frauds to these agreements.  This attitude is clear from the recent amendments to the Delaware LLC Act in reaction to the 2009 Delaware Supreme Court opinion in Olsen v. Halvorsen which held that any part of oral LLC agreements that is not capable of performance within one year is subject to the statute of frauds.  In response to Olsen, Section 18-101(7) of the Delaware statute was amended to specifically state that “[a] limited liability company agreement is not subject to any statute of frauds.”  Therefore, oral LLC agreements are enforceable in Delaware.  Delaware partnership agreements are also not subject to any statute of frauds, making oral partnership agreements enforceable and not voidable on that ground.

Thus, beware of oral agreements.  Of course, oral agreements still need to be proven.  If you do not agree with a draft purportedly prepared to confirm an oral agreement, make sure to put your non-acceptance in writing.  Written LLC agreements should also include a statement that no amendment shall be effective unless in a signed writing to prevent a claim that oral negotiations became an amendment to the agreement.  Include provisions in term sheets or letters of intent stating that the term sheet or LOI will not be binding unless a formal agreement is signed and delivered.*

See Real Estate Joint Ventures for a description of our practice in the area of real estate LLCs, partnerships and other joint ventures.

* Saman Aminolsharei, a law student intern with Olshan assisted in the research and writing of this post.

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