Section 1541 of Maine’s Limited Liability Company Act provides that, in the absence of a Statement of Authority, any manager, member, president or treasurer has the authority to bind the limited liability company. The Maine LLC Act Drafting Committee added this provision to the LLC Act to address concerns of the real estate and commercial finance bar. In retrospect, I don’t think we (the Committee) have done enough to explain to the rest of the Maine Bar the potential for damage and mischief this provision creates, and why filing a Statement of Authority is so critical to limiting or eliminating this potential. This post is my attempt to define the potential. The idea for the post came to me from reading some recently issued opinions from California and New York. These cases provide examples of harm that could have been avoided with carefully crafted limits on apparent authority.

Apparent Authority – Cases in Point

A limited liability company does not act on its own. It acts through natural persons. Only natural persons authorized to act on the LLC’s behalf can legitimately bind the LLC. Authorizing persons to act on its behalf allow the LLC to borrow money, buy and sell assets, contract for services, and otherwise engage in commercial transactions with others to conduct its business. In other words, authorizing persons to act on its behalf is essential to the achieving the LLC’s purposes.

However, authorizing persons to act on its behalf also exposes the LLC to risks. In the absence of checks on the power of these persons, the LLC could suffer significant losses. Two recent court opinions highlight these risks. The first opinion comes from the Second Appellate Division of New York’s Supreme Court[1] and concerns the case of CitiMortgage, Inc. v. Kenneth Caldaro, et. al., 145 A.D.3d 851 (2016). Per the facts of the opinion, Vicky Caldaro, a member of R.V.P. Associates, LLC, deeded R.V.P.’s real estate to herself and Kenneth Caldaro. That raises the first issue:  did Vicky have the authority from the other members of R.V.P. to do that? Vicky and Kenneth then borrowed money from QuickenLoans, pledging a mortgage interest in their recently acquired (from R.V.P.) real estate as collateral for the QuickenLoans debt. QuickenLoans then sold the debt and the security interest in the real estate to CitiMortgage. Presumably, Vicky and Kenneth defaulted on that debt because CitiMortgage attempted to enforce its claimed rights against the real estate pledged as collateral.

When CitiMortgage sought to enforce its rights to the real estate, it discovered that the deed from R.V.P. to the Caldaro’s was never recorded. Further, according to the Caldaro’s, the deed was lost. CitiMortgage then went to court to force R.V.P. to execute a deed to the Caldaro’s so CitiMortgage could enforce its claim against the real estate pledged to it. R.V.P. said, “not so fast”. They said Vicky did not have authority to convey the real estate to herself and Kenneth.

The Appellate Division judges held that Vicky had apparent authority to bind the LLC. She had apparent authority because she was listed as a member of the LLC on the LLC’s Statement of Organization. In fact, she was the only person listed as a member on the Statement of Organization. Further, the members of R.V.P. never executed an LLC Agreement or Operating Agreement. Based on the Statement of Organization and the absence of any contrary documents available to CitiMortgage, Vicky had apparent authority to bind R.V.P. As CitiMortgage had no notice that Vicky intended to defraud it in pledging an interest in the real estate as collateral, CitiMortgage was a bona fide encumbrancer. In other words, CitiMortgage had a valid mortgage interest in R.V.P.’s property.

The other members of R.V.P. seem like innocent victims here. However, they were not completely powerless to prevent the real estate from being pledged as collateral. At the very least, they could have amended the Statement of Organization and entered into a binding Operating Agreement. Still, they were (it seems) victims of risks created by unchecked apparent authority.

The second opinion was issued in the case of Western Surety Company v. La Cumbre Office Partners, LLC, — Cal.Rptr.3d — (2017), 2017 W.L. 445408 comes from California’s Court of Appeal for the Second District. To get the gist of the case, imagine that you become a member of an LLC (La Cumbre) with others to acquire a medical office building in Santa Barbara. One of the members of the LLC (Crespano) is an LLC owned by Melchiori. Melchiori is the managing member of La Cumbre’s manager, MIC. Melchiori also owns a majority interest in a construction company, MCC.

MCC acquires surety bonds to provide financial backing for its obligations under construction contracts. The surety bonds are issued by Western Surety. Under the bonds, if MCC defaults on its construction contracts, Western Surety will make the damaged parties whole, financially speaking. As a condition of issuing the bonds, Western Surety demands to be indemnified. Like any other person in its business, it will seek an indemnity promise from MCC and any person related to MCC. So, when MCC asked Western Surety to issue the surety bonds, MCC sought an indemnity from Melchiori. In satisfying Western Surety’s diligence demands, Melchiori submitted his financial statement. His financial statement showed his (indirect) interest in La Cumbre.

While the parties dispute how this happened, La Cumbre became a party to Western Surety’s indemnity agreement. However, Western Surety’s counsel made a significant error in drafting the signature page of the Indemnity Agreement. He drafted the signature block for La Cumbre as follows:

LA CUMBRE

 

By: _____________________

Melchiori, Managing Member

Melchiori, however, is not the managing member of La Cumbre. He is the managing member of MIC. MIC is the manager of La Cumbre. So, the signature line should have been drafted as follows:

LA CUMBRE

By: MIC, its Manager

 

By: ____________________

Melchiori, Managing Member

Judge Yegan, writing for the Appeals Court, stated that, under California law, Melchiori’s signature binds La Cumbre, even though he signed as managing member of La Cumbre. Melchiori was, in fact, the managing member of MIC, the Manager of La Cumbre. The right person signed the Indemnity Agreement, even though the position granting him the power to bind La Cumbre was misstated. If the person with apparent authority for an LLC signs an agreement on the LLC’s behalf, his or her signature binds the LLC, even if his or her position is misstated.

That Western Surety dodged the proverbial bullet in this case is interesting, but not central to our issue. Our issue is about the apparent authority Melchiori had and which, had he signed a properly drafted agreement, would not have been questioned. Because Melchiori had this authority, and Western Surety could rely on it, La Cumbre’s medical office building was now subject to Western Surety’s claims for indemnity. So, imagine how you would feel when you realize that your share of about $3.65 million of capital contributions made to La Cumbre was subject to risks that had nothing to do with La Cumbre’s business and of which you were completely unaware.

Back to the Maine Act

Section 18-402 of the Delaware LLC Act effectively limits apparent authority to the authority provided in the LLC Agreement. In other words, under Delaware law, apparent authority of LLC members and managers is governed by the LLC Agreement. If the LLC Agreement does not address the authority of members and managers, any member or manager may bind the LLC.

The Maine Act addresses apparent authority similarly to the Delaware Act. However, instead of requiring third parties to reference the LLC Agreement, the Maine LLC Act makes the Statement of Authority the central and primary governing document for apparent authority. To the extent it addresses apparent authority, the Statement of Authority governs. In the absence of a Statement of Authority, pretty much anyone connected with a Maine LLC has authority to bind the LLC. As the two cases above illustrate, a situation in which a large group of people have authority to bind an LLC is not a good situation. Ideally, apparent authority would be limited to persons who have actual authority, and their apparent authority would be no greater than their actual authority.

Tailoring apparent authority to match apparent authority can be accomplished by restating in a Statement of Authority relevant provisions of the LLC Agreement. But, that’s not a perfect solution. The authority provisions of the LLC Agreement could be amended. If that happens, and the Statement of Authority is not amended, then the Statement differs from the LLC Agreement, and that could be bad.

Perhaps, there’s another way of tailoring apparent authority to match actual authority. Perhaps you can file a Statement of Authority that simply states, for example, “[T]he Managers of the Company have the power and authority to conduct the business and affairs of the Company per the terms of the [LLC Agreement], as amended.” Would that, in effect, give you the same result that applies under the Delaware LLC Act?

Apparent authority of the members and management of a Maine LLC should be addressed.  The best way to address apparent authority is to file a Statement of Authority. Failing to file the statement creates, in many cases, unnecessary risks.

[1] The Supreme Courts in New York are trial courts. The Appellate Courts of the Supreme Courts are the intermediate appeals courts. The Court of Appeals is the highest appeals court.

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