Many states allow for oral understandings to serve as an Operating Agreement. Can you see the danger in this? Do you know people who conveniently forget important facts? This may be why the state of New York requires a written Operating Agreement.
But for the other states, let’s consider an arrangement where three friends form an LLC. Their oral and unwritten deal is that they will split the profits three ways. One can hope that everyone will live up to the deal.
But what if the oral understanding provides that a departing member will be entitled to earn payouts over a six year period? Or provides for other arrangements performed over one year in length?
A recent Delaware case dealt with this exact issue. The holding is as you would expect: Oral understandings are much better enforced if they are instead written and signed by all parties.
The heart of the matter is the Statute of Frauds – an old English rule which sensibly holds that contracts for real estate transactions and agreements that are to be performed over one year must be in writing. The point being that those old English judges (and today’s modern judges) don’t want people coming into their courtrooms and arguing there was an oral deal to sell real estate or an oral understanding for a multi-year payout. From a judge’s standpoint, it is very difficult to sort out a “he said/she said” argument. You’d better get your important agreements in writing or you won’t get far in court.
In the Delaware case, the claimed oral understanding was a six year payout for a departing member. The court relied on the rule of the Statute of Frauds, contracts to be performed over one year in length must be in writing, to deny the plaintiff their request for relief.
The lesson is, you should make sure your Operating Agreement is in writing. Then you must make certain that everyone signs it. A written and executed document can easily be reviewed by a court. Or, better yet, you won’t have to go to court because your written agreement will be clear to all.