Don’t Be Up Schitt’s Creek: Risk of Theft or Conversion of a Member’s Interest in an LLC Without an Operating Agreement

Posted on August 30, 2024, by Starlett Massey

Individuals in Florida commonly start a Florida limited liability company (LLC) without retaining a lawyer to prepare an operating agreement. They do so by registering with the Florida Division of Corporations (sunbiz.org). 

In the first blog in this series, we discussed the pitfalls of this approach. Specifically, we examined LLCs without operating agreements and the risk of unauthorized actions by members. In this second blog, we explore how the lack of an operating agreement can create the risk of theft or conversion of a member’s ownership interest by a third party.

How Florida LLCs are governed

The Florida Revised Limited Liability Company Act, Florida Statute § 605.0105, et seq. (the “FRLLCA”) govern how Florida LLCs operate. LLCs without operating agreements, however, do not benefit from protections that control the rights and duties of the members and the manager. 

How LLC operating agreements help protect against theft or conversion of a member’s interest by a third party

Any individual who files an annual report or submits any other record to the Division of Corporations does so “under penalty of perjury that the information stated in the record is accurate.” See F.S. § 605.0205(3). Operating agreements govern how a company accepts new members and governs the rights and duties of the members.  

Even if a new member has not signed the company’s operating agreement, the new member is bound by the terms of the operating agreement. See F.S. § 605.0106(2). Unfortunately, despite the penalty of perjury, it is feasible for an affiliate of a member to file an annual report that is not authorized by the company in order to claim an ownership interest that they do not have.  

Where an LLC does not have an operating agreement, a third party’s unlawful or unauthorized claim to membership of a company may become difficult – if not impossible – to prove.  

Hypothetical: Roland and Jocelyn form a Company to import gourmet food for local restaurants by filing online Articles of Organization for the Company with the Division. Roland and Jocelyn are confident that their happy marriage is a sufficient foundation for the governance of the Company and decide that they do not need to hire the town lawyer to prepare an operating agreement. 

Ten profitable years later, Johnny moves into town. Roland and Johnny become friends, and Johnny impresses Roland with his discovery of two new food vendors for the Company. For reasons not relevant here, Jocelyn takes a disliking to Johnny and refuses to pay Johnny the $20,000 he is owed for gourmet food Johnny sourced for the Company.  

One night, over a game of cards, to keep the peace, Roland tells Johnny not to worry about not getting paid and that he and Jocelyn will give Johnny a 33.3% interest in the Company in lieu of the money owed him. Johny believes in the future success of the Company and agrees. Roland does not tell Jocelyn or get her agreement to transfer 33.3% of the Company to Johnny. 

To impress his new business partners, Johnny files an amended annual report that reflects that the Company has three members: Roland, Jocelyn, and Johnny. The Company continues operations for several more successful years. Neither Roland nor Jocelyn have paid attention to the Division records, each believing the other has handled this minor administrative task.  

Johnny continues to file the annual reports reflecting his status as a member of the Company.  Twyla, the owner of the local deli and the Company’s biggest customer, hits the lottery and decides to buy the Company for $1M to bring all of her profit margins in-house. Because it’s a small town, everyone is aware of the pending deal, and on closing day, Johnny arrives to collect his 1/3 of the sales proceeds.  

Days later, after Jocelyn and Roland meet with a business lawyer, they realize the cost of their legal fees in fighting Johnny’s claim to the Company (and their respective legal fees for their divorce counsels) will exceed 1/3 of the sales price of the Company. Hence, they acquiesce to Johnny’s 1/3 claim.

Avoid the pitfalls of doing business without an LLC operating agreement

Schedule an appointment and learn about the benefits to your business. Contact MLG today.

“Don’t Be Up Schitt’s Creek!” Stay tuned for the third blog in this series, when we examine additional risks of doing business without an operating agreement, including failed succession planning.