by Adv. Shemer Sendak and Ayelet Shuber
David acquires membership interests in a Delaware LLC, but never signs the LLC operating agreement. Years later, David is sued for breach of contract of the same LLC operating agreement. David argues that, because he never signed the operating agreement, he was not a party to the LLC agreement and therefore could not be held liable under its terms. Is David bound under Delaware law by the terms of the agreement even though he did not sign it? Surprisingly, the answer is most likely yes. Despite the general rule that only one who signs an agreement is bound by its terms, under certain circumstances in Delaware, a company or individual may be bound by an agreement it has not signed.
The Delaware Limited Liability Company Act explicitly states that LLC members and the LLC itself are parties to an LLC operating agreement and bound by its terms even when they have not executed the agreement. Section 18-101(7) of the Delaware LLC Act provides as follows:
“A member or manager of a limited liability company or an assignee of a limited liability company interest is bound by the limited liability company agreement whether or not the member or manager or assignee executes the limited liability company agreement. A limited liability company is not required to execute its limited liability company agreement. A limited liability company is bound by its limited liability company agreement whether or not the limited liability company executes the limited liability company agreement.”
The Delaware courts have confirmed this section. In the 2014 Delaware Court of Chancery decision Seaport Village Ltd. v. Seaport Village Operating Company, LLC, et al., the plaintiff claimed that defendant was not entitled to attorney’s fees provided to the prevailing party under the company’s operating agreement because it had never signed the operating agreement. The court disagreed and held that, as Section 18-101(7) makes clear, a “limited liability company is a party to its own limited liability company agreement, regardless of whether the limited liability company executes its own limited liability company agreement.” This section, and recent case law interpreting it, underscores the importance of having all LLC members negotiate, agree on and execute the LLC Operating Agreement, to avoid a situation where a member may find itself bound by an agreement it did not execute. Likewise, LLC members should be aware that they may be bound by amendments made to the LLC operating agreement even if they did not sign the agreement, depending on the terms of the operating agreement. Assignees to LLC membership interests should also note they will likely be bound by the terms of the LLC operating agreement, and should therefore review the terms of the agreement carefully.
The Delaware LLC Act is not the only place under Delaware law where non-signatories may be held responsible for performing under an agreement. Indeed, some other scenarios in which this issue comes up and where it is worthwhile to be especially attentive include in relation to merger agreements (where parties to a merger may bind certain non-signatory shareholders to agreements), arbitration and forum selection clauses (which may be applied to certain non-signatories), in situations where minority shareholders are bound by agreements entered into by majority shareholders, in agreements in which company affiliates are bound by the company’s contracts, and in disputes related to non-compete provisions in franchise agreements.
Recently, the decision in Medicalgorithmics S.A. v. AMI Monitoring, Inc. reinforced the fact that there are situations in Delaware where a non-signatory may be bound by an agreement, even when it may seem counterintuitive. In the case, a medical device manufacturer terminated its agreement with a distributor, claiming that the latter breached the contract. The distributor counterclaimed. A defendant in the case argued that it could not be bound by the agreement for which the plaintiff claimed breach because it had never signed the agreement. The court disagreed, and ruled that the defendant non-signatory to the agreement was bound by its terms because it was an affiliate of the signatory, it was controlled by the signatory, and it had accepted the benefits of the agreement.
The Medicalgorithmics decision is not the first time Delaware courts have ruled in this manner. Indeed, there are several well-settled exceptions in Delaware to the general rule that non-signatories to an agreement are not bound by its terms. When one of these exceptions applies, it may obligate those who have not signed an agreement to its terms: the third party beneficiary exception, the agency exception, the joinder exception, and equitable estoppel.
The first exception which binds an entity that has not signed an agreement to the terms of the agreement involves third party beneficiaries—nonparties to an agreement who nevertheless may benefit from certain terms of the agreement. To determine if a third party beneficiary is bound by the terms of the agreement, Delaware courts will consider several factors: the third party beneficiary’s involvement in the contract negotiation, the relationship between the non-signatory third party beneficiary and the parties who signed the agreement, and whether or not the third party beneficiary received a direct benefit from the agreement. The more these factors apply to the third party beneficiary, the likelier it is that it will be bound by the terms of the agreement even if it didn’t sign it.
Under the agency exception, a court may also find that an agent is bound by the terms of an agreement signed only by the principal. This exception may come into play in a situation where, for example, an employee (the agent) is bound by the terms of an agreement its employer (the principal) signed, where the employees’ actions under the agreement were authorized by the employer. An example would be an agent/employee’s breach of a certain term in the agreement signed by the principal/employer, where the employee breached the agreement while working for the employer. To determine whether an agent is bound under the terms of the principal’s agreement, a court first looks to see if there is an agent-principal relationship by investigating whether the agent is acting on the principal’s behalf and is subject to the principal’s control. The court then considers whether the principal authorized the agent to take action under the agreement.
Additionally, the so-called “joinder” or “manifestation of intent” exception binding a non-signatory to the terms of an agreement comes into play when a party either specifically signs a document joining the agreement, or where the joinder to the agreement can be inferred, such as when a non-signatory manifests an intent to be bound by the agreement. An example of this latter situation occurs when a wholly-owned subsidiary of a parent company signatory is bound by the terms of the parent company’s agreement.
Finally, the “estoppel exception” binds non-parties to an agreement where they have indicated assent to the contract in some other way, such as by enjoying certain benefits of the agreement after it was executed. This exception is often used to compel non-signatories to submit to arbitration or to litigation in a certain jurisdiction.
It is worth noting that the circumstances discussed here, in which non-signatories may be bound by terms of an agreement they did not sign, vary from state to state, and we address only Delaware law.