Can Members Ratify Defective Decisions by a California LLC?

In California, limited liability companies (LLC) are a popular method of ownership of real property and their operation is important to understand.

In the recent Second District Court of Appeal decision of Camden Systems, LLC v. 409 North Camden, LLC, Camden Systems, LLC appealed from the judgment entered in favor of defendants 409 North Camden, LLC and its individual members after the trial court granted defendants’ summary judgment motion.

Camden Systems’s complaint sought declarations that certain actions taken by members of 409 North Camden, including distributions to the members, were invalid, and it sought return of the distributed funds.

In its motion, 409 North Camden acknowledged that some of the actions taken by its members at the company’s February 2021 annual meeting were invalid in light of defective notice of the meeting, but it argued that at its February 2022 annual meeting a majority of the members ratified the prior actions, thereby curing any defect in the 2021 notice.

The trial court agreed and granted summary judgment in favor of 409 North Camden.

On appeal, Camden Systems contended that the members’ ratification of the actions taken at the February 2021 meeting did not cure the defective notice because members of limited liability companies, unlike corporations, may not ratify prior actions taken on behalf of company.

However, the California Revised Uniform Limited Liability Company Act (Corp. Code, § 17701.01 et seq.; the Act),which governs the management and operation of limited liability companies, provides that a limited liability company generally “shall have all the powers of a natural person in carrying out its business activities.” (§ 17701.05.)

Because a natural person has the power to ratify acts taken on the person’s behalf, limited liability companies likewise may, through their members, ratify actions previously taken on behalf of the company.

In addition, the court did not err in upholding the resolution adopted by the majority of 409 North Camden’s members to indemnify its members and advance defense costs and expenses incurred in the lawsuit filed by Camden Systems.

In 1963 a group of six friends purchased a two-story office building in Beverly Hills. From 1963 until 2016 the purchasers (and some of their heirs) owned the building as tenants in common without any formal partnership agreement.

In 2016 the owners, still composed of the original purchasers and their heirs, formed 409 North Camden as a manager-managed limited liability company and transferred ownership of the office building to the company.

At the time of its formation, 409 North Camden had 13 members. Jeffrey Young, the son of one of the original owners, was elected as the manager of the company.

In 2020 Camden Systems became a member of 409 North Camden by purchasing the membership interests of three existing members.

As of October 2020, there were 10 members of the company, all of whom—except for Camden Systems—were the building’s original purchasers or their family members. Camden Systems owned a 22.5 percent interest in the company, comprising the largest single membership interest.

The operating agreement of 409 North Camden provides that “[t]he Company shall make quarterly distributions of Available Cash at such times and in such amounts as determined by the Manager, subject to the approval of the Members.”

Since September 2016, the company distributed approximately $773,000 in Available Cash to its members. Each distribution was authorized by a majority of the members. The members did not authorize any distributions after Camden Systems became a member in July 2020.

On January 11, 2021, Young sent the members of 409 North Camden a notice that the company’s annual meeting would take place on February 20, 2021. The notice included copies of three documents Young indicated would be discussed at the meeting regarding potential building upgrades or modifications.

The notice stated an agenda and annual report would be distributed “a few days” prior to the meeting. No other topics of discussion or potential action items were mentioned in the notice.

On February 11, 2021, Young sent the company’s members a meeting agenda for the upcoming meeting, which listed four action items that members would vote on at the meeting: (1) re- election of Young as manager; (2) withholding cash distributions for the first quarter of 2021; (3) authorization of payment of expenses in excess of $10,000; and (4) approval of a “[m]anagement assistance fee” of $1,500 per month to member Kenneth Young.

On February 15, 2021, an attorney for Camden Systems sent a letter to Jeffrey Young complaining that Young had failed to produce certain corporate records Camden Systems had previously requested.

Camden Systems’s attorney asserted the records were necessary for his client to prepare for the upcoming member meeting, and therefore, it intended to object to any business taking place at the February 20 meeting without having first received the records.

Camden Systems also provided a notice to Young that it intended to object to any business being conducted by the members at the February 20 meeting because the January meeting notice did not state the general nature of the business to be transacted, as required by the Corporations Code.  

Further, although the February 11 notice specified the business to be transacted at the meeting, the notice was untimely because it was sent less than 10 days before the meeting, in violation of the Code.

The annual meeting was held as scheduled on February 20, 2021. Joseph Shabani, the manager of Camden Systems, attended the meeting and reiterated Camden Systems’s objections as stated in its attorney’s letter and notice.

The four action items listed in the meeting agenda were voted on and approved by a majority of the members who were present. Shabani, on behalf of Camden Systems, abstained from each vote.

On March 25, 2021 Camden Systems, in its individual capacity and derivatively on behalf of 409 North Camden, filed this action against 409 North Camden (as a nominal defendant) and its members (member defendants), alleging causes of action for breach of fiduciary duty, breach of contract, and declaratory relief.

The allegations in the complaint were based, in part, on the alleged impropriety of the authorizations for cash distributions made between 2016 and July 2020 and the actions taken at the February 2021 meeting.

On May 3, 2021, prior to responding to the complaint, the member defendants adopted a written resolution regarding the pending litigation. The resolution stated in its recitals that after Camden Systems became a member of 409 North Camden, Shabani and his attorney told Young that Shabani “expect[ed] to buy” the remaining interest in 409 North Camden and “‘things will not go well for you if you refuse to sell the property to him.’”

Shabani had also contacted individual members and threatened to sue them if they did not sell their interests in the company to him. According to the resolution, the member defendants were “uniform in their decision that they do not want to sell their interest in the Company or the Property at all and certainly not to Shabani under these circumstances.”

The member defendants resolved that 409 North Camden would not make upcoming cash distributions and would instead reserve all excess funds for defense of the lawsuit.

In addition, the member defendants agreed 409 North Camden “shall indemnify and hold the Manager and the Members harmless” against the lawsuit and shall “advance defense costs and expenses accordingly.” The resolution was dated May 3, 2021 and signed by all members of the company except Camden Systems.

The annual meeting was held on February 19, 2022. The members approved by majority vote the ratification of the prior cash distributions, the actions taken at the February 2021 meeting, and the indemnification resolution.

Shabani, on behalf of Camden Systems, voted no or abstained from each vote, except the ratification of the 2021 vote to pay expenses in excess of $10,000, for which Shabani voted yes.

The meeting minutes do not state that Shabani or Camden Systems objected to the ratification process prior to or during the meeting.

The third amended complaint alleged three causes of action against the member defendants: a request for declaratory relief finding the actions taken at the February 2021 meeting were without force and legal effect because the meeting notice was untimely and/or did not sufficiently state the nature of the business to be conducted; a claim for money had and received based on the allegedly improper cash distributions; and a request for declaratory relief finding the May 2021 indemnification resolution was invalid because the company was without legal authority to indemnify the members.

On May 10, 2022, the member defendants moved for summary judgment, or in the alternative, summary adjudication.

The member defendants argued that, even if the notice for the February 2021 meeting was defective, it was undisputed that the notice for the February 2022 meeting, at which the members ratified their earlier actions, was timely and sufficiently detailed.

The ratification thus cured any defects in the prior actions. Further, regarding the cause of action for money had and received, Camden Systems did not have standing to challenge actions taken before it became a member of the company in 2020, and, even if it had standing, the cash distributions were ratified during the procedurally proper 2022 meeting. Finally, the indemnification resolution was authorized under the operating agreement.

In opposition, Camden Systems argued the purported ratification in 2022 had no legal effect because limited liability companies do not have the power to ratify earlier actions.

Camden Systems further argued it had standing to pursue the money had and received cause of action even though it was not a member of the company when the distributions were authorized because at least one distribution payment was made after Camden Systems became a member of the company.

Finally, the indemnification resolution was ineffective because any action not within the ordinary course of the company’s business required unanimous consent of the members.

On July 26, 2022, following a hearing, the trial court granted the motion for summary judgment, and on September 13, 2022, the court entered judgment in favor of the member defendants. Camden Systems timely appealed.

The Act provides that the activities and conduct of a limited liability company are generally governed by its operating agreement.

With certain enumerated exceptions, the operating agreement may establish rules that differ from the statutory default rules.

To the extent an operating agreement “does not otherwise provide for a matter,” the matter is governed by the Act.

Declaratory relief is available to any person interested under a written instrument who desires a declaration of his or her rights or duties with respect to another, or in respect to, in, over or upon property in cases of actual controversy relating to the legal rights and duties of the respective parties. (Code Civ. Proc., § 1060.)

Declaratory relief pursuant to this section has frequently been used as a means of settling controversies between parties to a contract regarding the nature of their contractual rights and obligations.

Likewise, the correct interpretation of a statute is a particularly suitable subject for a judicial declaration.

Resort to declaratory relief therefore is appropriate to attain judicial clarification of the parties’ rights and obligations under the applicable law.

The member defendants do not dispute that the initial notice for the February 20, 2021 meeting, sent in January 2021, did not contain the general nature of the business to be discussed or the proposals to be approved—specifically, the reelection of Young as manager, withholding of first and second quarter distributions, payment of certain expenses, and payment of a management assistance fee to Kenneth Young.

It is also undisputed the second notice of the meeting, sent on February 11, 2021, was sent less than 10 days prior to the meeting. Accordingly, the actions approved at the meeting were invalid at the time.

Despite the invalidity of the February 2021 actions, Camden Systems was not entitled to a declaration the actions taken at the meeting were invalid because the actions were subsequently ratified.

Camden Systems did not dispute that the notice for the February 2022 meeting (at which the ratification votes were taken) was sent more than 10 days in advance of the meeting and contained sufficient information regarding the actions to be addressed.

Instead, Camden Systems contended the ratification was ineffective because the members did not have legal authority to ratify their earlier actions.

The concept of ratification is derived from the law of agency that has repeatedly been applied in the context of corporate governance.

In the context of acts by agents, ratification is the voluntary election by a person to adopt in some manner as his own an act which was purportedly done on his behalf by another person, the effect of which, as to some or all persons, is to treat the act as if originally authorized by him.

The effect of a ratification is that the authority which is given to the purported agent relates back to the time when he performed the act.

A ratification can be made only in the manner that would have been necessary to confer an original authority for the act ratified.

Applying this law, courts have found an action that was initially within the authority of a corporation’s board but was not properly authorized may be ratified through a resolution of its board of directors when duly assembled.

A resolution of the board of directors declaring a dividend, even though it is unlawful in its inception for lack of a duly held meeting, can be ratified by the board of directors.

Execution of a note secured by real property that was originally approved at a procedurally defective board meeting was ratified by subsequent resolutions adopted at procedurally proper board meetings.

A resolution acknowledging existence of loan at full board meeting ratified loan allegedly negotiated by corporation’s president without board’s authorization.

Ratification is generally not permitted when it will prejudice the rights of a third party. No unauthorized act can be made valid, retroactively, to the prejudice of third persons, without their consent.

Camden Systems did not contend on appeal that ratification was improper because Camden Systems suffered prejudice from the company’s ratification of the February 2021 actions.

Camden Systems conceded shareholders and boards of directors have rights of ratification, but it contended such rights do not extend to limited liability companies.

Camden Systems did not cite any authority for the proposition that general principles of ratification cannot be applied to limited liability companies in the same way those principles are applied to corporations, labor unions, and other organizations.

Instead, Camden Systems argued the Corporations Code expressly grants ratification powers to shareholders and boards, but grants no comparable power to members of a limited liability company.

However, a limited liability company generally shall have all the powers of a natural person in carrying out its business activities. It follows that a limited liability company would have the same authority as an individual to ratify a previous action.

In the absence of any authority prohibiting a limited liability company from ratifying an earlier action, there is no basis for a declaration that the actions taken as a result of the February 2021 meeting, which were later ratified by a majority of the members with proper notice, were invalid.

In fact, Camden Systems effectively received the remedy it initially sought—a procedurally proper vote on the actions taken.

A common count for money had and received is not a specific cause of action; rather, it is a simplified form of pleading normally used to aver the existence of various forms of monetary indebtedness.

A cause of action for money had and received is stated if it is alleged [that] the defendant ‘is indebted to the plaintiff in a certain sum for money had and received by the defendant for the use of the plaintiff.

The claim is viable wherever one person has received money which belongs to another, and which in equity and good conscience should be paid over to the latter.

The plaintiff must prove that the defendant received money intended to be used for the benefit of the plaintiff, that the money was not used for the plaintiff’s benefit, and that the defendant has not given the money to the plaintiff.

Camden Systems argued the member meetings between February 2017 and June 2020 were not properly noticed, and therefore, the votes taken at those meetings approving cash distributions to members were invalid, resulting in the members’ receipt of funds that rightfully belonged to the company.

That argument failed because Camden Systems did not have standing to challenge actions taken by the company prior to Camden Systems’s membership, and further, as discussed, the 2020 votes were ratified in February 2022.

A member of a limited liability company may bring a derivative lawsuit on the company’s behalf only if the plaintiff was a member, of record or beneficially, at the time of the transaction or any part of the transaction of which the plaintiff complains.

It is undisputed that Camden Systems was not a member of the company until
July 2020.

However, even if Camden Systems had standing to challenge the decision to make the $50,000 distribution, that distribution was explicitly ratified during the February 2022 meeting, and, as discussed, the ratification was procedurally proper and legally effective.

Camden Systems did not identify any other portion of the 2017 to 2019 distributions that was made after it became a member of the company.

Accordingly, it had no standing to bring a derivative claim challenging those distributions.

LESSONS:

1.         The California Revised Uniform Limited Liability Company Act (Corp. Code, § 17701.01 et seq.; the Act), which governs the management and operation of limited liability companies, provides that a limited liability company generally “shall have all the powers of a natural person in carrying out its business activities.” (§ 17701.05.)

2.         The Act provides that the activities and conduct of a limited liability company are generally governed by its operating agreement. With certain enumerated exceptions, the operating agreement may establish rules that differ from the statutory default rules. To the extent an operating agreement “does not otherwise provide for a matter,” the matter is governed by the Act.

3.         The concept of ratification is derived from the law of agency that has repeatedly been applied in the context of corporate governance. In the context of acts by agents, ratification is the voluntary election by a person to adopt in some manner as his own an act which was purportedly done on his behalf by another person, the effect of which, as to some or all persons, is to treat the act as if originally authorized by him.

4.         Ratification is generally not permitted when it will prejudice the rights of a third party.  No unauthorized act can be made valid, retroactively, to the prejudice of third persons, without their consent.

5.         However, a limited liability company generally shall have all the powers of a natural person in carrying out its business activities. It follows that a limited liability company would have the same authority as an individual to ratify a previous action.

6.         A member of a limited liability company may bring a derivative lawsuit on the company’s behalf only if the plaintiff was a member, of record or beneficially, at the time of the transaction or any part of the transaction of which the plaintiff complains.