"Freedom of" or "Freedom from"? The Enforceability of Contracts and the Integrity of the LLC

Abstract

The sudden growth of limited liability company (LLC) legislation in the past ten years has been accompanied by a corresponding amount of scholarship dedicated to the logistics, concerns, and implications of the limited liability company. Most legal scholarship has examined the potential liability and the scope of the fiduciary duty of the members of an LLC. At issue in this Note is not the extent to which the members of an LLC owe duties to it or to each other but rather the extent to which the LLC is independent of its members. LLC legislation and case law expressly serve the principles of freedom of contract. Preserving the freedom of members to contract with one another as to the operation of the LLC, however, can occur at the expense of the LLC. The law recognizes the LLC as an entity that has protected rights, at least for some purposes. This Note examines whether this status implies that, when executing agreements, the members of an LLC do not bind the LLC itself. It argues that courts should consider the separate entity characteristics of an LLC when considering whether to enforce against it an agreement to which it is not a party. Part I introduces two recent holdings that advance opposite conclusions as to whether an LLC should be bound by an arbitration and choice-of-forum clause in its operating agreement when it was not itself a signatory to the agreement. It then examines what effect the policies favoring arbitration have on the enforceability of arbitration clauses and argues that, notwithstanding freedom-of-contract principles, an arbitration clause should not be enforced against a nonparty, even where that nonparty is an LLC. Part II suggests that comparing the LLC to the corporation might be more appropriate than comparing it to the partnership, and applies citizenship and internal-affairs-doctrine analyses to the LLC to demonstrate that the LLC can be considered a separate entity whose interests should be balanced against freedom-of-contract principles. Part III proposes that while providing for freedom of contract in LLC agreements might attract would-be members to form an LLC in a state that exalts such freedom in its LLC legislation, a state court system's refusal to respect the independence of an LLC might counter any such lure. The Note concludes that freedom of contract does not necessarily justify enforcing a contract against an LLC when it is not a party to the contract and that enforcement of such a contract could harm both the LLC and the state enforcing the contract.