The Mississippi Supreme Court recently invalidated a deed by a minority LLC owner to a new LLC and the subsequent deed of trust on the property. Even though the bank dealing with the new LLC did not know that the prior deed was invalid, the bank lost its security interest in the property.
The Takeaway
This could have far-reaching implications for Mississippi real estate attorneys, lenders, and title companies. Since limited liability company operating agreements (or other business entity documents for that matter) are not public record, any business in the chain of title could potentially invalidate a lender’s security interest in a mortgage. We can expect banks and other lenders to take a closer look at transfers in the chain of title from business entities.
The Facts
Michael was a minority owner of Kinwood LLC. He formed another LLC (Northlake LLC) of which he was the sole owner. He then deeded Kinwood LLC real estate to Northlake LLC and used the real estate to secure a loan. Northlake LLC defaulted on the loan and declared bankruptcy.
It turns out that the operating agreement of Kinwood LLC did not permit Michael to transfer the real estate from Kinwood LLC in the first place. As a minority owner, Michael didn’t have the votes required to execute a deed without the consent of the other members.
When the other members of Kinwood LLC learned what had happened, they had the bankruptcy judge declare both the deed to Northlake LLC and the deed of trust void.
The bank appealed the bankruptcy judge’s order to the district court, which affirmed, and then to the Fifth Circuit. The bank argued that the deed of trust was not void, but voidable. Because the bank had accepted the deed of trust from Northlake LLC in good faith (without knowledge that the transfer from Kinwood LLC was not authorized), the deed of trust should be enforceable.
The Fifth Circuit found that the case involved a matter of Mississippi law for which there is no controlling precedent. It certified the following question to the Mississippi Supreme Court:
When a minority member of a Mississippi limited liability company prepares and executes, on behalf of the LLC, a deed to substantially all of the LLC’s real estate, in favor of another LLC of which the same individual is the sole owner, without authority to do so under the first LLC’s operating agreement, is the transfer of real property pursuant to the deed: (i) voidable, such that it is subject to the intervening rights of a subsequent bona fide purchaser for value and without legal notice, or (ii) void ab initio, i.e., a legal nullity?
The Law
- A limited liability company operating agreement can limit the actual authority of a member to bind the company in certain transactions.
- Even if a member does not have actual authority, he may have apparent authority. Apparent authority can bind the LLC unless:
- The member does not have actual authority to act for the company; and
- The person with whom he is dealing has knowledge of the fact that the member has no such authority.
The Analysis
- Actual Authority – Do to the limitation in the operating agreement, Michael clearly did not have actual authority to transfer the real estate from Kinwood LLC to Northlake LLC.
- Apparent Authority – Focusing on the transfer from Kinwood LLC to Northlake LLC: Michael knew he didn’t have actual authority. That knowledge was imputed to Northlake LLC. Applying the above analysis for apparent authority:
- The member (Michael) did not have actual authority to act for the company (Kinwood LLC);
- The other party to the transaction (Northlake LLC) had knowledge that Michael didn’t have authority to transfer the property.
- Thus, Michael had no apparent authority to transfer the property from Kinwood LLC to Northlake LLC.
The Holding
Since Michael had neither actual nor apparent authority to transfer the property, his actions did not affect the title to the property.
MS appears very lax in its oversight of Registry Deeds, and LLC’s appear to operate as if there were no rules which apply to them because they are LLC’s.