New York Addresses Fiduciary Duties of LLC Organizers
The New York Appellate Division recently applied the fiduciary rules for corporate organizers to the organizers of LLCs, and found the LLC organizers to be fiduciaries of the investors they solicited to become members. Roni LLC v. Arfa, No. 1758, 601224/07, 2010 N.Y. App. Div. LEXIS 4613 (June 3, 2010).
The defendants were the promoters and organizers of several New York LLCs. The organizers entered into real estate purchase agreements, and then assigned the agreements to the LLCs after their formation. The organizers, who were the initial members of the LLCs, solicited outside investors to purchase member interests in the LLCs. The investors’ funds were then used by the LLCs to purchase the real properties.
Subsequently the investors sued the organizers, claiming that the organizers concealed brokerage commissions they received from property sellers and mortgage brokers. The investors alleged that the undisclosed commissions inflated the purchase prices of the real estate by at least $6.5 million.
The investors asserted claims for waste, breach of fiduciary duty, actual fraud, constructive fraud and an accounting. The organizers moved to dismiss for failure to state a cause of action and for failure to plead actual fraud and breach of fiduciary duty with specificity. The trial court denied the motion and upheld all claims, other than the claim for waste. The organizers appealed the dismissal of the motion, contending that the investors had not alleged adequate facts to establish that the organizers were their fiduciaries.
The key to the court’s decision was its extension of the corporate rule to LLCs. The court noted that “[i]t is well settled that both before and after a corporation comes into existence, its promoter acts as the fiduciary of that corporation and its present and anticipated shareholders.” Id. at **5. From there it was a short jump to LLCs: “By extension, the organizer of a limited liability company is a fiduciary of the investors it solicits to become members.” Id. at **5-6. As fiduciaries, the organizers were obligated to fully disclose the organizers’ interests that might affect the LLC and its members, including the organizers’ profits from organizing the LLC. Id. at **6. The court held that the investors had therefore stated a cause of action by alleging that the defendant organizers had failed to disclose the commissions they received from sellers and mortgage brokers, which inflated the purchase prices of the LLCs’ real estate. Id.
The organizers also defended on grounds that the investors had failed to allege that the undisclosed commissions were material, that the investors justifiably relied on the organizers’ silence, and that the investors were damaged. The court made short work of those defenses. Damages had been alleged, said the court. And because the case was an appeal of the trial court’s denial of the plaintiffs’ motion to dismiss, the issues of materiality and reliance could not be resolved as a matter of law, but would have to be resolved at trial. Id. at **7-8.
The Roni court’s resolution of the fiduciary duties of LLC organizers is an example of legal reasoning by analogy. The court looked at the rule that applied to organizers of corporations, and apparently deciding that LLCs are similar enough to corporations, applied the corporate rule to LLCs.
As the law of LLCs develops, state courts are frequently called upon to decide novel LLC issues. In doing so the courts often look to the law applicable in the analogous corporate context. Examples that I have written on previously include New York (de facto corporations, here), Colorado (creditors’ claims against directors, here), Oregon (requirements for derivative suits, here), and Michigan (officer liability for corporate torts, here).
The Roni court did not explain the principles underlying the corporate rule that it relied upon, but simply applied it “[b]y extension.” Id. at **5-6. The court’s implicit recognition of a close analogy between corporations and LLCs was presumably based on the entity nature of each and the similar roles played by the organizers of each type of entity.
Sometimes an LLC's Signature on a Contract Can Result in a Member's Personal Liability
Most business people know that if they want to avoid personal liability when they sign a contract on behalf of an LLC, they should use the name of the LLC and their title. A typical example would be:
ACME LLC
______________________
By: John Smith, Member [For a member-managed LLC]
But what’s the result if language in the contract states that the signing member is personally liable? In Losh Family, LLC v. Kertzman, 155 Wn. App. 458, 228 P.3d 793 (April 12, 2010), the Washington Court of Appeals recently ruled that the language in the contract can overrule the form of signature.
William and Teresa Grover formed Grover International, LLC in 2005 and shortly thereafter acquired a business. In connection with the acquisition they received an assignment of the seller’s real estate lease. Their LLC signed the assignment using a conventional corporate style of signature, as “Grover International, LLC by William Grover member.” Losh Family, LLC, 155 Wn. App. at 461.
So far so good. But the lease assignment said that the lease was assigned to “William and Teresa Grover as individuals, dba Grover International, LLC” (“dba” of course being the customary abbreviation for “doing business as”). Id. The lease assignment in fact referred five different times to the assignee as “William and Teresa Grover as individuals, dba Grover International, LLC.” Id. at 463.
In 2006 the Grovers sold their business, and the new buyer later defaulted on the lease. The owner of the real estate sued the Grovers, the LLC, their seller and their buyer. The trial court ruled on summary judgment that all defendants were liable jointly and severally, including William and Teresa Grover individually.
The Court of Appeals expeditiously determined that the language in the assignment referred to the Grovers personally and that the LLC’s signature did not limit the assignment’s imposition of personal liability on the Grovers. The court referred to the “long established principle that where an agreement contains language binding the individual signer, ‘additional descriptive language added to the signature does not alter the signer’s personal obligation.’” Id. at 464 (quoting Wilson Court Ltd. v. Tony Maroni’s, Inc., 134 Wn.2d 692, 700, 952 P.2d 590 (1998)).
The Losh fact pattern is the sort that lawyers involved in mergers and acquisitions hate to see. Inconsistent agreements tend to be disputed and to yield unpredictable results. The Losh contract was seriously inconsistent, and under one interpretation the Grovers would be personally liable for a lease obligation under a document that they signed only in a representative capacity. And indeed, so ruled the court.
Mr. Grover likely took no consolation from the court’s admonition that if he “did not want to be personally bound on the assignment, he should have insisted on the elimination of the language within the agreement that designated the assignee as ‘William and Teresa Glover as individuals’” (which ignores the balance of the phrase, “dba Grover International, LLC”). Id.
It is puzzling that the Losh court did not analyze the conflicting language in the contract as an ambiguity that would allow the admission of extrinsic evidence. The court ignored the large body of law which recognizes that an ambiguous or contradictory contract may be clarified by the admission of extrinsic evidence to determine the parties’ intent. E.g., Berg v. Hudesman, 115 Wn.2d 657, 801 P.2d 222 (1990).
The court also ignored the fact that the contract’s identification of the parties was not a completely clear statement that personal liability was intended. The contract language did not refer simply to the Grovers individually, but also referred to the Grovers doing business as Grover International, LLC, which at the time was an existing LLC. The phrase “doing business as” is usually used only for situations where a corporation or LLC does business under an alternate name. In Losh, however, the dba referred to an existing and separate entity, not just an alternate name for the Grovers.
The court’s ruling illustrates how simple inconsistencies in a contract quicken the blood of gimlet-eyed litigators and lead to arguable judicial decisions.
