Attorney Expelled from Mississippi Law Firm Is Not Entitled to Share in Proceeds of Large Contingent Fee - a Deal's a Deal
Freedom of contract is a basic principle of Mississippi’s LLC Act, but freedom of contract includes the freedom to make a bad contract. Case in point: the Mississippi Court of Appeals recently held that the plain language of a law firm’s LLC operating agreement allowed the members to expel attorney David Martindale and pay him only $1,100 for each of his 18 percentage points of his membership interest. That ruling enforced what was a bad bargain from Martindale’s point of view, because it allowed him no share in the firm’s $7,664,000 fee from a long-running contingent fee case that settled seven months after his expulsion. Martindale v. Hortman Harlow Bassi Robinson & McDaniel PLLC, No. 2010-CA-02077-COA, 2012 WL 4497756 (Miss. Ct. App. Oct. 2, 2012).
Background. Martindale practiced law with Hortman Harlow Bassi Robinson & McDaniel PLLC (the Firm) for 14 years. The Firm is a Mississippi professional limited liability company, or PLLC, which is an LLC formed for providing professional services under Article 9 of the Mississippi LLC Act. In 2006 the Firm took on the representation of an injured oil-field worker in a personal injury, contingent fee lawsuit, and devoted nearly all of its resources to the case. Martindale was not involved in the lawsuit, and questioned and criticized the Firm’s expenditures on the case.
The other members of the Firm, relying on the Firm’s operating agreement, expelled Martindale in February 2009 and tendered him a $19,800 check for his membership interest. The operating agreement allowed the members to expel a member by unanimous vote, in which case the Firm was required either to dissolve or to pay the former member $1,100 for each percentage point of his membership interest. The members opted to pay Martindale rather than dissolve.
Martindale refused the Firm’s check, and in May 2009 the Firm filed a lawsuit for declaratory relief, asking for a declaration that it had fulfilled its contractual obligations to Martindale. Four months later the contingent fee case was resolved, and the Firm received its fee of $7,655,000.
The Firm moved for summary judgment, contending that the operating agreement provided Martindale’s exclusive remedy for payment after his expulsion. The trial court found the language of the agreement to be clear and unambiguous, and granted summary judgment to the Firm.
Court of Appeals. The Court of Appeals began by reviewing the relevant provisions of the Firm’s operating agreement.
Section 9.5 of Hortman Harlow’s operating agreement states: “Upon the termination of a Member’s Membership Interest under Section 9.1(b) . . . , the other Members may elect either (1) to pay an amount equal to the terminated Members [sic] points as calculated pursuant to Section 9.2(a) less any debt to the company; or (2) to dissolve the Company . . . .” Section 9.2(a) provides the payment formula for a terminated member’s interest in the law firm: “The terminating Member shall receive an amount equal to One Thousand One Hundred and No/100 Dollars ($1,100.00), multiplied by each percentage point of Membership Interest owned by the terminating Member as set forth on Schedule “B” in lieu of his positive capital account balance . . . .”
Martindale, 2012 WL 4497756, at *2. After briefly paraphrasing the statutory language, the court found that “the only reasonable interpretation of sections 9.2(a) and 9.5 is that the parties intended for these sections to provide a member’s exclusive right to compensation upon his or her expulsion.” Id. at *3. The court therefore found the contract to be unambiguous.
Martindale argued that Section 13.10 of the operating agreement preserved his right to equitable relief, by stating that “rights and remedies [under this agreement] are given in addition to any other rights the parties may have by law, statute, ordinance or otherwise,” and that he had several grounds for equitable relief. Id. at *4.
Equity. Martindale pointed to Section 79-29-306(3)(a) of the prior LLC Act (which applied at the time of his termination): “A court of equity may enforce a limited liability company agreement by injunction or by such other relief that the court in its discretion determines to be fair and appropriate in the circumstances.” He contended that that section and two prior Mississippi cases entitled him to a more favorable equitable remedy. The court dismissed that argument, pointing out that § 79-29-306(3)(a) and the prior cases only apply if there is a breach of the operating agreement. Id.
Intrinsic Fairness. Martindale also claimed that under the Mississippi doctrine of “intrinsic fairness,” the Firm should have treated him in an “intrinsically fair” manner. This rule requires that actions of a majority stockholder toward a minority shareholder in a closely held corporation must be “intrinsically fair” when the majority stockholder stands to benefit, and the rule applies to LLCs. Id. at *5. The court, however, found “no indication they breached this duty in administering his proper payout under the contract.” Id. Martindale got the benefit of his bargain: “While Martindale’s payout is meager in light of the large settlement after his expulsion, we find Martindale received what he initially bargained for under the firm’s operating agreement.” Id.
Implied Duty of Good Faith and Fair Dealing. The court likewise dispatched Martindale’s argument that the Firm’s failure to pay him the fair value of his interest breached the Firm’s implied duty of good faith and fair dealing under the operating agreement. The court found that a party does not breach the implied covenant of good faith and fair dealing when it takes only those actions authorized by the contract. “Because Hortman Harlow could not have acted in bad faith by exercising a contractual right, we find the firm did not breach its implied duty of good faith and fair dealing under the operating agreement.” Id. at *6.
Having rejected all of Martindale’s arguments for equitable, fair, or good-faith treatment, the court affirmed the trial court’s ruling, enforcing what the Court of Appeals found to be the plain and unambiguous language of the operating agreement.
The Dissent. Three of the nine judges of the Court of Appeals dissented from the majority’s opinion. A dissenting opinion in a court of last resort, as U.S. Supreme Court Chief Justice Charles Evans Hughes wrote, “appeal[s] to the brooding spirit of the law, to the intelligence of a future day, when a later decision may possibly correct the error into which the dissenting judge believes the court to have been betrayed.” Alex Kozinski & James Burnham, I Say Dissental, You Say Concurral, 121 Yale L.J.Online 601, 602 (2012). In the Martindale case, the Court of Appeals is not a court of last resort. If David Martindale appeals to the Mississippi Supreme Court, the dissenting opinion should, like a searchlight, illuminate a more complete view of the Firm’s operating agreement than is apparent from the majority’s opinion.
The dissenting opinion includes a more extensive quotation of the relevant provisions from the Firm’s operating agreement, which is helpful. The analysis of the dissent begins with this: When a member is expelled by a unanimous vote of the other members and the members elect to pay the expelled member for his interest rather than dissolve the LLC, then under Section 9.5 they must pay the expelled member “an amount equal to the terminated Member[’]s points as calculated pursuant to Section 9.2(a) less any debt to [the] Company.” Id. at *8 (emphasis added).
An examination of Section 9.2(a) shows that it does more than provide a means to calculate how much must be paid to the departing member; it also characterizes the payment as being “in lieu of his positive capital account balance.” It is this phrase that the majority relied on. But Section 9.2(a) is part of a paragraph dealing with payments on the death or retirement of a member:
Section 9.2 Payments to Terminated Members. Upon termination of a Member’s interest because of death or retirement, the Member shall be entitled to receive from the Company the amounts set forth below:
(a) The terminating Member shall receive an amount equal to One Thousand One Hundred and No/100 Dollars ($1,100.00) multiplied by each percentage point of Membership Interest owned by the terminating Member as set forth on Schedule “B” in lieu of his positive capital account balance.
Id. at *7. Section 9.5 only refers to the calculation method of Section 9.2(a), and if the words “in lieu of his positive capital account balance” were deleted, the calculation would be the same.
The dissent also makes the point that under Section 9.4 of the operating agreement, a disabled member’s interest is terminated “and such Member shall be entitled to receive the payments as provided under Section 9.2 of this Agreement.” Id. at *9. The dissent points out that the difference between “as calculated pursuant to Section 9.2(a)” and “as provided under Section 9.2” is meaningful and at the least creates an ambiguity.
The dissent appears to have the better view of the operating agreement’s payment provisions for an expelled member.
Implied Duty of Good Faith and Fair Dealing Does Not Impose a Confidentiality Obligation on Delaware LLC Members
Many limited liability company agreements do not include confidentiality provisions. That may be because the company expects to have agreements with its employees and consultants that include confidentiality obligations. Or it may be that the parties and their lawyers simply don’t address it in the formation of the LLC. In any event, members who invest in an LLC but don’t work for it are in many cases bound only by an LLC agreement with no confidentiality restrictions.
LLC managers are sometimes surprised to discover that their LLC agreement does not obligate the company’s members to hold the LLC’s information in confidence. This may become an issue when there is a dispute with a member and the member requests information from the company. Many state LLC statutes give members the right to obtain certain records and information from the LLC, and the state acts don’t usually require that the member keep the information confidential. E.g., Del. Code Ann. tit. 6, § 305; Wash. Rev. Code § 25.15.135.
A canny LLC manager might logically ask, “Isn’t there any sort ofimplied obligation that the member keep company information confidential?” Many states imply a duty of good faith and fair dealing in contracts, either by statute or as part of the state’s common law. E.g., Del. Code Ann. tit. 6, § 18-1101(e) ( limited liability company agreement may not limit or eliminate liability for any act or omission that constitutes a bad faith violation of the implied contractual covenant of good faith and fair dealing); Badgett v. Sec. State Bank, 116 Wn.2d 563, 569, 807 P.2d 356 (1991) (there is in every contract an implied duty of good faith and fair dealing).
Earlier this year the Delaware Court of Chancery dealt with a claim that the implied covenant of good faith and fair dealing imposed confidentiality obligations on an LLC member. Kuroda v. SPJS Holdings, L.L.C., No. 4030-CC, 2010 Del. Ch. LEXIS 57 (Del. Ch. Mar. 16, 2010). The case was complex. As the court said:
This is round two of a bout between sophisticated, experienced parties who have woven a complex web of overlapping contracts, agreements, and duties that the Court must now untangle and interpret in order to make sense of who among these sophisticated parties owes whom what. Plaintiff seeks money he alleges defendants owe to him pursuant to a limited liability company agreement.
The counterclaims include misappropriation of trade secrets, breach of fiduciary duty, breach of the implied covenant of good faith and fair dealing, and breach of contract.
Kuroda, 2010 Del. Ch. LEXIS 57, at *1, 2.
Kuroda provided consulting services to an investment firm LLC in which he was a non-managing member. He later left the company, started a competing investment firm, and allegedly used investor lists and market strategies from the first company in his own business. Francis Pileggi has provided a compete synopsis of the case here, and Larry Ribstein has commented on the court’s treatment of the fiduciary duty elements of the case here.
Kuroda was a party to a consulting agreement with the LLC containing confidentiality provisions. The defendants, however, did not base their trade secret misappropriation claim on the consulting agreement because it would have required arbitration in Japan. The defendants instead argued that the LLC agreement’s implied covenant of good faith and fair dealing imposed a confidentiality obligation on Kuroda.
The court described the implied covenant of good faith and fair dealing as inhering in every contract, and requiring a contract party to refrain from arbitrary or unreasonable conduct that would prevent the other party to the contract from receiving the “fruits of the bargain.” Kuroda, 2010 Del. Ch. LEXIS 57, at *39. The court noted that the implied covenant does not constitute a free-floating duty on contracting parties, but instead is used to ensure that the parties’ reasonable expectations are fulfilled. The implied covenant has a narrow purpose and is therefore only rarely invoked successfully. Kuroda, 2010 Del. Ch. LEXIS 57, at *39, 40.
The court refused to invoke the implied covenant of good faith and fair dealing to create a confidentiality obligation in the LLC agreement. Noting that the defendants used confidentiality provisions in other documents related to the LLC, but not in the LLC agreement itself, the court said “any use of the implied covenant to insert a contractual duty of confidentiality into the LLC Agreement would be an override of the express terms of that agreement.” Kuroda, 2010 Del. Ch. LEXIS 57, at *40, 41.
An LLC manager seeking to prevent a member from disclosing or using the LLC’s information might wonder whether state trade secret law would impose a duty of confidentiality on the member. In most states the Uniform Trade Secrets Act (USTA) will apply. (According to the National Conference of Commissioners on Uniform State Laws, 47 states have adopted the USTA.)
Business people often think that any private or semi-private information about an LLC, its members or its business is legally protected. The USTA does not reach that far, however. For there to be an actionable misappropriation under the USTA, the member must have acquired the information by improper means, or acquired the information under circumstances giving rise to a duty to maintain its secrecy or limit its use. Del. Code Ann. tit. 6, § 2001. A non-managing LLC member may have been legitimately exposed to the LLC’s information, or may have obtained the information from the LLC by making a request under the state statute, and without a contractual commitment there will not be a duty. The result is different if the member is a manager, because then the manager’s fiduciary obligations will create a duty to not disclose the LLC’s information.
Even if the member is a managing member, not all LLC information will be a protectable trade secret. To be a trade secret under the USTA, the information must derive independent economic value from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use. It must also be the subject of efforts that are reasonable under the circumstance to maintain its secrecy. Id.
So, trade secret law may not protect the LLC’s information unless the members have a contractual obligation not to disclose or use the information. And the Kuroda case underscores the need for express confidentiality provisions in the LLC agreement. Lawyers who assist clients in the formation of LLCs should consider adding confidentiality provisions to their LLC checklists and form agreements.