LLCs allow investors to invest in businesses without fear of liability for harms caused by the LLCs’ activities, but there are exceptions. Case in point: the Montana Supreme Court recently had to decide whether to allow a claim that an LLC member should be liable for the LLC’s obligations on two vehicle service contracts. The Supreme Court held that the member was not liable, even though the member had benefited from the LLC’s contracts, had made some payments on the contracts on behalf of the LLC, and had brought suit in his own name to recover the vehicle being serviced. Weaver v. Tri-County Implement, Inc., 311 P.3d 808 (Mont. Oct. 22, 2013).
C.R. Weaver was one of two members of Mikart Transport, LLC, a Montana member-managed LLC. Mikart entered into agreements with Tri-County Implement, Inc. for service on a Freightliner truck and a Volvo semi-truck. Tri-County carried out the work but was not fully paid, so it asserted a lien and refused to release the Volvo.
Weaver sued Tri-County in his own name for fraud and for return of the Volvo. Tri-County counterclaimed against Weaver and asserted third-party complaints against Mikart and the other member, demanding payment for the work on the two vehicles. Tri-County moved for summary judgment on its claims and the trial court found in its favor on all counts. Judgment for the amount due to Tri-County and for an additional $21,180 in attorneys’ fees was entered against Mikart, the other member, and Weaver. Weaver appealed the trial court’s imposition of personal liability. Id. at 810.
All state LLC statutes provide that LLC members and managers are not liable for the debts and obligations of their LLC simply because they are members or managers, and that is where the Weaver court began. The court quoted Section 35-8-304(1) of the Montana LLC Act:
[A] person who is a member or manager, or both, of a limited liability company is not liable, solely by reason of being a member or manager, or both, under a judgment, decree or order of a court, or in any other manner, for a debt, obligation, or liability of the limited liability company, whether arising in contract, tort, or otherwise or for the acts or omissions of any other member, manager, agent, or employee of the limited liability company.
The court recognized that an LLC’s liability shield is a corollary of its status as a separate legal entity, distinct from its members and with obligations separate from those of its members. Weaver, 311 P.3d at 811. But the liability shield for members and managers is status-based, and certain acts or omissions of a member may go beyond the shield. “[T]his liability shield is not absolute and does not provide immunity to a member for his own wrongful conduct.” Id.
Applying those rules to Weaver’s appeal, the court found that Weaver’s liability would depend on whether he personally breached a contract obligation or committed a tort with regard to Tri-County. Id. at 812. The trial court had relied on the facts that (a) the Volvo that Mikart had hired Tri-County to service was owned by Weaver, (b) Weaver had personally made some payments to Tri-County but had failed to make others, and (c) Weaver personally brought the legal action against Tri-County to recover the Volvo. The Supreme Court, however, found those facts insufficient.
On the contract prong of the analysis, the agreements for the work performed on the two trucks were solely between Tri-County and Mikart. Weaver never guaranteed payment or made any other promises to Tri-County. Without an agreement between Weaver and Tri-County, Weaver could not be liable for breach of contract. Against that bedrock principle, it was immaterial that Weaver owned the Volvo, sued Tri-County personally, or made some partial payments on the amount Mikart owed to Tri-County. To conflate Mikart’s failure to pay its debts with Weaver’s failure to pay Mikart’s debts “would eviscerate the protection afforded by Montana’s Limited Liability Company Act and render the LLC business form superfluous.” Id.
On the tort analysis, the court found that the allegation that Mikart may be unable to pay its debts did not, by itself, establish wrongful conduct that would impose liability on Weaver. There was no fraud or other tortious conduct. (A tort is an actionable, civil wrong, such as fraud, breach of a fiduciary duty, or negligently causing an auto accident.)
The court concluded that there was no basis for holding Weaver liable for Mikart’s obligations to Tri-County, and reversed the judgment against Weaver. Id.
Comment. If hard cases sometimes result in bad law, then Weaver must be the inverse, an example of an easy case making good law. It’s satisfying to see a court march through a weak argument and systematically deconstruct it to reach the right result.
Tri-County’s argument in its brief to the Supreme Court focused mainly on Weaver’s close connection to Mikart, and on the litany of facts: Weaver paid part of what Mikart owed to Tri-County, Weaver owned the Volvo that Mikart contracted with Tri-County to repair, and Weaver personally filed the lawsuit to recover the Volvo. Appellees’ Brief at 10-13. But no legal argument was asserted to show how the facts led to a cause of action: not a promise by Weaver, not wrongdoing on Weaver’s part, not unjust enrichment to Weaver, not piercing the veil.
Although the opinion does not discuss it, one other well-recognized route by which claimants against an LLC can sometimes also pursue their claim against an LLC’s members or managers is by piercing the veil of the LLC. I have written about LLC veil-piercing cases several times; a collection of those posts is available here. (The Montana courts apparently have not ruled definitively on the applicability of veil-piercing to LLCs. See White v. Longley, 244 P.3d 753, 280 n.2 (Mont. 2010).)
A Georgia LLC sold its business and agreed in the sale contract not to compete with the buyer for three years. During the noncompetition period the members of the selling LLC, but not the LLC itself, started a competitive business. The buyer sued, the trial court found the members liable for breach of the noncompetition covenant, and the members appealed. The Georgia Court of Appeals reversed, finding that the members were not liable on the noncompetition covenant. Primary Invs., LLC v. Wee Tender Care III, LLC, No. A13A0412, 2013 WL 3665318 (Ga. Ct. App. July 16, 2013).
The case turned on the noncompete clause of the sale agreement: “Until three years after the Closing Date (the ‘Noncompetition Period’), Seller [the selling LLC] agrees that neither Seller nor its agents will, unless acting in accordance with Buyer’s prior written consent … open any child care facility within a ten-mile radius of any Business Locations being sold to the Buyer hereunder.” Id. at *1 (emphasis in original). The selling LLC’s members opened a new childcare facility within 10 miles of one of the sold facilities, and the buyer objected.
The court’s analysis addressed three questions. First, did the seller itself violate the noncompete? The court said no – there was no contention that the selling LLC was involved in opening the new facility, nor that the members were acting as agents on behalf of the selling LLC. The Buyer therefore failed to show any violation of the noncompete clause by the seller. Id. at *2.
Second, were the LLC members parties to the sale agreement? The members were not mentioned by name in the sale agreement, and the member who signed the agreement did so only in a representative capacity, on behalf of the LLC. So the members were not parties to the sale agreement, and “‘[i]t is axiomatic that a person who is not a party to a contract is not bound by its terms.’” Id. at *2 (quoting Kaesemeyer v. Angiogenix, Inc., 278 Ga. App. 434, 437, 629 S.E.2d 22 (2006)).
The third and more subtle question was whether the purchase agreement’s use of the words “its agents,” in the phrase “neither Seller nor its agents,” referred to the members. The plaintiffs pointed out that the Georgia LLC Act makes every LLC manager an agent of the LLC. Ga. Code Ann. § 14-11-301. They argued that because the seller’s members were all managers, they were agents of seller and therefore included individually in the phrase “neither Seller nor its agents,” and that as a result the members were bound individually to the terms of the noncompete clause. Primary Invs., 2013 WL 3665318, at *3.
The court conceded that because the members were managers they were indeed agents of the LLC, but dismissed the plaintiffs’ argument for two reasons. One, the court said that nothing in Georgia’s LLC Act allows a principal (the LLC) to bind its agents (the members) for the LLC’s contractual obligations. Two, under the LLC Act, members and managers of an LLC are not liable, solely by virtue of being a member or manager, for the LLC’s debts, obligations or liabilities. Ga. Code Ann. § 14-11-303. The court referred to earlier Georgia cases holding that an LLC member is separate from the LLC and is not a proper party to a proceeding against the LLC solely by reason of being a member of the LLC. Primary Invs., 2013 WL 3665318, at *3.
The court’s final conclusion was that the phrase “neither Seller nor its agents” in the LLC’s sale agreement did not bind the LLC’s members or managers individually, and it reversed the trial court’s judgment against the members on the liability issue.
Comment. The result in this case appears correct, but the court’s opinion doesn’t fully explain the language that the parties were battling over. Look at it again: “neither Seller nor its agents” will compete. The opinion doesn’t address what was intended by “nor its agents.”
If the reference to the LLC’s agents meant agents acting on behalf of the LLC, it was superfluous. In that case the usual rules of agency law would make the LLC but not the agents liable, which would be the same result as if the reference to agents were deleted.
If we assume that the agreement’s reference to agents had a purpose, it must have been that the LLC was agreeing that it would be liable if it competed, or if any of its agents competed even if they did not do so in a representative capacity. In other words, the agreement could just as well have said “neither Seller nor any Member of Seller” will compete.
That interpretation would not create personal liability for the members who competed in the forbidden zone. As the court pointed out, they were not parties to the agreement. But under that interpretation, their competition would constitute a breach by the LLC of its noncompete agreement.
In the event of proscribed competition by a member, the buyer would be able to raise its claim against the LLC, which should be able to respond out of the sale proceeds. Even if the proceeds had been distributed, claims could be asserted against the members who had received distributions, under the Georgia LLC Act. Ga. Code Ann. § 605.
Caution: LLC Members and Managers Should Be Careful When Executing Documents In A Representative Capacity
Note: The following is posted by guest blogger Janet Jacobs.
Like most other entities, LLCs can act only through their representatives, and LLC members are often called on to act and execute documents on behalf of the LLC. Generally, LLC members and managers are not held personally liable for the debts and liabilities of the LLC, provided the acting member or manager indicates that he or she is signing on behalf of the LLC. Usually, the simplest way to demonstrate that the signatory is not accountable personally is to add his or her title to the signature line on the document. Example: Mary Smith, Managing Member of XYC, LLC. However, as pointed out in a recent Maryland case, adding a title to a signature block will not remove personal liability if the text of the document clearly indicates an intention to hold the signatory personally liable.
In Ubom v. Suntrust Bank, No. 2862 (Md. Ct. Spec. App. Apr. 4, 2011), Mr. Ubom applied for a line of credit in the name of his law firm, Ubom Law Group (“ULG”). Mr. Ubom was the sole member and the managing attorney of ULG. The credit agreement form requested information about the applicant (ULG) and the guarantor. Mr. Udom duly completed the applicant LLC’s information. On the page of guarantor information, he provided his driver’s license and social security numbers, date of birth, address, personal financial information and employment information. The only detail that Mr. Udom did NOT provide on the guarantor information page was his legal name. On the signature page of the credit agreement, Mr. Ubom signed twice: once on the applicant line and once on the guarantor line. Both signature lines allowed the signatory to add a title – Mr. Udom added the words “Managing Partner” after each of his signatures.
The credit agreement contained the following language: “To induce Bank to open the Account and extend credit to the applicant, or to renew or extend such other credit, each of the individuals signing this Application as a ‘Guarantor’ … hereby jointly and severally guarantee payment to the Bank of all obligations and liabilities of the applicant of any nature whatsoever….” Mr. Udom asserted that he had questioned the bank’s representative specifically about his personal liability based on this language, and that person had assured him that so long as Mr. Udom (a) left the “Legal Name of Guarantor” blank and (b) inserted his title on the signature lines, he would not be personally obligated to repay UGL’s debt to the bank.
Three years later, the loan was in default and Suntrust filed a complaint against ULG as the primary obligor and Mr. Udom as guarantor. Mr. Udom did not deny that ULG was liable, but he did contest the allegation that he was personally liable as guarantor, on the grounds that he signed only in a representative capacity, as should have been evident from the addition of the words “Managing Partner.”
Not so, said the lower court. Citing the fact that Mr. Udom was “a sophisticated gentlemen … an attorney,” it granted summary judgment in favor of the bank. While it is beyond the scope of this blog to delve into whether attorneys are automatically mavens in all aspects of business dealings, the lyrics of a song written by the immortal George Gershwin come to mind: “It ain’t necessarily so.”
The court of appeals agreed with the lower court. It turned down Mr. Udom’s request to introduce testimony concerning the bank’s assurances regarding his personal liability, on the grounds that Maryland followed the principle of “objective interpretation” of a contract. In other words, a court should look only at the contract, except in cases of ambiguity, fraud, duress or mistake. In the court’s eyes, the language of the contract was unambiguous. (The court did not discuss whether there was any fraud, duress or mistake involved in the execution of the contract.)
The Udom court explained away Mr. Ubom’s careful addition of the words “Managing Partner” as being only a "descriptive phrase". It pointed out quite correctly that there would be no value in having the primary obligor (the LLC) also act as guarantor of the same obligation, a common sense approach that would be quite persuasive were it not for a conflicting ruling made by the same court in an earlier but strikingly similar case.
In L & H Enterprises Inc. v. Allied Building Products Corp., 88 MdApp. 644 (1991), the credit agreement signed by two officers of the debtor entity provided as follows: “In consideration of [the creditor’s] extending credit I/we jointly and severally do guarantee unconditionally at all times … the payment of indebtedness … of the [debtor]….” The signing officers had provided some personal information but wrote “N/A” in the section calling for information about their respective spouses. The court found the insertion of “N/A” to be compelling evidence of the officers' intention not to be held personally liable, because the spouse’s signature would be a prerequisite for the creditor to reach marital assets. (It would have been helpful if the opinion had confirmed that the officers were, in fact, married, and that the inclusion of “N/A” didn’t simply mean that the officers were single.) The court also found it very significant that there was only one signature line for the applicant; there was no place where a guarantor could sign. As the officers clearly signed the agreement on behalf of the applicant entity, despite the clarity of the italicized language, sufficient ambiguity was created by these other factors to relieve the officers of personal liability.
The opinion issued by the Udom court contains one snippet of information that lends some credence to Mr. Udom’s allegation that he had been told he would nto be held personally liable for ULG's debt: Suntrust Bank held the mortgage on Mr. Udom’s house. Even if one discounts Mr. Udom’s assertion that the bank manager talked him into taking out a business loan, there was a pre-existing relationship between the parties that could have led Mr. Udom to rely on the word of a trusted bank manager rather than the language of the contract.
The Udom case provides some useful takeaways:
- First, for LLC members and managers who execute documents in the name of the LLC and who wish to avoid being held personally liable for the LLC's debts:
- Trust but verify: if the language of the agreement does not align with oral statements made by the other contracting party, consult an attorney before you sign.
- Remember, there is a reason documents require more than one signature. Each signature line generally supports different promises, obligations, covenants, representations or acknowledgments. Be sure you understand what each signature line is supporting. If one signature line is for the entity, the presence of a second signature line should be a red flag.
- Don’t rely on the insertion of a title to protect you from personal liability. If the text of the document indicates an intent to bind anyone other than the LLC, you can expect that if your LLC defaults, the other party to the agreement may try and enforce personal liability. Signing while crossing your fingers and hoping for the best will not change the objective interpretation of the promises, obligations, covenants, representations or acknoweldgements in the text of the document.
- Second, for attorneys reading this blog: irrespective of your practice area, you are assumed to be a sophisticated business person. At a minimum, you will be expected to have read and understood any document you signed. You will not get the benefit of the customary judicial flexibility extended to ordinary consumers in their dealings with banks and other institutions.
The Washington legislature is currently considering a bill that would apparently require any contract that calls for the payment of money by an LLC or corporation, to include an extra signature by an authorized representative that would render the representative personally liable for any amounts due on the contract. HB 1535. In other words, under this bill any LLC or corporation making a contractual commitment that involves the payment of money would have to include a personal guarantee from a natural person.
This would be an extraordinary change to Washington law. No other state has anything comparable in its laws.
The Background. The bill would upend the familiar principle of the law that “when an agent makes a contract on behalf of a disclosed or partially disclosed principal whom he has power to bind, he does not thereby become liable for his principal’s nonperformance.” Griffiths & Sprague Stevedoring Co. v. Bayly, Martin & Fay, Inc., 71 Wn.2d 679 , 686, 430 P.2d 600 (1967). See Restatement (Second) of Agency § 320 (1958).
When an LLC manager (or a corporate officer) signs a contract on behalf of a company, the manager usually signs only as an agent of the company. The fact that the manager is signing as an agent is reflected in the typical signature block:
By: Wile E. Coyote
Vice President of Product Development
Under these well-accepted rules, LLC managers and corporate officers can sign contracts on behalf of their company without fear of becoming personally liable. If the rule were otherwise it would be exceedingly difficult to find a manager willing to sign for an LLC or corporation.
The Bill. The heart of the bill is a requirement that any “business payment contract” must contain an additional signature line, directly following and on the same page as any other signature line that the authorized business representative must sign. The additional signature line must be immediately preceded by the following legend in bold, 14-point or larger typeface:
By signing this contract you, the undersigned, agree to become PERSONALLY LIABLE for any sums due pursuant to this document, regardless of whether you are signing on behalf of a limited liability company, corporation, or nonprofit corporation.
This bill, if passed, will clearly make it difficult for LLCs to find managers willing to sign contracts for their LLC.
Drafting and Interpreting Statutes. The language of HB 1535 has some internal conflicts. I have described above the interpretation that I and other business lawyers that I have talked to have given to the bill. It is possible, however, that it was intended to simply require a warning legend on guarantee contracts, although that is a more difficult interpretation. In any event it needs to be clarified.
It is not an easy thing, to draft statutes so that they are clear, unambiguous and sufficiently detailed. This has repeatedly been driven home to me in my participation on a Bar committee that has reviewed proposed legislation.
HB 1535 is scheduled for public hearing in the Washington legislature’s House Committee on Business & Financial Services at 1:30 p.m. Tuesday, February 1, 2011, in Olympia, Washington. At the hearing I expect we will learn what is behind this bill and what the intent of its sponsors is. More information is available about the bill’s scheduled hearings here.