Delaware: Fiduciary Duties Exist Even When LLC Manager Has No Discretion in Voting
A contract that limits a corporate director’s vote is generally invalid, but not so for LLC managers. The guiding principle for LLCs is freedom of contract, unlike corporations, but that principle can clash with the principles undergirding an LLC manager’s fiduciary duties. For example, what’s the result if an LLC’s operating agreement requires that one of the LLC’s managers vote as directed by a designated member? Does that manager have any fiduciary duties? The Delaware Court of Chancery recently held that such a manager was not without fiduciary duties, even though he had no power to vote. Ross Holding & Mgmt. Co. v. Advance Realty Group, LLC, No. C.A. 4113-VCN, 2013 WL 764688 (Del. Ch. Feb. 28, 2013).
The plaintiffs owned units in Advance Realty Group, LLC, a Delaware LLC. Several of the plaintiffs were individuals who were executives of the LLC until their termination in 2007, and the other plaintiffs were entities owned by the individual plaintiffs. The plaintiffs raised a number of claims after their termination, but the most noteworthy was their contention that defendant Ronald Rayevich, a manager of the LLC, had breached his fiduciary duties to the LLC.
Rayevich was a member of the LLC’s managing board, which had the duty to manage the business and affairs of the LLC. He had no discretion in how to vote as a member, however, because he was required by the LLC’s Operating Agreement to follow the voting instructions of one of the LLC’s members.
The defendants moved for partial summary judgment on several of the plaintiffs’ claims, including the claim against Rayevich.
The Claim. The plaintiffs’ claim against Rayevich centered on his involvement in the managing board’s approval in 2008 of the LLC’s Conversion and Exchange Agreement (Agreement), which the plaintiffs contended negatively affected their LLC interests. The plaintiffs argued that although Rayevich had no choice in voting for the Agreement, he nonetheless violated his fiduciary duties because he failed (1) to evaluate whether the terms of the Agreement were in the best interests of the members, (2) to voice his opposition in light of the conflicts of interests involving his fellow board members, or (3) to take any steps to prevent the self-dealing of the insider defendants. Id. at *3.
Rayevich contended that he was entitled to summary judgment because (a) the plaintiffs had not overcome the presumption that he acted in good faith, and (b) even if he did breach his fiduciary duties, he was not acting willfully or in bad faith and therefore was exculpated from liability under the provisions of the LLC agreement.
The court pointed out that Rayevich is presumed to have acted on an informed basis in good faith, but said that he could not avoid liability simply by pointing out that he had no discretion to vote as a board member. Even though he could not vote, he had an obligation to consider the interests of the members and to take action to protect their interests. “[F]iduciary duties extend beyond voting. They may involve, for example, studying the proposed action, determining the appropriateness of the proposed action, setting forth a dissenting view to fellow board members, and, in the proper circumstances, informing unit holders about the potential adverse affects of a proposed action.” Id.
Procedural Posture. The court’s opinion is a ruling on the defendants’ motion for summary judgment. To prevail on a summary judgment motion the moving party must demonstrate that there is no material question of fact, and that on the undisputed facts it is entitled to judgment as a matter of law. Id. at *1. The party resisting a summary judgment motion does so either by showing that the moving party is not entitled to judgment under the law, or that the relevant facts are disputed. The parties establish the facts through affidavits submitted to the court, and there is no live testimony. A summary judgment motion can be an efficient way to resolve issues before trial.
The plaintiffs’ claim against Rayevich failed because they did not establish the facts necessary to resist his summary judgment motion. “Specific facts, as contrasted with mere allegations, are needed to resist a motion for summary judgment.” Id. at *3. The plaintiffs did not put forth facts to show Rayevich’s lack of good faith, that he was not independent and disinterested, that he was not informed about or had not considered the Agreement, or that his conduct was willful or in bad faith. Rayevich was therefore presumed to have acted in good faith and was entitled to exculpation under the LLC’s Operating Agreement, and the court ordered summary judgment in his favor on the plaintiffs’ claims.
Comment. Ross Holding points out the need for LLC managers to be proactive, and that fiduciary duties extend beyond mere voting. In the context of a multi-manager board, a manager who either has no vote or who is outvoted must be informed and give independent consideration to the proposal, and must consider expressing a dissenting view when appropriate and possibly informing the members about the potential adverse impact of a proposed action.
South Carolina Supreme Court Rules That LLC Does Not Shield Its Member From Liability for His Tortious Conduct
A limited liability company will generally shield its members and managers from the LLC’s debts and obligations, but the shield is not absolute. LLC members or managers who carry out an LLC’s tort can in some cases be personally liable for the injured party’s damages. The South Carolina Supreme Court had to decide such a case earlier this year. 16 Jade St. LLC v. R. Design Constr. Co., LLC, No. 27107, 2012 WL 1111466 (S.C. Apr. 4, 2012).
(A tort is not a breach of contract – it is an actionable, civil wrong. Examples include fraud, breach of a fiduciary duty, and negligently causing an auto accident. A party injured by a tort may be able to recover damages from the wrongdoer if requirements such as causation and proof of damages are satisfied. Tort law has its origins in the English common law and is part of the common law of all U.S. states.)
Background. Carl Aten and his wife were the only members of R. Design Construction Co., LLC, a construction contractor. R. Design contracted with Jade Street for the construction of a four-unit condominium, and Aten served as R. Design’s general manager on the project. Jade Street had numerous complaints of defects in the construction, and ultimately R. Design walked off the job. Jade Street sued R. Design and Aten for negligence, breach of implied warranties, and breach of contract.
The trial court found that R. Design was liable for breach of contract, negligence, and breach of implied warranties. It also found that Aten was personally liable for his negligence. Id. at *2.
The Court’s Analysis. Aten argued on appeal that South Carolina’s Uniform Limited Liability Company Act (ULLCA) shielded him from personal liability for any negligence he committed while working for R. Design. The relevant ULLCA language states:
Except as otherwise provided in subsection (c), the debts, obligations, and liabilities of a limited liability company, whether arising in contract, tort, or otherwise, are solely the debts, obligations, and liabilities of the company. A member or manager is not personally liable for a debt, obligation, or liability of the company solely by reason of being or acting as a member or manager.
S.C. Code § 33-44-303(a). (Subsection (c) provides for member liability if the LLC’s articles of organization so provide and the member has consented in writing to that provision. It was not applicable to Aten.)
The court saw the question as one of statutory interpretation – did the legislature intend the LLC statute to shield members from personal liability for acts they commit in furtherance of the LLC’s business? 16 Jade St., at *2. The court noted that this was a question of first impression in South Carolina.
Looking first to other states, the court pointed out that a majority of the states that have examined similar statutory language “have concluded that a member is always liable for his own torts and cannot rely on his status as a member of an LLC as a shield.” Id at *3 (citing cases from half a dozen states). The court also cited a number of scholarly articles which opine that LLC statutes do not insulate a member from tort liability “primarily due to the common law concept that one is always liable for his torts.” Id. In the spirit of two-handed lawyers, the court also referred to a few courts that have concluded that their states’ LLC statutes do shield a member from personal liability for at least some types of torts.
Having surveyed the landscape, the court then dissected the language of Section 33-44-303(a). The first sentence says that the liabilities of the LLC, whether arising in contract or in tort, are solely the liabilities of the LLC. Since an LLC is a fictional entity and can act only through an agent such as a member or manager, that sentence seems to say that the member or manager who carries out the LLC’s tort does not thereby incur any personal liability. “[T]his language suggests R. Design alone is responsible for torts committed by Aten in the course of the company’s business.” Id. at *4. The court saw the second sentence as reinforcing the first, by stating that merely being or acting as a member or manager of an LLC will not cause the member or manager to be liable for the LLC’s obligations.
The court recognized, however, that interpreting the statute to shield LLC members or managers who commit torts in furtherance of the LLC’s activities would remove a long-standing common law remedy for injured parties. The court accordingly applied a higher standard of review. “Statutes will not be held in derogation of the common law unless the statute itself shows that such was the object and intention of the lawmaker, and the common law will not be changed by doubtful implication.” Id. at *5 (quoting 82 C.J.S. Statutes § 534 (2009)).
The court then referred to the majority view of the courts of other states, comments from the legislative history of Section 33-44-303, and comments from Section 304 of NCCUSL’s Revised Uniform Limited Liability Company Act (RULLCA). Id. These all follow the principle that shielding LLC members and managers from the LLC’s debts and obligations does not apply to claims seeking to hold members or managers liable for their own tortious conduct. These authorities treat members or managers, even when acting on behalf of the LLC, as also acting on their own behalf when committing a tort.
The court also reviewed the rule for corporations – i.e., that a shareholder is not liable for the debts or obligations of the corporation but is responsible for the consequences of its own conduct – and could find no evidence that the legislature intended to change that rule with respect to LLCs. Id.
Finding no clear legislative intent to restrict the common law, the South Carolina Supreme Court ruled in a three-to-two decision that Section 33-44-303(a) “does not insulate the [member] tortfeasor himself from personal liability for his actions.” The court accordingly affirmed the trial court’s finding that Aten was personally liable for torts he committed in furtherance of R. Design’s business. Id. at *6.
The brief dissenting opinion argued that the statute was clear and unambiguous and not amenable to an interpretation that a member tortfeasor of an LLC is personally liable for torts committed in the furtherance of an LLC’s business. Id. at *7. The dissent did not address the majority’s point that interpreting the statute to shield those who commit torts would derogate from the common law and therefore required a higher standard of review.
Comment. Both the majority and the dissenting opinions ignored the inherent ambiguities in Section 33-44-303(a). For one, the first sentence cannot mean what it seems to say. Ignoring the reference to subsection (c), it says: “the debts, obligations, and liabilities of a limited liability company, whether arising in contract, tort, or otherwise, are solely the debts, obligations, and liabilities of the company.” No exceptions are noted. Read literally, it precludes joint liability of an LLC. Consider the following hypothetical. An LLC borrows money from a bank, and the LLC’s sole member guarantees the LLC’s payment obligation to the bank. A literal reading of the first sentence would mean that only the LLC is liable to repay its debt and the member is shielded from the guarantee obligation it willingly agreed to.
For another, consider that even reading the first two sentences together would not change the result, if the member was acting as a member. The statute does not explicitly require that the member act on behalf of the LLC, only that the member be “acting as a member.” What does that mean? Members in a manager-managed LLC have the status of members and the right to vote for managers, but they don’t act on behalf of the LLC.
The majority opinion acknowledged that removing the LLC’s liability shield for members who commit torts on behalf of the LLC “appears to strip away one of the main reasons why a person chooses to form an LLC,” and the court expressed particular concern about single-member LLCs. Jade St., 2012 WL 1111466,at *5. But to have held the other way would have been to open the floodgates – wouldn’t we all want our own single-member LLC to shield us from what would otherwise be liability for our own torts?
South Carolina’s statute allows an LLC to be organized for any lawful purpose. S.C. Code § 33-44-112(a). You could form an LLC for the purpose of owning and driving your personal vehicle. Under the dissent’s view of Section 33-44-303(a), you would presumably be “acting as a member” and therefore would not be liable for any injuries caused by your negligent driving.
This is a far-fetched example, of course, but it shows the lack of clarity in the statute. Given that ambiguity, the majority opinion arrived at what appears to be the correct result, particularly in light of its agreement with the majority of other courts and commentators that have considered this issue for comparable statutes, and with the comments to NCCUSL’s RULLCA.
Texas Court Follows Form Over Substance In Sorting Out Different Fiduciary Duties in Multi-Level LLC and Partnership
The Texas Court of Appeals struggled to reconcile conflicting fiduciary duty rules between two related entities, an LLC and a limited partnership, in Strebel v. Wimberly, No. 01-10-00227-CV, 2012 WL 112253 (Tex. App. Jan. 12, 2012).
Douglas Strebel and John Wimberly started a tax advisory business and formed Black River Capital, LLC, a Delaware limited liability company, in 2003. The business prospered, and on December 8, 2005 they restructured the business and amended and restated the LLC agreement. Strebel and Wimberly were the LLC members, with profit sharing ratios of 60% and 40% respectively. They and their wives were the managers, and Strebel was the Managing Manager and CEO with broad decision-making and management powers. Strebel was required to consult with the other managers before making certain major decisions, and to obtain Wimberly’s consent before taking certain other specific actions, including changes to Wimberly’s profit sharing ratio.
At the same time, they formed a new Texas limited partnership, Black River Capital Partners, LP, and transferred all of the LLC’s business assets to the limited partnership (LP). The LLC was the LP’s general partner, with broad power and authority to control the LP, and had a 1% profit share. The limited partners were Strebel, Wimberly, Strebel’s wife, and Eric Manley. Later Steve Houle also became a limited partner.
The LLC and the LP had completely different fiduciary duty rules. The LLC’s operating agreement stated that “the Managers shall have fiduciary duties to the Company and the Members equivalent to the fiduciary duties of directors of Delaware corporations.” Id. at *3 (emphasis added) . In stark contrast, the LP’s partnership agreement stated that “the General Partner shall have no duties (including fiduciary duties) except as set forth in th[e] Agreement,” and there were no other relevant provisions. Id. (emphasis added).
Problems between Strebel and Wimberly began to develop later. Strebel was in the driver’s seat as Managing Manager of the LLC, which in turn was the general partner of the LP. He also held a majority of the limited partners’ voting rights in the LP. Using his authority, Strebel retroactively reduced Wimberly’s profit share in the LP, and caused the LP in 2007 to award a $3 million bonus to himself and another $1 million in bonuses to limited partners Houle and Manley. Wimberly received no bonus. Id. at *5. Unhappy with these developments, Wimberly sued Strebel in 2007, alleging breach of fiduciary duty, unjust enrichment, oppression of a minority member, defamation, and breach of contract.
A jury trial returned a verdict in Wimberly’s favor. The jury found that Strebel had breached his fiduciary duties and awarded Wimberly damages of $2.9 million. Id. at *6. The trial court had instructed the jury that Strebel owed Wimberly fiduciary duties in his management of the business of the “Black River Entities,” because of their relationship at the LLC level (Strebel as Managing Manager and Wimberly as member) and at the LP level (both were limited partners). Id.
The Court of Appeals analyzed the fiduciary duties separately at the LLC level and at the LP level. Id. at *8. The court began with the LLC. Strebel had contended that the words in the LLC agreement “the Managers shall have fiduciary duties to the Company and the Members” meant that fiduciary duties were owed to the Members collectively, and that therefore no fiduciary duties were owed to any Member individually. Id. After a surprisingly lengthy discussion, the court disposed of that argument and pointed out that such an interpretation would in effect delete the words “and the Members” from the LLC agreement. The court agreed with the trial court that the LLC agreement imposed on Strebel, as the Managing Manager, fiduciary duties of due care, good faith, and loyalty to Wimberly as an individual member of the LLC. Id. at *9.
The limited partnership agreement, on the other hand, was clear that the LP’s general partner (the LLC) owed no fiduciary duties to the LP or its limited partners. The trial court had found, however, that Strebel owed Wimberly a fiduciary duty because they were both limited partners. The LP agreement was silent on whether there were any fiduciary duties between the limited partners. After a lengthy discussion of prior cases and a Baylor Law Review article, the court concluded: “We reconcile these cases by holding that status as a limited partner alone does not give rise to a fiduciary duty to other limited partners.” Id. at *13.
The court’s determination that there were no fiduciary duties owed by the LP’s general partner or any limited partner effectively destroyed Wimberly’s cause of action, because the court focused only on the harm to Wimberly directly resulting from the actions of the LLC as it controlled the LP, and ignored the obligations of the LLC’s manager to its members as he directed the LP’s activities:
[W]e conclude Wimberly’s claims relate to actions taken by Strebel as the controlling manager of the general partner (i.e., Black River, LLC) against Wimberly as a limited partner in Black River LP while operating under the LP agreement. The contractual disclaimer of fiduciary duties in the Black River LP Agreement thus forecloses Wimberly’s recovery on his breach of fiduciary duty claim.
Id. at *15. The court reversed the trial court’s finding on the breach of fiduciary duty claim, and remanded for further proceedings on Wimberly’s oppression of a minority member claim. Id. at *18.
Unfortunately, the court’s analysis exalted form over substance. The LLC’s only business was to control the LP – all of the LLC’s assets had been assigned to the LP. The LLC’s Managing Manager Strebel owed the LLC’s members the duties of good faith and loyalty. How could the LLC’s manager satisfy the duty of loyalty he owed to the members other than ensuring, as the LLC directed the LP, that the LP’s limited partners who were also LLC members were treated fairly and in good faith?
The court in its analysis relied on the chestnut that applying the LLC’s fiduciary duties to the actions taken by its manager in directing the LP “would render meaningless the express disclaimer of fiduciary duties in the limited partnership agreement under which that the parties were operating.” Id. at *17. But that’s not correct, because three of the limited partners (Manley, Houle, and Strebel’s wife) were not members of the LLC, and for them the disclaimer was highly meaningful.
This case shows the analytical difficulties that can arise in sorting out the obligations of managers in multi-entity, multi-level structures. It’s also a lesson for the lawyer advising clients about such structures to be wary of inconsistent standards and obligations.
