Well-Drafted LLC Operating Agreement Allows Members to Be Terminated

Berndt v. Berndt, Wis: Court of Appeals, 4th Dist. 2013 - Google Scholar:

This is a decision of the Wisconsin Court of Appeals, affirming the grant of summary judgment to an LLC and two members who terminated the interests of two other members. Here, the operating agreement allowed members to be removed for wrongful conduct. The Court concluded that the Defendants appropriately (a) gave notice of the termination; and (b) offered to purchase the interests of the departing members.

The court rejected an argument that the actions taken by the Defendants were not in good faith. The covenant of good faith and fair dealing did not apply because the Defendants had proper grounds to terminate the plaintiffs' interests in the LLC.

This case illustrates the importance of carefully drafting an operating agreement for every limited liability company. The terms of the operating agreement allowed the Defendants to terminate the Plaintiffs for wrongful conduct and to purchase their interests in the company.

Edward X. Clinton, Jr.

www.clintonlaw.net

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District Court Compels Arbitration of Dispute Between Broker and Insurance Company

Chambers v. AVIVA LIFE & ANNUITY CO., Dist. Court, ND Illinois 2013 - Google Scholar:

This is a routine dispute between a broker and an insurance company. The broker was required to maintain errors and omissions insurance. He allegedly failed to do so and the insurance company brought a collection action against him for the cost of the errors and omissions insurance.

The broker then brought claims against the insurance company. However, all of his claims were dismissed because the parties had entered into an arbitration agreement, which is governed by the Federal Arbitration Act, 9 U.S.C. Section 4.

In recent years, the United States Supreme Court has decided several cases which have strengthened the Federal Arbitration Act.  These decisions serve to remove many typical civil litigation cases from the court.

Here, Judge Kendall granted the motion to dismiss and compelled arbitration pursuant to the parties' agreement.  Usually, the court stays the lawsuit while the arbitration is pending.  Here the court, based on cases decided in other circuits, elected to dismiss the entire case. This is an issue which may be litigated in the future.

The court writes:

"The FAA provides that once the Court determines that arbitration should be compelled, the Court "shall on application of one of the parties stay the trial of the action until such arbitration has been had in accordance with the terms of the agreement, providing the applicant for the stay is not in default in proceeding with such arbitration." 9 U.S.C. § 3. Pursuant to this provision, all of the defendants requested this Court to stay the case pending arbitration of Chambers's claims. However, the Court finds that dismissal of the case, and not a stay, is the proper remedy in this case."
Edward X. Clinton, Jr.

www.clintonlaw.net

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LLC Operating Agreements And Fiduciary Duty

This post is based upon an excellent article in Business Law Today titled, Eliminating Fiduciary Duty Uncertainty - The Benefits of Effectively Modifying Fiduciary Duties in Delaware LLC Agreements. The authors are Paul Altman, Elisa Maas and Michael Maxwell.

The issue is whether members of an LLC owe each other fiduciary duties. In the absence of any explicit disclaimers, Courts have held that the members of an LLC do owe each other a fiduciary duty.

A fiduciary duty is a high duty requiring the members to be loyal to the enterprise and each other. They are not permitted to (a) divert business to another entity; or (b) take excessive compensation or, obviously convert company assets.

There are situations where these fiduciary duties can hinder the members of the LLC. The authors recommend that any disclaimer of any fiduciary duty be explicit and unambiguous.

If the LLC operating agreement is silent, the courts will assume that all of the traditional fiduciary duties apply.

Edward X. Clinton, Jr.

www.clintonlaw.net

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Where There Is No LLC Operating Agreement, The Statute Controls

Davis v. WINNING STREAK SPORTS, LLC, Kan: Court of Appeals 2013 - Google Scholar:

Sometimes an LLC is formed, but the parties fail to prepare an operating agreement. Here, the parties formed an LLC and then engaged in litigation.

How are disputes resolved when the parties do not prepare an operating agreement? There is a simple answer - the state statute provides the terms of the parties operating agreement.

The Court explained:


"The controlling statute for this appeal is K.S.A. 17-7670, which provides:

"(a) Subject to such standards and restrictions, if any, as are set forth in its operating agreement, a limited liability company may, and shall have the power to, indemnify and hold harmless any member or manager or other person from and against any and all claims and demands whatsoever.
"(b) To the extent that a member, manager, officer, employee or agent has been successful on the merits or otherwise or the defenses of any action, suits or proceeding, or in defense of any issue or matter therein, such director, officer, employee or agent shall be indemnified against expenses actually and reasonably incurred by such person in connection therewith, including attorney fees."

Since there was no operating agreement, the plaintiff who had prevailed in other litigation with the LLC was entitled to indemnification. The Appellate Court remanded the case and instructed the trial court to use standards developed in Delaware courts interpreting Delaware's limited liability company act.

Comment: We see this problem quite often - people establish an LLC, but fail to take the time to engage a lawyer and complete the operating agreement. They are then often stuck with a bargain they did not anticipate in that the state statute provides the terms of the operating agreement. This is a cautionary but common tale.

Edward X. Clinton, Jr.

www.clintonlaw.net
www.clintonlegalmalpractice.net

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