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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LLC Question - Does The LLC Have To Buy The Interest Of A Departing member?

CONCORDIA PARTNERS, LLC v. Ward, Dist. Court, D. Maine 2013 - Google Scholar:

The typical LLC operating agreement contains a provision governing the terms of a member's withdrawal. The operating agreement often provides that the other members or the LLC itself have a right of first refusal. This means if Member X wants to sell his interest in the company, he must first offer it to the other members. They have a period of time in which to buy his interest or refuse to buy it.

The LLC at issue here was governed by the law of the State of Maine. Like most states, Maine allows the members to set the rules by drafting an operating agreement.

The court explains the terms of the agreement as follows:

"Under Section 8.3, before a member can transfer his or her interest in Concordia, the Transferring Member must notify the Managers of the company. In this regard, Section 8.3 provides:
If any Transferring Member, desires to transfer . . . all of any part of theLLC Units owned by the Transferring Member and such proposed transfer is not subject to the provisions set forth in Section 8.2 hereof [pertaining to Selling Members with a Bona Fide Offer], the Transferring Member shall first notify the Managers stating the nature of the Offered Interest to be transferred and the name of the person to whom the same is to be transferred and the manner of and reason for such transfer and the consideration (if any) to be received.

(Operating Agreement ¶ 8.3.) Providing notice triggers a period during which Concordia, as an "Optionee" under Section 8.1(e), has the option to purchase the member's interest for its Fair Value: "For a period of forty-five (45) days after determination of Fair Value in accordance with Section 8.1 above . . . the Optionee shall have the option to purchase the Offered Interest at its Fair Value upon the Deferred Payment Terms." (Id. ¶ 8.3.) The same Section then goes on to state:
If the Optionee (collectively) does not exercise the option to purchase the entire Offered Interest prior to the expiration of the Transfer Option Period, the Transferring Member may transfer the entire Offered Interest, provided the transfer occurs on the terms stated in the original notice received by the Managers to the person named therein and the transfer occurs within thirty (30) days following the expiration of the Transfer Option Period.

(Id.) Therefore, under Section 8.3, when a Transferring Member notifies Concordia of its desire to sell its membership units, Concordia as an "Optionee" has the right to purchase that member's interest in Concordia. However, nothing in Section 8.3 obligates Concordia to purchase a member's interest."


In this case the court dismissed a claim by the withdrawing member. That member sought to compel the LLC to purchase his interest. His claim failed because the Operating Agreement did not require the LLC to purchase the interest. The only requirement was that the member offer the interest to the LLC. There was no requirement to buy the interest.

Comment: this is a routine case. It illustrates the importance of the operating agreement and the importance of carefully drafting that agreement before you invest your money in the LLC.

Edward X. Clinton, Jr.

www.clintonlaw.net

www.clintonlegalmalpractice.net

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The Fees Involved In Forming an Illinois Limited Liability Company

Often an entrepreneur will start a business and contact an attorney to form an entity. That entity is usually a limited liability company. The LLC is preferred because it is flexible - it can be taxed as a partnership would be taxed and it has liability protection that the partnership does not have. It has many advantages over the traditional corporation because it is more flexible and more adaptable to different circumstances.

Recently, LegalZoom and other online services advertise that they can form limited liability companies for $99. If that is true, why should you choose an attorney?

In Illinois, to form an LLC online the price is $612.75. That price must be paid to the State of Illinois. That fee must be paid even if the purchaser uses LegalZoom or an online service. So, if the quoted price is $99, the LLC will actually cost the client at least $711.75.

Why bother with an attorney?

An attorney can draft an operating agreement, which is the basic contract that governs the LLC. The operating agreement sets the rules of the road for the LLC - who makes the decisions and who gets to contribute capital and, often, who can deduct losses. Unlike any computer program or template the attorney can tailor the operating agreement to the client's actual needs. The lawyer can perhaps add a non-competition clause to prevent a key employee from leaving the new enterprise and starting his own competitor. The lawyer can chose a dispute resolution format - you can select arbitration or litigation in a certain forum. Maybe the LLC also needs a form contract for customers or suppliers. Again, only a lawyer can draft such a contract, after asking the client the right questions.

The LLC can also be designed to have two or three classes of members - each with certain rights and obligations. The benefits of the LLC far outweigh the disadvantages. The corporate lawyer has the skills and ability to design the enterprise to make it flexible and useful for any particular enterprise. Thus, LegalZoom will seem cheap until you talk to a lawyer.

Edward X. Clinton, Jr.

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Personal Jurisdiction - Illinois Can Assert Personal Jurisdiction over Colorado Web Company

The case is captioned Innovative Garage Door Co. v. High Ranking Domains, LLC, 2012 IL App (2d) 120117.

The plaintiff purchased internet leads for its garage door business from a Colorado company, High Ranking Domains.

In 2010, High Ranking Domains cancelled the contract and began selling leads to another Illinois company.

Garage Door sued for breach of contract and High Ranking Domains moved to dismiss for lack of personal jurisdiction. The trial court granted the motion and Garage Door appealed.

The Second District Appellate Court reversed. It held that the contract with the Illinois company and the websites contacts with Illinois were sufficient to confer jurisdiction on the Illinois courts. The court comments "HRD can derive profit only when a consumer in one of those localities uses its services and HRD then provides the information to a business in the same location. Thus, its ability to do business is specifically location-oriented. Illinois is one such location." Because HRD sought to obtain leads from Illinois and sell them to an Illinois company, there were sufficient contacts for personal jurisdiction.

Edward X. Clinton, Jr.

www.clintonlaw.net

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Court Rejects Broad Ranging Attack on Employment Arbitration Clause

Diggs v. CITIGROUP, INC., Dist. Court, ND Texas 2013 - Google Scholar:

This is an employment case.  Because the employee signed an arbitration clause, the court ordered the parties to proceed to arbitration.  Citigroup sought sanctions.  The employee argued that arbitration clauses were systematically unfair to employees.  The argument was based on a research study.

This looks like a test case, designed to attack arbitration clauses.

Edward X. Clinton, Jr.

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Illinois Supreme Court Answers Corporate Law Question

Pielet v. Pielet, Ill: Supreme Court 2012 - Google Scholar:

The Illinois Supreme Court has answered an important corporate law question.  Can you sue a dissolved corporation? The Illinois Business Corporation Act says "yes." The next question is: can you sue the corporation when the claim does not accrue until the corporation has dissolved? The Illinois Supreme Court has answered "No" to that question.

The court sets forth the statutory provision:

"¶ 31 The section of the Business Corporation Act of 1983 relevant to this appeal is section 12.80 (805 ILCS 5/12.80 (West 2006)), which provides:

"The dissolution of a corporation *** shall not take away nor impair any civil remedy available to or against such corporation, its directors, or shareholders, for any right or claim existing, or any liability incurred, prior to such dissolution if action or other proceeding thereon is commenced within five years after the date of such dissolution. Any such action or proceeding by or against the corporation may be prosecuted or defended by the corporation in its corporate name."

¶ 32 The first question we must resolve today is whether this provision permits a claim for breach of contract to be asserted against P.B.S. One, Inc., a dissolved corporation, where the alleged breach did not take place until after the corporation was dissolved.^[3]"

In this case, Pielet was owed certain funds by a corporation.  The corporation was dissolved and the liability was transferred.  Pielet could not sue the corporation because the obligation did not accrue until after the corporation dissolved.

Comment: from a policy standpoint the opinion makes sense.  It is not a good idea to allow a corporation to incur and obligation, dissolve, and leave the other party without a remedy.  Letting someone sue when the breach occurs after the corporation is dissolved is more problematic.  My concern with this case is that it may create a loophole for clever corporate planning.  A corporation might be able to use this case to avoid payment of an obligation.

Edward X. Clinton, Jr.

www.clintonlaw.net

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