Does an Inactive Member of a Member-Managed LLC Owe Fiduciary Duties?
October 22, 2018
Consider the following hypothetical: The operating agreement of an LLC vests management authority in its two members. In practice, and by informal mutual consent, only one of the members actively manages the LLC’s business and financial affairs. (Not an altogether unusual arrangement, by the way.) When things go awry between the two members, and the active member accuses the inactive member of engaging in misconduct violating fiduciary duties owed to the LLC and to the active member, can the inactive member disclaim those fiduciary duties on the ground he owes no such duty as a de facto non-managing member?
A disclaimer of the sort was raised and rejected in a ruling earlier this month by Manhattan Commercial Division Justice Barry Ostrager in Marcus v Antell, 2018 NY Slip Op 32527(U) [Sup Ct NY County Oct. 5, 2018], where the court relied on a strict application of New York’s LLC Law § 401 (b) (ii) providing that any member of a member-managed LLC “shall have and be subject to all of the duties and liabilities of a manager provided in this chapter.”
It’s not quite as simple as it sounds.
Let’s begin with the statute. The full text of § 401 (b), captioned “Management of the limited liability company by members,” provides:
If management of a limited liability company is vested in its members, then (i) any such member exercising such management powers or responsibilities shall be deemed to be a manager for purposes of applying the provisions of this chapter, unless the context otherwise requires, and (ii) any such member shall have and be subject to all of the duties and liabilities of a manager provided in this chapter.
Subsection (b) (ii)’s reference to the “duties and liabilities of a manager in this chapter” points to LLC Law § 409 (a), captioned “Duties of managers,” which, in so many words, imposes fiduciary duties on LLC managers.
I suggest you read § 401 (b) a few times, then ask yourself, does the phrase “any such member” used at the start of subsection (b) (ii), which is preceded by the conjunctive “and,” refer to a member referenced in the section’s conditional, prefatory clause (“If management of a limited liability company is vested in its members . . .”) or does it refer to a member “exercising such management powers or responsibilities” as that phrase appears in subsection (b) (i)?
If the former, meaning that subsections (b) (i) and (ii) operate independently, that would seem to render subsection (b) (i) meaningless, a disfavored outcome under general rules of statutory construction.
If the latter, then the legislature wittingly or unwittingly has opened the door to fact-intensive litigation in which members of member-managed LLCs accused of breaching fiduciary duty can try to show, consistent with subsection (b) (i), either that they exercised no management powers or responsibilities or, even if they did, that the “context requires otherwise” – perhaps, as nonsensical as it may sound, even when an operating agreement expressly vests management in the members.
The Marcus Case
The preceding paragraph essentially describes how the argument played out in Marcus which involves a messy business divorce in its sixth year of litigation between an osteopath (Antell) and a chiropractor (Marcus) who practiced together as co-owners of a professional corporation and an LLC that provided the P.C. with non-medical administrative services. The LLC agreement (read here) contains fairly typical provisions in Article Five vesting management authority in the members collectively, listing certain major decisions requiring unanimous member consent, and requiring members to perform their duties “with due care.”
Marcus’s complaint accused Antell of ditching buyout negotiations and instead taking certain oppressive or unauthorized actions – freezing him out of bank accounts and credit lines; barring his access to the LLC’s computer systems; shifting employees from the LLC to the P.C.; transferring funds from the LLC to accounts controlled by the P.C. or the osteopath – designed to oust Marcus from the venture.
Following discovery, Antell moved for summary judgment dismissing Marcus’s direct and derivative claims for breach of fiduciary duty, claiming that he (Antell) had no such duties as a non-managing member. On the facts, he relied on deposition testimony given by Marcus to the effect that he, and he alone, ran and supervised the LLC’s business.
On the law, Antell relied on the language in § 401 (b) (i) and a trio of trial court decisions, in two of which – Kalikow v Shalik, which I wrote about here, and Landes v Provident Realty Partners II, L.P. – the courts dismissed fiduciary breach claims against LLC members who, unlike Antell, were designated non-managing members in the operating agreements. In the third case, Lester v Capo, the court dismissed fiduciary breach claims against members of a member-managed LLC based on the plaintiff’s concession that, by mutual consent, they were non-managing members at the time of the alleged breaches.
Marcus opposed Antell’s argument both on the facts and the law. On the facts, he pointed to affidavits filed by Antell early in the litigation and in a related bankruptcy filing in which he identified himself as a managing member of the LLC. He also pointed to Antell’s deposition testimony describing his LLC oversight activities, and to the allegedly wrongful actions Antell took on the LLC’s behalf designed to oust Marcus from the business.
On the law, Marcus relied on the operating agreement’s Article Five provisions vesting management in the members and on the language of § 401 (b) (ii) (“any such member shall have and be subject to all of the duties and liabilities of a manager provided in this chapter”). Marcus also cited a number of case precedents in which courts upheld (or refused to dismiss) fiduciary breach claims against LLC members though, as far as I could tell, in each case the defendants were designated managing members.
In short, the precise legal issue presented in Marcus — i.e., whether consistent with LLC Law § 401 (b), a member of an LLC whose operating agreement expressly vests management authority in all its members, yet who claims in practice to have yielded all management authority to another member, can assert non-manager status as a defense to a claim for breach of fiduciary duty — is not one that appears previously to have been addressed by New York courts.
First impression or not, Justice Ostrager came down squarely on the side of imposing fiduciary duties on LLC members of member-managed LLCs under § 401 (b) (ii), without regard to the degree of their active participation in managing the LLC’s affairs – so squarely that he deleted subsection (b) (i) from his quotation of § 401 (b) in the following passage:
New York’s Limited Liability Company Law, § 401(b) states: “If management of a limited liability company is vested in its members, then … any such member shall have and be subject to all of the duties and liabilities of a manager provided in this chapter.” The chapter provides: “A manager shall perform his or her duties as a manger, including his or her duties as a member of any class of managers, in good faith and with that degree of care that an ordinarily prudent person in a like position would use under similar circumstances.” § 409(a). Further, “New York case law is replete with cases demonstrating that a managing member of an LLC has a fiduciary duty to other members of the LLC.” Kalikow v. Shalik, 986 N.Y.S.2d 762, 767 (Sup. Ct., Nassau Cty. 2014).
Based on the LLC agreement’s provision vesting management in the members, Justice Ostrager then dealt the coup de grâce to Antell’s argument, writing:
Here, Article Five of CAAM’ s Operating Agreement clearly states: “The authority to establish the overall business policy and direction of the LLC shall be vested in the Members, with all actions requiring the unanimous consent of the Members.” Thus, all members of CAAM are considered managing members pursuant to the terms of the Operating Agreement. Antell and Marcus are both defined as members under the Operating Agreement. Therefore, “[a]s a managing member of the company and as a co-member with the plaintiff, the defendant owed the plaintiff a fiduciary duty to make full disclosure of all material facts.” Salm v. Feldstein, 20 AD3d 469, 470 (2d Dep’t 2005). Regardless of how active Antell was or was not in managing the affairs of CAAM, the explicit terms of the Operating Agreement make clear that any member of CAAM, including Antell, is a managing member and has fiduciary obligations to CAAM and Marcus as such.
It would have been a nice bonus for us LLC aficionados had Justice Ostrager’s decision addressed Antell’s reliance on subsection (b) (i) of LLC Law § 401. It’s too early to tell if an appellate court will do us the honors, as Antell thus far has not filed a notice of appeal and may never do so (perhaps because of triable issues surrounding his predicate contention that he never exercised management responsibilities). If he does, I’ll be sure to report any decision. If he doesn’t, I suspect the issue will recur in some germinating, future LLC member dispute, most likely in the analytically more challenging context of a member-managed LLC that has no written operating agreement.