February 19, 2015

The Liability of Managers and Other Agents for Their Own Actions on Behalf of an LLC

Robert R. Keatinge

The eponymous characteristic of the limited liability company (LLC) is that the LLC, as a separate legal entity, is liable for its obligations to others and that no other person, whether as owner or agent, is vicariously liable for those same obligations. Of course, an LLC, like any legal entity, must act through individuals or other legal entities with the authority to act on behalf of the LLC. The individual or legal entity with this authority may be known by a number of designations: managers, managing members, authorized persons, officers, or employees, or simply as agents (collectively “Actors”). Under all LLC statutes, the general rule is that the members of the LLC are not personally liable for obligations of the LLC, subject to such exceptions as personal guarantees or “piercing” of the organizational veil. This article discusses a different aspect of vicarious liability: when an Actor will be liable to a third party for actions taken on behalf of the LLC. It does not address the liability of the LLC (or its owners qua owners) to the third party or the relationship between the LLC and its Actors.

Whether an Actor will be personally liable to the third party for an obligation incurred by the Actor while acting on behalf of the LLC is a complex question which will turn on: (1) whether the obligation is based in contract or in tort; (2) whether the duty breached by the Actor is a duty to the LLC or to the third party; and (3) if the obligation is a liability for damages, whether the damages are physical harm to the person or property of the third party or for economic loss suffered by the third party.

Contract

Actors, in their capacities as agents of an LLC, are generally subject to the same rules applicable to other agents. The Restatement (Third) of the Law of Agency (“Restatement of Agency”) § 6.01(2) provides the general rule that an agent (here the Actor) is not a party to – and thus is not liable to – a third party on a contract between a fully-disclosed principal (here, the LLC) and a third party, even if the agent, in its representative capacity as such negotiates and performs the contract. This rule is based on the concept that the agent, in contracting, is creating a contract that is binding on its principal and that the third party is relying on the principal for performance under the contract. Thus, other than the agent’s duty to the principal and the agent’s warranty of authority to the third party insuring that the agent does have the legal power to bind the principal (Restatement of Agency § 6.10), the agent does not have an individual role in the contract between the principal and the third party.

This result can be modified by the agreement of the agent, as, for example, where the agent has agreed to become a party to, or guarantee, the contract. But as a general rule, when an Actor on behalf of an LLC enters into a contract with a third party, the third party’s relief under the contract is limited to the LLC. The Actor’s conduct in entering into or performing the contract is immaterial to the liability for breach and the third party’s exclusive remedy is against the LLC. If the Actor is performing the contract on behalf of the LLC, the only person to whom the Actor is answerable is the LLC.

Tort

The Restatement of Agency has a different rule when an agent commits a tort that results in damage to a third party. Section 7.01 of the Restatement of Agency provides that an agent is liable to a third party harmed by the agent’s tortious conduct, irrespective of whether the agent is acting in a representative capacity or whether the principal is also liable to the third party. This rule is well-demonstrated by the idea that an Actor who negligently causes an automobile accident while driving in the course of his or her duties as Actor on behalf of an LLC is nonetheless personally liable to the third party injured in the accident. This is true regardless of whether the LLC is also liable to the injured third party. As discussed below, many LLC acts recognize this rule, although they recite it in different ways.

Not all tortious conduct of an agent that results in liability to a third party will subject the agent to liability to the third party. As explained in Section 7.02 of the Restatement of Agency, the tort must violate a duty owed directly by the agent to the third party. Thus, an agent (or any other person) who operates a motor vehicle on a public highway owes a duty to others on the highway not to cause damages to them through negligence. Section 7.02 notes that an agent’s breach of a duty owed to the principal is not an independent basis for the agent’s tort liability to a third party. For example, when a basketball player’s agent negotiates a contract with a third party for the player’s services and then negligently fails to inform the player about the contract or the player indicates he cannot perform, but the agent fails to inform the third party, the third party may not recover damages for agent’s negligence because the agent owes duties to the player but not the third party.

Physical Harm vs. Economic Loss

Even if the third party has a claim in tort for negligence, the liability of both the Actor and the LLC may be limited by a general rule that has developed significantly over the past few decades. The “Economic Loss Rule” is expressed in case law and described in the Restatement (Third) of Torts: Liability for Economic Harm (“Restatement of Torts: Liab. for Econ. Harm”), which is currently being completed by the American Law Institute. The Restatement describes the Economic Loss Rule as holding that there can be no liability in tort for causing pure economic loss. The definition of “economic loss” for purposes of this rule is generally defined as a loss or damage other than one resulting from personal injury to the plaintiff or physical damage to the plaintiff’s property, and encompasses such matters as lost profits, diminution in value, lost opportunity, and other monetary losses. The Economic Loss Rule is sometimes stated as precluding an action in tort by a party suffering only economic loss from a breach of an express or implied contract absent an independent duty of care under tort law.

The Restatement of Torts: Liab. for Econ. Harm § 3 Comment a expressly does not adopt the Economic Loss Rule, which it characterizes as the “minority view” and proposes a much more limited rule. Restatement of Torts: Liab. for Econ. Harm §§ 1 (“an Actor has no general duty to avoid the unintentional infliction of economic loss on another”) and 3 (“there is no liability in tort for economic loss caused by negligence in the performance or negotiation of a contract between the parties”). While the basic rules governing economic loss are neither settled nor simple, they do represent an important current in rules governing liability. The rationale for the rules dealing with economic loss or economic harm is that, in matters involving economic loss (generally, pecuniary damage other than that arising from damage to the plaintiff’s person or property), the contract between the parties, as opposed to general tort law, should govern, even where the damage results from the negligence of one of the parties. The basis supporting this rationale is that the parties may readily establish the standards of conduct and protect themselves from the failure to meet those standards under the contract between them, so there is no need for a tort remedy.

When this limitation on tort liability is combined with the general rule that an agent (here the manager or other Actor) is not liable to a third party on a contract between a fully disclosed principal (here the LLC) and a third party, this concept, even as defined by the Restatement of Torts: Liab. for Econ. Harm, will further limit the liability of an Actor to the third party.

While the Economic Loss Rule and the Restatement of Torts: Liab. for Econ. Harm both protect Actors from tort liability for economic loss arising in the course of negotiating or performing contracts, there are important exceptions to this protection. Not surprisingly, the protection does not apply to professional services (thus, an attorney may be liable in tort for economic loss arising from the attorney’s negligence) or fraud. The Restatement of Torts: Liab. for Econ. Harm also provides an extensive discussion of the sort of fraudulent or negligent misrepresentations (including promissory fraud) that will subject an Actor to liability in tort even if the tort occurred in the negotiation or performance of a contract.

Application of LLC Statutes

All of the concepts discussed above will be generally applicable to persons acting on behalf of limited liability partnerships and corporations, and, with respect to all such persons other than general partners, limited and general partnerships. Those rules that are based on agency principles will apply to all agents. There are some additional rules that may have unique application to LLCs as a result of state LLC legislation. Many – but not all – of the LLC statutes have an express statement to the effect that Actors (sometimes limited to statutorily-defined managers, sometimes including employees and other agents) are not liable solely by reason of being or acting as an Actor. The statutes tend to divide into three general categories: (1) silence on the liability of Actors, (2) a general statement that managers are not liable for the obligations of the LLC, or (3) a statement that managers (or, in some cases, all Actors) are not liable for the obligations of the LLC “solely by reason of” (being or acting as) a manager (or other Actor). In addition, some of the statutes providing for non-liability of managers or other Actors include an express exception for Actors who are professionals. For a table showing the different formulation of these provision in different states, see Larry E. Ribstein and Robert R. Keatinge, Ribstein and Keatinge on Limited Liability Companies at Appendix 12-3.

Recently, a few cases have considered the liability of managers or managing members under statutory language stating that a member or manager is not liable for a debt or obligation solely by reason of being or acting as a member or manager. In Dass v. Yale, 2013 IL App (1st) 122520 appeal denied, 117224, 2014 WL 1385161 (Ill. Mar. 26, 2014), the court held that the manager of an LLC was not personally liable in connection with a warranty of condition of certain sewer lines and promise to conduct further testing of those lines made by an LLC of which the defendant was manager. Similarly, in 16 Jade St., LLC v. R. Design Const. Co., LLC., 398 S.C. 338, 728 S.E.2d 448 (2012), reh'g granted (May 4, 2012), opinion withdrawn and superseded on reh'g sub nom. 405 S.C. 384, 747 S.E.2d 770 (2013), after a somewhat convoluted appellate history concluded that the defendant (a member of the LLC that acted as contractor on a construction project) owed no duty to plaintiff (the property owner) for certain construction defects.

Both of these cases looked at certain legislative history in the Uniform Limited Liability Company Act (1996) which provides: “A member or manager, as an agent of the company, is not liable for the debts, obligations, and liabilities of the company simply because of the agency. A member or manager is responsible for acts or omissions to the extent those acts or omissions would be actionable in contract or tort against the member or manager if that person were acting in an individual capacity.” This language, appears to be a clumsy restatement of the concept better enunciated in Restatement of Agency § 7.02 (“An agent is subject to tort liability to a third party harmed by the agent's conduct only when the agent's conduct breaches a duty that the agent owes to the third party.”). As such, the manager in Dass and the member in 16 Jade Street were not held individually liable for negligence that occurred in the LLC’s discharge of its contract with the plaintiff.

Conclusion

Much attention has been given to the vicarious liability of members qua owners of an LLC because members are not vicariously liable for the obligations of the LLC solely by reason of their status as owners – thereby distinguishing them from general partners in general and limited partnerships. Only recently has the liability of Actors in LLCs and other organizations for actions taken on in their capacity as agents of the organization become the subject of extensive legal analysis. Recent case law, statutory provisions, and the Restatement of Torts: Liab. for Econ. Harm have focused greater attention on this issue and provided some guideposts that may help in developing a clear set of principles. As a general matter, the following rules should apply:

  • To the extent that an LLC’s obligation to third party liability arises under a contract between the LLC and the third party, the Actor will not be liable even if the Actor is instrumental in entering into or performing the contract for the third party
  • To the extent that an Actor is negligent in performing his or her duties for the LLC, the Actor will not be liable to a third party for any damage incurred by the third party unless the Actor owed an independent duty to the third party.
  • To the extent a third party sustains economic harm (i.e., harm other than personal injury or injury to the third party’s property) as a result of the negligence or other tort committed by an Actor in the course of negotiating or performing a contract between the LLC and third party, the Actor will not be liable to the third party under the Economic Loss Rule or the Restatement of Torts: Liab. for Econ. Harm.
  • Notwithstanding the rules set forth above, an Actor will be liable to a third party for damages resulting from the Actors actions if: (1) the Actor is a professional in the context of the LLC’s rendition of professional services to the third party or (2) the Actor has made fraudulent misrepresentations (including promissory fraud).

Each of these rules are general statements of principles that are subject to many exceptions, qualifications, and nuances. They do not deal with the liability of the Actor to the LLC or the liability of the LLC to the third party.

Further, there are many other factors that may have an impact on the liability of the Actor to the third party. For example, while as a matter of common law an agent may not have obligations under a contract between the principal and the third party, the agent may agree to become a party to that contract or may be subject to liability under other state statutory or common law.

In addition, as noted above, the Economic Loss Rule varies from the rules with respect to economic harm articulated in the Restatement of Torts: Liab. for Econ. Harm. The rules under the Economic Loss Rule and those under the Restatement differ on the extent to which the Actor is protected in the case of economic harm (under the Restatement, the protection is limited to economic loss caused by negligence in the negotiation or performance of a contract between the parties while the economic loss rule has been read as broadly as to eliminate liability in tort for causing any economic loss to another), and the extent to which the damages that the third party has sustained constitute “economic loss” or “economic harm” (the Restatement attempts to clarify the distinction between “economic loss” and injury to the plaintiff’s person or property in a way that is more rigorous than that employed by the common law of some states). Thus, the liability of the Actor may turn on whether the jurisdiction in which the claim is determined has adopted the Restatement of Torts: Liab. for Econ. Harm or some variation on the “Economic Loss Rule.”

Nonetheless, the important lesson that may be taken from this Sturm und Drang of varying rules is that the liability of a manager or other Actor for actions taken on behalf of the LLC of which he or she acts is neither automatic nor totally precluded. In determining that liability, a court will need to analyze the nature of action (i.e., tort or contract), to duties owed by the Actor and to whom the duties are owed, the nature of the damages sustained by the third party (i.e., whether they are “economic” or not), and the language and intent of the state LLC statute. The cost and uncertainty of this analysis, as well as the clear encouragement that all of the rules provide for the parties to anticipate these problems before they arise, all strongly argue for contractual undertakings involving principals, agents, third parties, and – if appropriate – insurers at the outset of the transaction. As stated in the Restatement of Torts: Liab. for Econ. Harm § 3 Comment b

When a party’s negligence in performing or negotiating a contract causes economic loss to the counterparty, remedies are determined by other bodies of law: principally the law of contract, though sometimes also the law of restitution or relevant statutes. The law of contract and the law of restitution have been developed for the specific purpose of allocating economic losses that result from the negotiation and performance of contracts. They provide a more extensive and finely tuned apparatus for the purpose than the law of torts, which has developed primarily to address injuries that occur outside contractual relationships.

Robert R. Keatinge

Robert R. Keatinge is of counsel at Holland & Hart LLP in Denver, Colorado.