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March 27, 2019 Practice Points

Issues in the Imposition of Fiduciary Duties on Departing LLC Members

As a growing number of states adopt default fiduciary obligations between members of LLCs, issues may arise in the context of departing members.

By Cole Schlabach

A growing number of states have adopted versions of the Revised Uniform Limited Liability Act, codifying, among other things, certain default rules related to fiduciary duties among members. For example, the new Arizona Limited Liability Act, A.R.S. § 29-3101 et al, becomes effective September 1, 2019 for all LLCs formed after that date, and applies to all LLCs after August 31, 2020. (Other states recently adopting versions of the act include Pennsylvania, where the act was effective February 21, 2017, and Illinois, where it was effective July 1, 2017.)  Under Arizona’s new law, all members of member-managed LLCs owe fiduciary duties to one another and to the company unless otherwise limited or eliminated in the company’s operating agreement.  See A.R.S. § 29-3409.

As a growing number of states adopt default fiduciary obligations between members of LLCs, issues may arise in the context of departing members with respect to determining when obligations to such individuals cease—particularly in the event of a buyout or planned withdrawal of a member. The new statutes may provide some guidance but are not always completely clear on when duties to departing members cease under every circumstance.

For example, Arizona’s newly enacted law specifies that, at least with respect to the departing member’s statutory fiduciary duties and obligations, such duties “end with regard to matters arising and events occurring after the person's dissociation.” A.R.S. § 29-3603(A)(1). A number of events can trigger an event of dissociation under the new law, but in the event of a voluntary withdrawal, the member’s dissociation occurs when “[t]he limited liability company knows or has notice of the person's express will to withdraw as a member, but if the person has specified a withdrawal date later than the date the company knew or had notice, the person is dissociated as a member on that later date.” Id. § 29-3602(A)(1) (emphasis added). Thus, when an individual provides notice of an intention to withdraw as a member of the LLC at a later date, the individual is not technically dissociated from the LLC until the scheduled date of withdrawal. This raises the question of whether, in the interim period between an announced withdrawal and the actual date of dissociation, fiduciary duties continue to be owed to and by the departing member.

Typically, where members of an LLC owe one another fiduciary duties, a planned buyout or other scheduled withdrawal does not necessarily extinguish those duties prior to actual dissociation. For example, in One to One Interactive, LLC v. Landrith, the Appeals Court of Massachusetts upheld a jury’s finding that LLC members had breached fiduciary duties to an outgoing member in connection with a buyout agreement, which was supported by such acts as “extensive maneuvering . . . to renege on their deal with [the outgoing member], and their use of improper tactics to pressure him to accept less than he was entitled to under the contract.” 76 Mass. App. Ct. 142, 147 (2010). In reaching this holding, the court rejected the argument that the LLC members’ proposed term sheet for the buyout provided the controlling contract on point, thus absolving the remaining members from the breach of fiduciary duty claim. Id. at 146.

However, there is at least some recognition of members’ ability to disaffirm continued fiduciary duties by agreement, at least in the case of sophisticated members agreeing to a buyout. In Pappas v. Tzolis, the Court of Appeals of New York relied on a contractual waiver of fiduciary duties among LLC members and overturned a ruling that the remaining member owed fiduciary duties to two outgoing members. 20 N.Y.3d 228 (2012). The outgoing members complained that the remaining member had surreptitiously negotiated the assignment of a lease held by the LLC before the close of the buyout, which resulted in a multimillion-dollar payment following the buyout. Id. The court reached its conclusion based on the sellers’ certification at the close of the buyout that they had engaged their own legal counsel, were not relying on any representation by the remaining LLC member, and that the remaining LLC member owed no fiduciary duty to the selling LLC members. Id. at 231–32. The court recognized that “plaintiffs were sophisticated businessmen represented by counsel. Moreover, plaintiffs’ own allegations make it clear that at the time of the buyout, the relationship between the parties was not one of trust, and reliance on Tzolis’s representations as a fiduciary would not have been reasonable.” Id. at 233.

Cole Schlabach is an associate with DLA Piper in Phoenix, Arizona.

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