In October, 2012, the Court of Appeals issued its opinion in Ziegler v. Knock, affirming the trial
court’s determination that there had been a breach of duty in accepting a
secret commission but dismissing the action based upon a choice of venue
provision in the subject agreements. Ziegler v. Knock, No. 2008-CA-002160-MR,
2012 WL 5273999 (Ky. App. Oct. 26, 2012).
By its determination of improper venue the Court’s decision as to breach
of fiduciary duty was rendered dicta.
That decision was reviewed here in Decision
of Trial Court Reversed, Inter Alia, For Lack of Jurisdiction (posted Nov.
19, 2012).
Presumably on a motion for
reconsideration, the Court of Appeals issued a new decision in this case. See
Ziegler v Knock, No. 2008-CA-002160-MR (Jan. 18, 2013). Like the prior holding it is designated “Not
to be Published.” On October 16, 2013,
the Kentucky Supreme Court denied discretionary review. The petition for discretionary review was
restricted to the proper venue question.
That being the case I held off on a substantive review of the
decision. Ultimately it has serious
issues.
In this decision, on the basis
that the question of venue had not been raised in a timely manner, the Court of
Appeals determined that Ziegler had waived that defense. Ergo, the Court of Appeal’s affirmance of the
trial court’s ruling stands, and the matter would not be re-litigated in Ohio.
Which brings us back to the
primary point, namely Ziegler’s breach of duty.
The contract between Ziegler and Knock contained a warranty that Ziegler
was not to receive a direct or indirect commission on the acquisition of the
property to be acquired by TZG III, LLC, the acquisition vehicle formed by
Zigler and Knock. In fact, Ziegler received
a $72,000 commission on the sale.
While the ultimate
determination that Ziegler’s conduct was improper is without question correct
(at this point I’m not considering the effect of the release signed by Knock
and Ziegler), the analysis applied by the Court of Appeals mixes concepts that
are and should be distinct from one another.
Ergo, it might be a case of right answer, wrong reason.
First is the issue of structure
and the beneficiaries of fiduciary duties.
David and Richard Knock were the members of Knock Investments, LLC. Ziegler Group, LLC appears to have been
wholly-owned by Michael Ziegler. Knock
Investments, LLC and Ziegler Group, LLC in turn formed and were the members in
TZG III, LLC; that LLC was the actual purchaser of the strip mall. The agreement to form TZG III, LLC was
labeled a “Membership Interest Purchase Agreement,” and it was in that document
Ziegler represented he was not receiving a commission.
One point of contention was
whether the Knocks could individually be plaintiffs, or whether only Knock
Investments, LLC had standing. The
Knocks were not individually parties to the Membership Interest Purchase
Agreement. Still the trial court allowed
them to proceed individually, a decision not set aside by the Court of Appeals
in either of its decisions.
The problem with this
conclusion is that it is manifestly erroneous.
The rights and claims of an LLC are not the property of its
members. See, e.g., KRS §
275.010(2) (LLC is a legal entity distinct from its member); id. § 275.250 (interest in an LLC is
personal property); id. § 275.240(1)
(property of LLC is that of the LLC and not of the members); Chou v. Chilton, Nos. 2009-CA-002198-MR,
2009-CA-002284-MR, 2012 WL 6526184 (Ky. App. Nov. 16, 2012) (individual member
of LLC could not in his own name bring claim for breach of fiduciary duties
owed to the LLC); R.C. Tway Co. v. High
Tech Performance Trailers, LLC, 2013 WL 842577 (W.D. Ky. Mar. 6, 2013)
(claim for misappropriation of company assets belongs to the LLC); Bobbitt v. Russellville Mobile Park, LLC,
No. 2007-CA-00684-DG (Ky. App. Sept. 12, 2008, modified Oct. 17, 2008) (member
of LLC, seeking to represent the LLC in court proceeding, engaged in
unauthorized practice of law; member was not an attorney and the interests of
the LLC were not those of the member).
Knock Investments, LLC, being a
party to the Membership Interest Purchase Agreement, had standing to object to
its breach. The Knocks, not being
parties to that agreement and absent other facts (e.g., intended third-party beneficiaries) not set forth in the
opinion, had no standing.
Turning to the substance of the
dispute, Ziegler represented that he was not earning a commission on the sale
of the property. In fact he did receive
a commission, and the court properly held him to account for his breach of that
covenant. The problem is in the muddled
manner in which it did so.
In explaining Ziegler’s
liability for accepting the commission the Court wrote:
…
because Knock Investments, LLC is a closely held entity owned by the Knocks
individually, and because the Knocks were asserting claims of fraud and
misrepresentation in their individual capacities rather than through the
corporate entity, they had standing to assert their individual interests as
members of the limited liability corporation. Ziegler and TZG have cited no
statutory law or case law in support of their assertion that this conclusion
was erroneous. The trial court's rulings are presumptively correct, and the
burden rests with the appellants to demonstrate error. Boggs v. Burton, 547 S.W.2d 786
(Ky. App. 1977).
… The trial court determined that if
Ziegler had not breached his fiduciary and contractual duty to forgo a
commission, the purchase price of Park Plaza could have been lowered. In the
alternative, the court determined that at the very least, the Knocks were
entitled to a percentile share of the commission which they could have
reinvested in the project or disposed of in some other manner. The basis of the
court's conclusion on this issue is that as partners with mutual fiduciary
duties, the Knocks and Ziegler were vested with the right to reap the benefits
of their joint venture commensurate with their percentile ownership interest.
Since Ziegler secretly received a 2% commission, the court concluded that
equity demanded that the Knocks also benefit from that commission commensurate
with their percentile ownership interest in the venture. The court awarded to
the Knocks a 74% interest in the commission based on their 74% interest in the
project. Since the relationship of partners imposes upon each the obligation of
good faith and fairness with respect to partnership affairs, Betts v.
Smither, 310 Ky. 402, 220 S.W.2d 989 (Ky. App. 1949), and since Ziegler
unduly benefitted from his acceptance of a commission in violation of his
fiduciary duty and the Membership Interest Purchase Agreement, we find no error
in the court’s determination that the Knocks are entitled to a pro rata share
of the commission.
The Court, in these few
sentences, mixed a significant number of concepts.
First, even between those who
stand in a fiduciary relationship with one another, is a breach of a
contractual obligation a breach of fiduciary duty? Assume that the receipt of a secret commission
is a breach of fiduciary duty. As was here
the case that limitation was reduced to a contractual obligation. There is then a breach of the
obligation. Does there now arise a
decision for breach of fiduciary duty, breach of contract, or both? The Court seemed to assume both, but it is
not obvious that is correct. Fiduciary
duties are gap-fillers. Conceptually,
where the express contract addresses the point, there is no gap to be addressed
by fiduciary obligation?
Second, what was the source of
the alleged fiduciary duty? The covenant
was that Ziegler, and not Ziegler Group, LLC, was not receiving a
commission. Was Ziegler a member in a
member-managed LLC or a manager of a manager-managed LLC? The opinion does not say. On the basis that the Ziegler Group, LLC was
wholly-owned by Ziegler, is he being held responsible for discharge of the
LLC’s fiduciary obligations? The opinion
does not say. Did the operating agreement identify Ziegler
as a fiduciary? The opinion does not
say. Has USACafes been adopted as Kentucky law? Essentially we are told that Ziegler violated
a fiduciary duty without being provided any direction as to the source of that
duty.
Third, where was the breach of
fiduciary duty? Even assuming Ziegler
was a fiduciary and that he accepted the commission, it does not necessarily
follow that there was a breach. What
fiduciary duty was violated? Subject to
“First” above I have no doubt there was a breach, but the Court needs to tell
us what it was and why.
Fourth, if this is a case about
a breach of fiduciary duties rather than contractual duties, why did the court
use a contract measure of damages, namely putting the Knocks back in the same
position they would have been but for the breach?
Fifth, and going back to the
point above on standing, whey is the recovery to the individual Knocks rather
than either the TZG III, LLC or to Knock Investments, LLC? Chou v.
Chilton and the statutory law make clear that injury to the LLC, in this
instance TZG III, LLC (if there had been no commission to Ziegler then TZG III,
LLC’s purchase price for the subject property would have been lower), is to be
addressed for the account and benefit of the LLC.
Sixth, from where came this
reference to “partners”? Members in an
LLC are members and they owe the duties and enjoy the benefits of members as
defined by the LLC Act. Partners in a
partnership are partners and they owe the duties and enjoy the benefits of
partners as defined in the law of partnerships.
Partnership law, by its express terms, does not apply among the members
in an LLC. See KRS § 362.1-202(2). Yes,
in LLCs there exists an obligation of good faith and fair dealing, but that is
a principle of contract law that is confirmed by the LLC Act. See
KRS § 275.002(7). And as good faith and
fair dealing is a principle of contract law (and not the law of fiduciary
duty), it cannot be the basis for the fiduciary duty Ziegler violated.
It is clear that Ziegler’s
conduct was improper, but this decision does little to illuminate why or to
provide guidance for the analysis of future disputes.
Which brings us back to the
question of the effect of the mutual release, an issue to which the existence
of the fiduciary duty is crucial.
Assuming a third-party independent relationship, a mutual release will
be binding upon each party, and each party, in entering into such an agreement,
is bound and required to look out for its own interest. Where, in contrast, one bound by a fiduciary
relationship seeks a release from the beneficiary of that relationship, the
release is effective if and only if the fiduciary has made full and complete
disclosure to that beneficiary. See, e.g.,
Restatement of (Third) of Agency §
8.05. Ziegler sought to avoid liability in this
dispute by refereeing a mutual release that had been entered into. Knock sought to avoid the application of that
release on the basis that Ziegler was a fiduciary. While the court may, ultimately, have been
normatively correct in setting aside the release on the basis that Ziegler owed
a fiduciary duty, its analysis was so muddled that little can be taken away
from it. For example, if Ziegler owed a
fiduciary relationship, had that situation so broken down by the time that the
mutual release was entered into that Knock had no right to expect Ziegler to be
acting in a fiduciary, as contrasted with an arms-length independent,
role? Such determinations matter. They were, however, ignored in this decision.
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