Wednesday, September 3, 2014

Arizona Court of Appeals Avoids Mechanistic Application of Corporate and Partnership Obligations to LLC Members

       In a recent decision from the Arizona Court of Appeals, it cautioned against mechanical application of corporate and partnership analogues to LLCs.  Responding to the suggestion that members in an LLC must owe fiduciary duties because shareholders in a closely-held corporation and partners in a partnership owe duties, the Court in TM2008 Investment, Inc. v. ProCon Capital Corp., 323 P.3d 704 (Ariz. App., 2014), wrote:
We decline in this case to mechanically apply fiduciary duty principles from the law of closely-held corporations or partnerships to a limited liability company created under Arizona law.  The legislature did not explicitly outline any such duties for members of an LLC; instead, the LLC Act allows the members of an LLC to not only create an operating agreement, but also delineate in that agreement the duties members owe one another.  See A.R.S. § 29-682(B) (“An operating agreement governs relations among the members and the managers . . . and may contain any provision that is not contrary to law and that relates to . . . duties or powers of its members. . . .”).  The members of Doveland Developments created a written operating agreement (the “Agreement”) which does, as discussed below, outline reciprocal duties the members would owe each other.  Therefore, the trial court erred by imputing, without reference to the Agreement a fiduciary duty to the members of Doveland Developments to each other based solely on principles applicable to closely-held corporations and/or partnerships.  (citations omitted).

      The Court went on to reverse a jury verdict on the basis that the instructions failed to properly describe the member’s obligations.  The subject LLC’s operating agreement detailed the member’s obligations.
Article V, Section A of the Agreement provides that “[t]he Members shall direct, manage, and control the business of the Company to the best of the Members’ ability and[] subject only to those restrictions set forth in the Act or this Agreement.”  (Emphasis added).  In Article V, Section F, the Agreement states:
It is agreed any Member shall not be liable to the Company or any other Member of any damages or the like relating to any vote, decision, action, inaction or the like taken on behalf of the Company in accordance with these provisions and other provisions of this Agreement if such is done in good faith and with reasonable business judgment including the duty to make management decisions with the care of an ordinarily prudent person in a like position and similar circumstances and in a manner believed to be in the best interests of the Company.  (Emphasis added).

This provision unquestionably establishes, pursuant to A.R.S. § 29-682(B), the existence and scope of the duties owed by and between TM2008 Investments and ProCon Capital as members of Doveland Developments.  We need not reach the issue of whether these duties are “fiduciary” in nature; that label may evoke different concepts and applications in different settings.  We do note, however, that in this Agreement:  (1) the obligation to act in good faith explicitly acknowledges what is generally implied at law in any contractual relationship; (2) the obligation to utilize reasonable business judgment and to act as an ordinarily prudent person in making decisions seems to establish an applicable standard of care; and (3) the obligation to act in a manner believed to be in the best interests of the Company appears consistent with the general concept of a duty of loyalty to the business entity, here Doveland Developments.

       Against this background the trial court instructed the jury:
Members in an L.L.C. owe a special duty to one another, which is called a fiduciary duty.  This duty requires Members to deal in utmost good faith with one another and fully disclose to one another all material facts relating to the L.L.C.’s affairs within their knowledge.
     Rejecting this instruction, the Arizona Court of Appeals wrote:
As previously noted, the trial court concluded in summary judgment proceedings that a fiduciary duty between the members existed, not based upon the parties’ written Agreement, but rather based upon comparison with other business forms and the common law.  Article V, Section F of the Agreement, however, establishes the duties owed and the liability yardstick by which the claims and defenses of this case are measured.  By failing to advise the jury of the parameters specifically outlined in Article V, Section F of the Agreement, the trial court did not inform or guide the jury concerning the nature and extent of the duties TM2008 Investments owed ProCon Capital.  We therefore reverse the verdict and judgment in favor of ProCon Capital and remand for a new trial.  (citations omitted).

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