Friday, April 9, 2021

A Collection of Important Guidance on LLC Law: CC Operations

A Collection of Important Guidance on LLC Law:  CC Operations

      In a decision from the U.S. Bankruptcy Court for the Western District of Kentucky, the court was called upon to determine whether certain members of an LLC, it being in bankruptcy, owed to the LLC fiduciary duties. Applying KRS § 275.170(4) which provides, inter alia, that in a manager-managed LLC the members, as members, do not owe fiduciary duties, and the section generally, which allows fiduciary duties to be modified or eliminated in a written operating agreement, it was held that the defendants in the action, the LLC’s members, owed no fiduciary duties. In addition, the court applied the express terms of the operating agreement waiving any liability for breach of a fiduciary or other duty. In re: CC Operations, LLC (Wheatley v. McCarty), Case No. 17-33389-THF, Adv. No. 19-03034-THF, 2020 WL 1970509 (Bankr.  W.D. Ky. April 23, 2020).

      CC Operations, LLC, the debtor in bankruptcy, was a Kentucky limited liability company that, in its articles of organization, elected to the “manager-managed.” Throughout the LLCs existence, while from time to time there had been other members, Chris McCarty and Lewis Pomerance were members, but not managers, of the company. After the company suffered a variety of setbacks, it filed for bankruptcy protection. In this suit, the trustee sought to hold McCarty and Pomerance liable for a variety of claims including breach of fiduciary duty, a variety of theories of fraudulent transfer and piercing the veil.

KRS § 275.170 Says What It Means and Means What It Says

      As “Defendants were only members of the LLC, and in Kentucky, a member of a manager-managed LLC does not owe fiduciary duties to the LLC or its members”, citing KRS § 275.170(4);

Because Debtor’s Amended and Restated Operating Agreement provided that CC Operations was a manager-managed LLC managed by someone other than Defendants, this Court finds further statutory grounds to reject the contention that Defendants, as members, owed any fiduciary duty to CC Operations at any point in time. 

The Operating Agreement Waived Liability

      Addressing liability for the alleged fiduciary duty violations, the Court found that the operating agreements at issue (there were an original and an amended agreement, although the trustee contested whether the amended agreement was properly adopted) waived any fiduciary duties. Specifically, Section 10.2 of the operating agreement provided:

Members of the Company will not be liable to the Company or the other Members for monetary damages for conduct as Members except to the extent the [LLC Act] ... prohibits elimination or limitation of member liability. (bracketed language and ellipses in original).

       In furtherance of KRS § 275.180(1), which as described by the Court provides that “‘A written operating agreement may … [e]liminate or limit the personal liability of a member or manager for breach of any duty provided for in KRS § 275.170.”’, the Court held this language sufficient to have waived any fiduciary duties that might have otherwise been owed the LLC. The Court did clarify, later in its opinion, that this waiver was technically of liability for breach of duties, rather than waiver of the duties themselves.

Adverse Domination Does Not Apply in LLCs

      Turning to the various allegedly improper transfers, with the exception of one tax distribution, the court found that all of the other alleged fraudulent transfers, if indeed fraudulent, had taken place outside the applicable statute of limitations, either two years under the Bankruptcy Code or five years under Kentucky fraudulent conveyance law. Where the trustee had sought to toll the statutes by virtue of the doctrine of adverse domination, the court found that it is applicable to LLCs nor applied outside the discovery rule context.

Adverse domination, a doctrine that tolls the statute of limitation when tortfeasors dominate and control a corporation so as to prevent the corporation from bringing a timely claim against them, is “merely a corollary of the discovery rule, applied in the corporate context.” Notably, the present case deals with an LLC rather than a corporation; this Court is unaware of any Kentucky decision applying the theory of adverse domination to LLCs, and other courts have expressly held that the theory is inapplicable in the LLC context.

      As to the assertion that adverse domination should toll the statute of limitations with respect to any claim for breach of fiduciary duty (and necessarily setting aside the court’s determination that no duties were owed by the individual defendants), the Court wrote:

The Court notes that adverse domination would also not toll the limitations period for any untimely breach of fiduciary duty claims. Under Kentucky law, the doctrine of “adverse domination” does not toll the statute of limitations for breach of fiduciary duty claims, because the “discovery rule” does not apply to claims for breach of fiduciary duty. 

Piercing is a Remedy and Not a Cause of Action

      The trustee’s complaint against McCarty and Pomerance set forth a count for “piercing the veil” to, in effect, hold them individually liable for certain claims against CC Operations and other business entities. This count was rejected on two bases. First, it was noted that “veil-piercing is a remedy for enforcement of a judgment and not an independent cause of action in and of itself, a distinction Trustee does not dispute. Kentucky does not permit veil-piercing as a means of consolidating entities to try and create assets for the debtor company, which is what Trustee apparently seeks to do.” In addition, the Court found that the necessary precedents of a piercing claim, namely “both an ‘egregious failure to follow corporate formalities,’ and ‘a high degree of control over the corporation’s day to day operations and decisions,’” were absent.  Rather:

Trustee fails to establish any such level of control or egregious action by either Defendant; on the contrary, Trustee’s complaint acknowledges that CC Operations had an operating agreement in place, filed separate tax returns, maintained a separate bank account, prepared separate financial statements, and produced regular annual reports, suggesting corporate formalities were indeed followed.

Trustee at no point alleges that either McCarty or Pomerance possessed a controlling membership interest in CC Operations, managed or supervised the LLC or its employees, or was in any way responsible for or involved in its daily operations. Assuming all allegations in the complaint to be true, the evidence of either and “egregious failure to follow corporate formalities” or “a high degree of control over the corporation’s day to day operations and decisions” by either Defendant remains tenuous and inadequately set forth. 

As a point of disclosure, this writer and Stoll Keenon Ogden represented Chris McCarty in this litigation. 

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