Operating an LLC in Good Faith

Posted by Hecht Walker, P.C.
Posted on April 25, 2017

Mr. Chausmer is Senior Counsel with the Firm and is a frequent speaker at CLEs to other business attorneys on matters involving LLCs, disputes related to fiduciary duties, and member-asserted derivative actions.

Limited liability companies are a very popular form of incorporation. Many people prefer them for their ease of incorporation and simplicity in governance. Among other things, they do not require an underlying set of rules – like corporate bylaws – to be incorporated. This is because there is already an established default statutory scheme available as a default.

If the membership elects to have an operating agreement for the LLC, the members must abide by it.

But what about the LLC, which is frequently not a specifically designated signatory of the operating agreement? It is common sense that the LLC is bound by its own governing document, right? O.C.G.A. § 14-11-101(18) confirms this, stating  “except as otherwise provided in the operating agreement, [the LLC] is bound by its operating agreement whether or not the limited liability company executes the operating agreement.”

This common-sense rule is sometimes forgotten by members and managers of the LLC. The Georgia Court of Appeals recently reaffirmed this rule when it reversed a trial court’s grant of a motion to dismiss in Practice Benefits, LLC v. Entera Holdings, LLC, A16A1946 (March 14, 2017). But it bears noting that – in order for this reversal to happen – the LLC first had to convince a Georgia trial judge that the LLC was not bound by its own operating agreement.

Practice Benefits was a member in Entera Holdings, LLC, a manager-managed LLC. Although the LLC’s operating agreement granted each member one vote, Practice Benefits had been historically allowed 2 votes because the operating agreement had been drafted before two of the LLC’s intended members chose to form Practice Benefits to hold their interests in Entera. Despite this inconsistency, Practice Benefits was still allowed 2 votes.

Later, when it came time to amend the LLC’s operating agreement to formalize this voting arrangement, the LLC’s manager refused and would only allow Practice Benefits to cast one vote moving forward. The manager then made distributions to all of Entera’s members except Practice Benefits.

Because the LLC’s manager owed a fiduciary duty to both the LLC and its members under O.C.G.A. § 14-11-305(1), Practice Benefits sued both the LLC and the manager, individually. But Practice Benefit’s claims were asserted directly against the manager and were not asserted derivatively on behalf of the LLC.

A derivative action is the standard way to hold a manager liable for potential breaches of fiduciary duties owed to members. This is because a derivative lawsuit is intended to benefit the LLC and all members based on the belief that a manager’s misconduct would adversely impact the LLC in its entirety.

There is a common exception to requiring derivative actions, however, when only 1 member suffers a “special injury” – an injury that only that member suffers and is different from one suffered by any other member of the LLC.

Here, because the manager had specifically targeted Practice Benefits – by depriving only Practice Benefits of its voting rights and distributions – the Court of Appeals reversed the trial court’s dismissal of Practice Benefits claims against the manager and held that Practice Benefits could sue the manager directly.

The Practice Benefits decision is a reminder that sometimes even the obvious things can be overlooked and not all decisions – either by LLCs or judges – should be presumed to be correct and proper

For more information, contact our business lawyers today.

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