Brief Fact Summary.
Fisk Ventures, LLC (Plaintiff), a member of Genitrix, LLC (Genitrix), brought suit to dissolve Genitrix. Segal (Defendant), the founder, president and sole officer of Genitrix, answered the petition and filed counterclaims and third-party claims, arguing various claims for breach of contract and fiduciary duties. The counterclaim and third-party defendants moved to dismiss these claims, stating that, if at all, their actions represented the exercise of their contractual rights.
Synopsis of Rule of Law.
LLC members do not breach their fiduciary duties or their LLC agreement, under which is the implied covenant of good faith and fair, by exercising the contractual rights permitted them in the agreement.
Segal (Defendant) founded Genitrix, LLC (Genitrix), in which the equity was divided into three classes of membership, Segal (Defendant) held 55 percent of Class A; Fisk Ventures, LLC (Fisk) (Plaintiff), Johnson (who controlled Fisk (Plaintiff)), Freund, and Rose held the Class B interests; and the Class C interests were held by passive investors. Genitrix’s LLC agreement (LLC Agreement) divided power among the Class A and Class B members, but was drafted in such a way as to require the cooperation of the Class A and B members. Defendant appointed two of the five board members, while the Class B members were able to appoint the remaining three. The Class B members also had a put right, so they could, at any time, force the company to purchase any or all of their Class B interests at a price determined by an independent appraisal. If exercised, the put would subrogate what otherwise would be senior claims of new investors. This made it difficult to raise money from new investors, but the Class B members refused to relinquish or suspend their put right. The company had much difficulty raising capital, which caused a Fisk (Plaintiff) note to convert to Class B equity, which diluted the Class A and C interests. Segal (Defendant), who was desperately seeking to raise new money, drafted a Private Placement Memorandum (PPM), but the Class B board representatives refused to consent to it, claiming Defendant was acting in haste. Although the Class B representatives asked to discuss the PPM at a board meeting, the meeting never occurred because the Class A representatives refused to take part in any meetings. Even though Plaintiff continued to make capital contributions throughout, the business eventually ran out of operating cash and stalled, and Plaintiff brought suit to dissolve Genitrix. Defendant made counterclaims against Plaintiff and third-party claims against Johnson, Rose, and Freund. Specifically, Defendant contended that the counterclaim/third-party defendants breached the LLC Agreement, breached the implied covenant of good faith and fair dealing implicit in the LLC Agreement, and breached their fiduciary duties to the company mainly by standing in the way of proposed financing. The counter-claim/third-party defendants moved to dismiss Defendant’s claims, arguing that he failed to state a claim upon which relief could be granted because his allegations suggested little more than the exercise of their contractual rights.
Do LLC members breach their fiduciary duties or their LLC agreement, under which is the implied covenant of good faith and fair, by exercising the contractual rights permitted them in the agreement?
(Chandler, Chan.) No. LLC members do not breach their fiduciary duties or their LLC agreement, under which is the implied covenant of good faith and fair, by exercising the contractual rights permitted them in the agreement. In this case, the LLC Agreement did not create duties that the counterclaim/third-party defendants breached. While it may be true, as Segal (Defendant) asserts that if only the Class members had acquiesced to his requests, the company would be thriving, but it may also be true that the company would be thriving if Defendant had acquiesced to the Class B members’ wishes. Regardless of who had the better business judgment, the LLC Agreement did not require either group to acquiesce to the other.
In spite of Defendant’s argument to the contrary, the LLC Agreement did not create a code of conduct for its members; but rather, the LLC Agreement served to limit or waive liability to the maximum extent permitted by law. Just because the LLC Agreement limited liability to instances where members acted with gross negligence, fraud, or intentional misconduct, this exculpatory provision did not and could not impose an all encompassing and seeming boundless standard of conduct. Even if it did, the court could not enforce a standard such as this because there would be no limit to its applicability. Finally, even if the LLC Agreement did somehow create a code of conduct for members, Defendant has failed to allege facts sufficient to support a reasonable inference that the counterclaim/third-party defendants beached this code; at most, they vigorously championed their own proposals and did not support Defendant’s plans. They did nothing that was grossly negligent, in bad faith, fraudulent, or willful. Regarding the breach of the implied covenant of good faith and fair dealing, which is implied in every contract and requires a party to a contract to refrain from acting in such a ways as to prevent the other party from receiving the fruits of the bargain, this covenant is not a contractual gap filler. Rather, it is intended to give effect to the spirit of what was actually bargained for. Therefore, it cannot be invoked where the contract itself expressly covers a particular subject.
Defendant argues that the counterclaim/third-party defendants breached the implied covenant by challenging or blocking the financing opportunities he proposed. However, neither the LLC Agreement nor any other contract gave him the right to unilaterally decide what fundraising or financing opportunities Genitrix should pursue. Furthermore, the LLC Agreement did address the subject of financing, specifically requiring the approval of 75 percent of the board. Implicit in such a requirement was the right of the Class B board representatives to disapprove of and therefore block Defendant’s proposals. In other words, simply exercising one’s contractual rights, without more, cannot constitute a breach of the implied covenant of good faith and fair dealing. Negotiating forcefully and within the bounds of rights granted by the LLC Agreement not the same as a breach of the implied covenant on the part of the Class B members. Finally, as to Defendant’s breach of fiduciary claims, these must also be dismissed because the LLC Agreement restricts or eliminates these to the maximum extent permitted by law and because even if the Class B members had a duty to not act in bad faith or with gross negligence, Defendant failed to plead facts in support of claims that anyone had breached such a hypothetical duty. The motion to dismiss Segal’s (Defendant) claims is granted.
In this case, the Genitrix LLC Agreement eliminated fiduciary duties to the maximum extent permitted by law by stating clearly that members had no duties other than those expressly articulated in the Agreement. Because the Agreement did not specifically articulate fiduciary obligations, they were eliminated. This is in accord with the view that where it is more likely that sophisticated parties have carefully negotiated their governing agreement, as in an LLC agreement, they should be able to eliminate fiduciary duties altogether.