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Fiduciary duties owed between members of a limited liability company

Fiduciary duties owed between members of a limited liability company

Arizona law governing partnerships imposes fiduciary obligations between the partners, and similar provisions exist under corporate law regarding fiduciary duties imposed upon directors of closely held corporations in their dealing with shareholders. In the case of TM2008 Investments, Inc. v. Procon Capital Corp., the Arizona Court of Appeals, Division One, determined that members of a limited liability company (LLC) do not owe the same fiduciary duty as in cases involving closely held corporations and partnerships. The appeals court reversed a jury verdict where the trial court did not advise the jury that LLC members did not owe fiduciary duties to the other members except to the extent those contractual fiduciary duties were defined in the LLC’s operating agreement.

Background and procedural history

The case arose from a dispute between members of an LLC formed to develop land into a residential community. After the project failed and the construction loan lender threated foreclosure, the plaintiff LLC member paid the loan in full and filed suit under a loan indemnification agreement to recover half of the money. The defendant, the other member of the LLC, countersued to recover investment and construction-related expenses. The countersuit asserted that both LLC members owe a fiduciary duty to each other like that imposed in closely held corporations and partnerships.

The trial court, without a trial, ruled in favor of the plaintiff on the indemnification claim. Following a jury trial on the countersuit, the jury found that a breach of fiduciary duty had occurred and judgment was entered against the other member personally and the member’s investment company for $1,039,754, plus $93,422 in attorneys’ fees. An appeal was filed in the Arizona Court of Appeals.

The decision of the Court of Appeals

The Court of Appeals reversed the trial court’s decision. The appeals court refused to “mechanically apply” the same fiduciary duty principles to an Arizona LLC that are applicable to closely held corporations or partnership s. The appeals court noted that the Arizona’s Limited Liability Company Act does not specify the duties for members of an LLC. The Act instead allows LLC members to create an operating agreement and define the duties the members owe to each other. The provisions in the agreement are valid and enforceable where they are not contrary to law and relate to the duties or powers of the members.

In this case, the operating agreement stated that a member would not be liable to the LLC or to any other member for damages relating to conduct taken on behalf of the LLC that was taken in good faith and the member used reasonable business judgment in a manner believed to be in the best interests of the LLC.

The appeals court determined that, since the LLC’s operating agreement specified the duties the members owed to each other, the trial court committed error by failing to inform the jury of the limits of liability that were specified in the agreement. The appeals court reversed the jury’s verdict and ordered the case sent back to the trial court for a new trial.

Contact an attorney

Entities seeking to form or dissolve a business organization, or confronted with business litigation matters, should consult qualified legal counsel, experienced in such matters, to ensure that the legal rights of the business are fully protected.