California limited liability company disputes | Courtroom war stories and lessons learned

LLC Operating Agreements Can Reduce Fiduciary Duties

LLC managers owe fiduciary duties both to the LLC and to the LLC’s members, similar to the duties owed by a partner to other partners in a partnership.  (Corp Code §17704.09.)  These include the duty of loyalty, care, and good faith and fair dealing.

While the duty of good faith and fair dealing can never be eliminated, the other duties can be modified by the LLC’s operating agreement.

A recent federal court decision from California’s Northern District — MedCision, LLC v. Stewart (link not available) — illustrates the point.

Facts: LLC operating agreement includes exculpatory provision

MedCision, LLC was founded in 2008 as a Delaware limited liability company to develop medical products and devices.  MedCision’s independent directors included Blair Stewart, Paul Nowak, Rodney Turner, and Heiner Dreismann.

MedCision had “perennial financial struggles,” and finally exhausted its funds by the end of 2017.  MedCision went into bankruptcy in December 2017.

The LLC then filed an adversary proceeding against the directors, alleging various acts of malfeasance during the final months prior to bankruptcy.  The complaint alleged that the board breached its fiduciary duty of care by improperly approving compensation, severance, and other payments for the departing CEO and CFO, and by declining a financing proposal that could have averted bankruptcy.  The complaint alleged that had the board complied with its duty of care, there would have been more value returned to the LLC’s members.

MedCision’s operating agreement contained an exculpatory provision providing that no member, director, or manager would have personal liability to the company for any breach of fiduciary duty or for any act or omission performed or omitted “in good faith on behalf of the company.”

Bankruptcy Court order: summary judgment in favor of the directors

Addressing the directors’ motion to dismiss the complaint, the bankruptcy court converted the motion to a motion for summary judgment, and granted the motion based on the exculpatory provision from the operating agreement.

The LLC appealed to the district court.

Northern District Court’s decision: affirmed; duty of care effectively eliminated

The district court affirmed the bankruptcy court’s order.

The court held that the complaint’s allegations regarding the directors permitting various transaction without undertaking a reasonable effort to inform themselves of the necessary facts or without appropriate deliberation “fell flat” in light of the exculpatory provision.

The court stated: “When confronted with provision like the one here, courts routinely find they entirely shield directors from liability for alleged breaches of the duty of care.”

Thus, the complaint stated “no viable claims” against the directors.

Lesson

LLCs are creatures of contract.  While the core fiduciary duty of good faith and fair dealing can never be eliminated, other fiduciary duties can be reduced, conditioned, explained, or effectively eliminated by the operating agreement.