Another LLC Attorney Disqualified Due to “Conflict of Authority”
A prior LLC Jungle post covered the Court of Appeal’s seminal opinion in the Jarvis v. Jarvis case here: Why Having “Co-Managers” for Your LLC is a Terrible Idea. In the Jarvis case, the Court of Appeal affirmed the disqualification of an attorney not on the typical grounds of an ethical “conflict of interest,” but rather, based on a “conflict of authority” — i.e., the attorney was hired by one of the two 50/50 general partners of a partnership, over the other partner’s objection.
In a case recently filed by California’s Sixth Appellate District — Altva Capital Management Limited v. Chung — the Court of Appeal followed the framework from Jarvis and affirmed the trial court’s disqualification of an attorney representing an LLC. While the Altva case is unpublished and therefore not binding precedent, it still provides a useful guidepost and confirms the impact of Jarvis on this area of the law.
Facts: LLC co-managed by divorcing spouses; wife hires attorney to represent the LLC in her own derivative action
Elizabeth Chung and David Chung were a married couple. Title to their home was held by their LLC – Bend Capital, LLC. Elizabeth and David were the only two members of the LLC. Each held a 50% interest, and each was a managing member.
During their divorce proceedings, Elizabeth and David disputed whether the LLC owed money on a loan then held by Altva Capital Management Limited (“Altva”). David contended that the loan was legitimate; Elizabeth contended the loan was a fraud perpetrated by David.
Elizabeth filed a lawsuit against David, Altva, and other parties, and included a derivative claim on behalf of the LLC seeking to invalidate the loan. Her lawsuit alleged that David, in violation of his fiduciary duties to the LLC, fabricated the loan to extract money from the LLC. Altva filed cross-claims against the LLC, Elizabeth, and David.
Without David’s consent, Elizabeth retained attorney Mikael Abye to represent the LLC in the action. Abye filed a demurrer on the LLC’s behalf against Altva’s cross-complaint. The next day, David filed a motion to disqualify Abye.
Trial court: attorney disqualified
The trial court granted the motion to disqualify Abye from representing the LLC.
The court observed that while the LLC’s operating agreement allowed either member to bind the LLC “in all matters in the ordinary course of business,” the representation of the LLC in a case featuring a dispute between the LLC’s two members was “outside the ordinary course” of the LLC’s business.
Court of Appeal: affirmed
The Court of Appeal affirmed, following the framework of the Jarvis case.
The court started by reviewing the LLC’s operating agreement. Section 4.1 of the agreement stated that the LLC would be managed by its members, and that any member could bind the LLC in all matters “in the ordinary course” of business. Matters outside the ordinary course were to be resolved by a “majority” vote — which here would be a unanimous vote since there were only two members who each held a 50% interest. The agreement contained no tie-breaking mechanism, and the court refused to infer one, holding that “devising a tie-breaking procedure would rewrite the operating agreement.”
The LLC, the court noted, “is embroiled in litigation because its two equal members disagree about the subject matter of the lawsuit.” The court agreed with the trial court’s conclusion that “the defense of this lawsuit, pitting equal member against equal member, is not a matter in the ordinary course” of the LLC’s business. As such, the operating agreement did not permit Elizabeth to “unilaterally retain counsel” and direct the LLC’s defense.
Lesson
The unpublished Altva case echoes the lessons from the seminal Jarvis opinion.
If an LLC has two managers, the operating agreement should include some type of tie-breaking mechanism to avoid deadlock on important issues. The agreement could, for example, provide for the appointment of a neutral provisional manager to cast a tie-breaking vote.
Where such a tie-breaking mechanism is absent from the operating agreement and a deadlock erupts, a receiver might need to be appointed to make decisions for the LLC on the deadlocked issues. Alternatively, parties should consider entering into a “Jarvis Stipulation,” under which both parties agree that: (1) the LLC need not actively participate in the case, (2) the parties will litigate all disputed issues, and (3) the LLC will be bound by the outcome. Such a Stipulation should be approved via court order.
Also, it should be obvious by now that attorneys need to tread very carefully when asked by only one of two managers to represent the LLC.