A Poke Bowl Full of Breached LLC Duties
LLC litigation involves many complex issues, and it’s not always easy to allege a claim properly. Some cases never get out of the starting gate, with the court sustaining a demurrer to the complaint and dismissing the case early.
An opinion recently filed by California’s Fourth Appellate District — Liu v. Xiang — illustrates these challenges. While the Liu case is not published and therefore not binding precedent, it still provides a useful guidepost.
Facts: poki bowl LLC concept fails with scammy behavior
Plaintiff Mengyuan Liu (Liu) invested $250,000 in an LLC formed to manage a new restaurant.
Liu was encouraged to invest by defendant Lin Yun Xiang (Xiang), who touted the idea of a poke restaurant chain to be called “Poki Cat” that would capitalize on “a new health food trend with explosive growth.” According to Xiang’s pitch, an investor would contribute a couple of hundred thousand dollars and obtain 51% of the ownership of a particular restaurant, with a separate entity called Element Catering Group, LLC contributing a nominal amount ($1,000) plus its “management skill and expertise” to obtain 49%. As each restaurant got off the ground, each investor would contribute 2% of his/her shares to Element to make Element the majority owner. It was envisioned that Element would have over 100 subsidiaries (the individual restaurants) and then apply for being listed on the U.S. stock market, making everyone rich.
Liu deposited her funds and became the 51% owner of Poki Cat Innovations, LLC, an entity that would own and operate a restaurant in Mission Viejo. Element became the 49% owner. The LLC was governed by a written operating agreement, which provided that: (1) profits and losses would be allocated according to membership interest percentage; (2) voting interests would be in accordance with membership interests; (3) certain actions needed to be approved by majority vote; and (4) members had the right to appoint and remove managers.
The operating agreement named two insiders of Element (Jin Luo and Emilie Lee) along with Liu to be the three managers of the LLC, with decisions on day to day issues being made by a majority of the managers.
According to Liu’s complaint against Xiang, Element, and several others affiliated with Element:
The restaurant concept failed. Only seven restaurants opened in the following years (far short of the envisioned 100). None made money. Element failed to contribute its $1,000 or any other funds, leaving the restaurants undercapitalized and “continually hungering for cash.” Element’s appointed managers excluded Liu from all decisions, and then unilaterally reduced Liu’s ownership interest from 51% to 42.18% after Liu refused to contribute additional capital. Element’s managers also undertook substantial obligations by the LLC without a member meeting or vote. Element also overcharged the LLC for supplies in self-dealing arrangements, and diverted payments belonging to the LLC to Element.
Liu’s complaint alleged several claims: promissory fraud, constructive fraud, breach of fiduciary duty, breach of contract, and conversion.
Trial court: demurrer sustained without leave to amend; case dismissed
The trial court sustained defendants’ demurrer without leave to amend and dismissed the case.
As to the fraud claims, the trial court held that the allegations lacked sufficient specificity.
As to the fiduciary duty claim, the trial court held that the defendants didn’t owe any duties because Liu was the majority owner of the LLC, not a minority owner.
As to the breach of contract claim, the trial court held that the claim belonged to the LLC, and Liu failed to allege the claim derivatively.
As to the conversion claim, the trial court held that the complaint lacked allegations about any specific amount of money converted.
Court of Appeal: reversed; the complaint stated valid claims
The Court of Appeal partially reversed.
The court affirmed the trial court’s dismissal as to the fraud claims. Liu’s allegations lacked specificity, and focused on “nonactionable opinions or predictions about future events” — i.e., defendants’ projections regarding the anticipated growth and success of the Poki Cat venture.
But as to the other claims, the court held that Liu’s complaint stated valid claims.
While Liu was initially listed as a majority owner, the complaint alleged that the other members ignored her rights, usurped her position as manager, unilaterally reduced her ownership interest to 42.18%, ignored the operating agreement’s voting provisions, and diverted money from the LLC’s revenues to benefit their separate interests, including specific examples. These allegations supported the claims for breach of fiduciary duty, breach of contract, and conversion.
(The opinion did not address this issue, but note that even if Liu had remained a majority member all along, she could still have a viable claim against other members for breach of the fiduciary duty of good faith and fair dealing as set forth in Corporations Code section 17704.09, subdivisions (d) and (f)(1).)
The court held that on remand, Liu would be allowed to amend her complaint and should clarify whether the claims were asserted directly or derivatively.
Lesson
In LLC litigation, the most straightforward claims are almost always breach of fiduciary duty and breach of the operating agreement. Fraud claims require enhanced specificity as to the actionable conduct. Standing (direct vs. derivative) is almost always a consideration, and can be pled in the alternative in unclear situations. The Liu opinion showcased some of these issues.