LLC Manager Causing the LLC to Pay Its Debt to a Related Entity is Not a Breach of Fiduciary Duty
The spectrum of LLC manager conduct that potentially constitutes an actionable breach of fiduciary duty is broad and varied, and the claims are almost always resolved based on the specific facts.
A case recently filed by California’s Second Appellate District — Fleming v. De La Torre — features claims based on the LLC’s payment of a loan from a related entity that was not documented in the LLC’s books and records, an amendment to the LLC’s operating agreement using an online form, and a capital call during the litigation. While the Fleming opinion is not published and therefore not binding precedent, it still serves as a useful guidepost.
Facts: LLC manager pays down an undocumented loan from a related entity
In the early 1990s, friends Tabitha De La Torre and Peter Robbins went into business together and created a graphic design firm, Bird Design, Inc. as equal owners. The business enjoyed two successful decades.
Using some of the profits from Bird Design, De La Torre and Robbins formed Lucas King, LLC as a single-asset entity to purchase and manage an office building on Sunset Boulevard in Hollywood. The LLC’s original operating agreement provided that De La Torre and Robbins were each 50 percent members and co-managers with full authority to act for the LLC.
The LLC borrowed money from Bird Design totaling $700,000 for the purchase of the building and to fund post-sale improvements. The loans were never documented in a written agreement or in either company’s books and records or tax returns.
Robbins and his wife, Harriet Fleming, divorced in 2009 and as a result of the divorce settlement Fleming obtained half of Robbins’ 50 percent interest in the LLC.
In connection with a refinancing of the mortgage on the LLC’s property, De La Torre could not find a copy of the LLC’s original operating agreement, so she created a new one using an online service. The revised operating agreement confirmed the ownership (De La Torre with 50 percent and Robbins and Fleming with 25 percent each), and designated De La Torre as the managing member with authority to act for the LLC. All parties signed the revised operating agreement.
The refinancing allowed the LLC to pay off the original mortgage obligation, and left some cash remaining. De La Torre proposed that $250,000 of the cash surplus be paid to Bird Design as partial repayment of the loans from Bird Design, and all three members agreed to this payment.
Later, the parties decided to go their separate ways and dissolve Bird Design. De La Torre followed the LLC’s accountant’s advice and Bird Design wrote off the remaining debt owed by the LLC ($450,000). None of the members objected.
A couple of years later, Robbins and Fleming sued.
Trial court: manager did not breach fiduciary duties
Robbins and Fleming claimed that De La Torre breached fiduciary duties because Bird Design “had not really loaned” the LLC any money, as the LLC’s books and records showed no loan.
During the litigation, De La Torre issued a capital call from the LLC’s members to address cash shortfalls resulting from the loss of tenants during the Covid-19 pandemic. Robbins and Fleming refused to pay and sought a preliminary injunction barring De La Torre from diluting their membership interest in the LLC as a result. The trial court granted the preliminary injunction, ruling that any funds contributed by De La Torre would be treated as a loan and not constitute the basis for membership interest dilution. De La Torre went on to contribute $60,000 to avoid foreclosure of the property.
Following a 10-day bench trial, the court issued a judgment in De La Torre’s favor. It found that Bird Design loaned $700,000 to the LLC for the purchase and renovation of the property, that Robbins and Fleming consented to the partial repayment and the write-off of the remaining amounts owing, and that De La Torre’s conduct as manager was reasonable and not wrongful. The court also rejected the claims challenging De La Torre’s capital calls.
Robbins and Fleming appealed.
Court of Appeal: affirmed (mostly)
The Court of Appeal affirmed most of the judgment.
The court confirmed that De La Torre did not breach fiduciary duties by causing the LLC to partially pay its loan debt to Bird Design. The court noted that the “viability of plaintiffs’ claims turns entirely on whether Bird Design loaned Lucas King money for the purchase and renovation of the property” and the evidence in the record was enough to confirm that the loan did occur.
While the LLC’s books and records showed nothing, De La Torre’s testimony alone — which the trial court found was credible — was sufficient. The court noted: “The failure of the ledgers and tax returns to document Bird Design’s loan means, as the trial court found, that those records are inaccurate, which is not surprising given how the two companies were operated by the long-time friends; the fact that no one documented the loan does not mean it wasn’t made.” The court also referenced the trial court’s finding that Robbins’ and Fleming’s testimony on this issue was not credible and was contradicted by their earlier deposition testimony, in which they admitted the loan had been made.
Since there was a loan from Bird Design to the LLC, De La Torre’s conduct was reasonable and in good faith.
The court reversed the trial court’s judgment only on one point: it disagreed with the trial court’s conclusion that De La Torre was authorized as manager to issue capital calls for the LLC in order for the LLC to pay its debts. The terms of the revised operating agreement did not authorize additional capital calls. It merely allowed members to advance funds voluntarily, which would be treated as a loan. Since the operating agreement did not authorize additional capital contributions being required, and since the statutory scheme weighs against personal liability of LLC members for the LLC’s obligations, the manager did not have the authority to require additional capital contributions.
Lesson
The Fleming case features several facts that tend to recur in LLC litigation: poorly documented financial transactions, disputes over LLC payments and obligations, and capital contribution requirements. Under the specific facts of the case, the LLC’s failure to document a loan transaction didn’t mean the loan didn’t occur, and the manager acted reasonably in causing the LLC to pay those loans.