In “business divorce” litigation involving LLCs, it is common to see a disgruntled LLC member asserting claims against the LLC’s manager. Depending on the type of harm alleged, those claims might be asserted directly (by the member against the manager, arising from harm primarily inflicted on the member), or derivatively (by the member on behalf of the LLC against the manager, arising from harm primarily inflicted on the LLC with downstream effects on the member).
With direct claims between a member and manager, the LLC is often not a party to the case. With derivative claims, the LLC is named as a “nominal defendant” and usually plays only a passive role in the litigation.
Here is an underappreciated fact in LLC Jungle litigation: the LLC itself sometimes has offensive claims against a member that are worth actively asserting. As long as the LLC’s manager duly authorizes the litigation, these are not “derivative” claims — they are claims owned by and asserted by the LLC on its own behalf.
Thus, while the LLC is required to take a passive role in responding to any derivative claims asserted by a member, it can still assert offensive claims against the member in a cross-complaint or a separate action.
LLCs have the power to sue (not just to be sued)
Under Corporations Code section 17701.05, an LLC “shall have all the powers of a natural person in carrying out its business activities, including, without limitation, the power to: … (b) Sue, be sued, complain, and defend any action, arbitration, or proceeding, whether judicial, administrative, or otherwise, in its own name.” Nothing in section 17701.05 limits the LLC’s power to sue to only claims against third parties.
Similarly, under Corporations Code section 17701.04, an LLC “is an entity distinct from its members.” This means that “members of the LLC hold no direct ownership interest in the company’s assets” including potential claims. (PacLink Communications Inter., Inc. v. Superior Court (2001) 90 Cal.App.4th 958, 964.) As such, where an injury occurs to the entire LLC or its assets, it is for the LLC “to institute and maintain a remedial action.” (Id. at 966, quoting Nelson v. Anderson (1999) 72 Cal.App.4th 111, 125-126.)
Below are some areas worth highlighting for potential LLC claims against a member.
Breach of Operating Agreement
Depending on the language of the LLC’s Operating Agreement, the LLC might have potential claims for Breach of Contract against members who fail to comply with their duties — e.g., failure to make required capital contributions. (The Operating Agreement might also specify less cumbersome remedies for such failures, such as membership interest dilution for unequal contributions.)
Breach of Fiduciary Duty (Good Faith and Fair Dealing)
Some published opinions state that in a manager-managed LLC, only the manager owes fiduciary duties and the members do not owe such duties. But that’s not what the statute says.
Corporations Code section 17704.09 addresses the fiduciary duties of LLC members and managers. Subdivision (d) states: “A member shall discharge the duties to a limited liability company and the other members under this title or under the operating agreement and exercise any rights consistent with the obligation of good faith and fair dealing.” Subdivision (f)(2) states that in a manager-managed LLC, the duty of good faith and fair dealing applies to members as well as managers.
Thus, while the duty of good faith and fair dealing is usually discussed as a contract principle, it also exists as a species of fiduciary duty owed to the LLC that uniquely applies to both members and managers.
Dissociation
Dissociation is an event whereby a member’s “right to vote or participate as a member in the management and conduct of the limited liability company’s activities terminates.” (Corporations Code section 17706.03.) There are several potential triggers for dissociation, but one involves an affirmative claim by the LLC.
Under Corporations Code section 17706.02(e), a member may be expelled (or dissociated) by judicial order upon application by the LLC if the member has: (1) engaged in wrongful conduct that has adversely and materially affected, or will adversely and materially affect, the LLC’s activities; (2) willfully or persistently committed a material breach of the operating agreement or fiduciary duties; or (3) engaged in conduct relating to the LLC’s activities that makes it not reasonably practicable ot carry on the activities with the person as a member.
Conversion
Since the LLC’s assets are owned by the LLC and not its members, the LLC is the proper party to assert claims for conversion against a member who wrongfully takes the LLC’s assets.
Declaratory Relief
Issues ripe for a claim for declaratory relief by an LLC against a member might involve compliance with capital contribution requirements, efficacy of managerial removal efforts, membership status, and ownership percentages.
[View source.]
