Source: https://www.nybusinessdivorce.com/2015/12/articles/llcs/can-llc-members-walk-away-from-fiduciary-duties/
Timestamp: 2020-07-15 08:30:55
Document Index: 350477743

Matched Legal Cases: ['§ 401', '§ 401', '§ 409', '§ 401', '§ 401', '§ 401', '§ 409', '§ 401', '§ 401']

Can LLC Members Walk Away From Fiduciary Duties? | New York Business Divorce
Home » Can LLC Members Walk Away From Fiduciary Duties?
Now let’s tamper with the last of the above default rules. Assume the Acme company is a two-member, 50/50, New York LLC whose articles of organization do not designate it as manager-managed hence its management is “vested” in its members subject to provision otherwise in its operating agreement as authorized by LLC Law § 401 (a). Further assume Acme’s operating agreement expressly vests sole management authority in one of the two members. Does Acme’s other, non-managing member owe fiduciary duties? About two years ago, in Kalikow v Shalik which I wrote about here, Nassau County Commercial Division Justice Vito M. DeStefano answered that question in the negative, reasoning that § 401 (a)’s vesting of management powers in the members is made subject to the operating agreement, and that LLC Law § 409 (a) imposes duties on LLC “managers” with no mention of non-managing members. So far so good. Now let’s try another, stickier variation. Assume Acme has no operating agreement, that from inception its two 50/50 members jointly managed it, but there came a time when one member announces to the other that he “withdraws” from all management responsibility — but still maintaining his membership interest and entitlement to his pro rata share of Acme’s profits — following which he forms and operates a competing business. Has the “withdrawn” member taken on the status of a non-managing member and successfully shed his fiduciary duties, thereby permitting him to compete freely against his own company?
Gilbert v Weintraub
The preceding question was posed but not directly answered in a decision handed down last month by Nassau County Commercial Division Justice Timothy S. Driscoll, denying a preliminary injunction motion in Gilbert v Weintraub, Index No. 602290/15 (Sup Ct Nassau County Nov. 24, 2015). The case involves a pair of agencies organized as New York LLCs that represent a variety of manufacturers of giftware and other merchandise. Gilbert and Weintraub are the sole, 50/50 members of each LLC, neither of which has an operating agreement or employment agreement with its two owners.
Amid escalating tensions between the two of them, in early 2015 Weintraub’s lawyer sent Gilbert correspondence proposing in broad, conceptual terms various judicial and non-judicial options for separating the two owners, including Weintraub “terminat[ing] his relationship with the LLCs and establish[ing] a business on his own to compete with the LLCs.”
In April 2015, alleging that Weintraub not only threatened to start a competing business but had already done so, Gilbert filed suit for damages and injunctive relief, and concurrently moved to preliminarily enjoin Weintraub from engaging in competitive activities. Justice Driscoll granted a temporary restraining order pending his determination of the motion. Weintraub’s opposing affidavit filed later that same month denied that he had formed a competing business or was competing in any way. However, while the motion remained pending and after the collapse of settlement negotiations in September 2015, Weintraub sent Gilbert a letter stating that effective two days later, “I withdraw from and cease any position of management or responsibility which I maintain as a member of [the LLCs] . . . and I resign as an employee of [the LLCs].” The letter goes on to state that Weintraub reserves the right “to participate in the profits of [the LLCs] as a member” and to “participate in the management of [the LLCs] in the future if and when I choose to do so.”
About a week later, Weintraub formed his own sales agency business and, according to Gilbert’s subsequent affidavit, was actively impeding and/or taking away business from their jointly owned agencies. Weintraub’s reply affidavit minimized but did not deny some competitive impact of his new business on the subject LLCs.
Gilbert’s legal argument in support of his injunction motion rested on the provision in LLC Law § 401 (a)’s default rule, mentioned above, vesting management in the members of an LLC not otherwise designated in the articles of organization as manager-managed, thereby tagging Weintraub with the fiduciary duties of a managing member whether he likes it or not, i.e., not subject to repudiation absent the other member’s consent.
Weintraub’s opposing legal argument also rested on LLC Law § 401, but not subdivision (a). Rather, Weintraub cited § 401 (b) which states:
If management of a limited liability company is vested in its members, then (i) any such member exercising such management powers or responsibilities shall be deemed to be a manager for purposes of applying the provisions of this chapter, unless the context otherwise requires, and (ii) any such member shall have and be subject to all of the duties and liabilities of a manager provided in this chapter. [Emphasis added.]
Under Weintraub’s reading of subdivision (b), the phrase “exercising such management powers or responsibilities” leaves each LLC member free to exercise or not to exercise management authority, therefore a member who avowedly refrains from doing so, in the words of the provision, is not “deemed to be a manager for purposes of” the LLC Law including § 409 defining the duties of a manager. In other words, by withdrawing from his management duties, according to Weintraub, he put himself in the same position as the defendant non-managing member in the Kalikow case mentioned above, even though in that case the operating agreement explicitly withheld from the defendant all management authority.
Weintraub’s argument was boosted by a letter sent by Gilbert’s lawyer to a number of the LLCs’ manufacturer clients soon after Weintraub formed his new entity, advising them that Weintraub had resigned his management responsibilities and that his role with the LLCs was limited to that of a member “with no management power,” leaving Gilbert with “exclusive power to make all management decisions.” On the other hand, the letter also asserted that were Weintraub to engage in a competing business he would be in breach of his fiduciary duties to Gilbert and the LLCs.
Does counsel’s letter push Gilbert into Kalikow territory? Perhaps.
Justice Driscoll’s decision, denying Gilbert’s injunction motion and vacating the previously granted restraining order, carefully recites the parties’ contentions and summarizes the applicable legal principles, including references to an LLC member’s “duty of undivided loyalty” akin to the duties among partners (citing Willoughby Rehabilitation & Health Care Center, LLC v Webster, 13 Misc 3d 1230(A) [Sup Ct Nassau County 2006]). The decision does not, however, address the parties’ dueling reliance on the two subdivisions of LLC Law § 401, nor does it pronounce whether Weintraub had the right to withdraw from his management duties and proceed as a non-managing member stripped of fiduciary obligations.
Rather, Justice Driscoll states that Weintraub in his dealings with Gilbert had taken “a reasoned approach to the termination of the parties’ business relationship” and had not “engaged in any improper conduct vis a vis [Gilbert], or withheld any material information from [Gilbert],” and therefore Gilbert failed to establish a likelihood of success on the merits of his claim against Weintraub for breach of fiduciary duty. The decision also finds that Gilbert failed to demonstrate a balancing of the equities in his favor, inter alia, based on the absence of evidence that the decision of certain manufacturers to continue working with [Weintraub and his new company] was attributable to any improper conduct by [Weintraub].”
So, as warned at the outset, the Gilbert decision does not resolve the tantalizing question whether a member of a member-managed LLC, absent provision in an operating agreement altering § 401’s default rules, can jettison fiduciary duties, including the duty not to compete, by unilaterally disavowing any management role while remaining a member. It’s still possible the Gilbert case will produce an answer to the question: there’s a pending motion by Weintraub to dismiss the case in which he contends anew that he owes no fiduciary duty to the LLC or its other member. On the other hand, not long after Gilbert filed his lawsuit, Weintraub filed his own action seeking to dissolve the two jointly-owned LLCs, making it even harder to predict if the court will be required to decide the issue which, I can say from my own experience, is a recurring one in the world of multi-member LLCs and is a reminder — as if another one is needed — that LLC members who go into business without an operating agreement can only blame themselves when troubles arise.
Update December 26, 2015: The open question remains alive and well following an initial decision by Justice Driscoll in the dissolution proceeding brought by Weintraub, filed on December 17, 2015 (read here), setting it down for an evidentiary hearing next year in conjunction with the trial of Gilbert’s suit. The supporting and opposing papers filed in the dissolution case predated Weintraub’s resignation letter and formation of his new company, hence the decision mentions neither event. Meanwhile, Weintraub’s motion to dismiss Gilbert’s suit apparently remains undecided.
Tags: compete, DeStefano, dissociate, Driscoll, fiduciary, Gilbert, manager-managed, member-managed, Weintraub, Willoughby, withdraw