Opinion ID: 2639041
Heading Depth: 1
Heading Rank: 7

Heading: Issue 2: Who must pay the expenses?

Text: During our review of the district court's holdings in favor of the Company, we are guided by our decision in Investcorp I and by the KRLLCA, but primarily by the language in the Company's operating agreement. We obviously must also consider other events in the case which have occurred since our decision in Investcorp I. Moreover, as in that case, the law of other states is only of moderate assistance. For these reasons, resolution of the latest Simpson family dispute is again fact driven. See 267 Kan. at 847-48. Our decision is therefore limited to the parties and factual situation before us. See State ex rel. Schneider v. City of Kansas City, 228 Kan. 25, 33, 612 P.2d 578 (1980). We begin by reviewing our decision in Investcorp I. The essence of our decision was that though the district court did not err by placing control of dissolution in the Company through its managers, the withdrawing members  primarily because they have a financial interest in the assets of the Company  continued as members during dissolution. See 267 Kan. at 848, 850. As a result, they ordinarily would be subject to the same conditions of membership as the remaining members. This would include, upon dissolution and winding up, entitlement to distribution from remaining assets, but only after all payments to creditors in satisfaction of liabilities of the Company have first been made. See K.S.A. 2003 Supp. 17-76,119(a). The withdrawing members argue, however, this court should find a deviation from this general rule under the circumstances of this case. According to them, the remaining members should pay all these expenses by having these amounts deducted from their share of the eventual distribution of Company assets. We next observe that under the Act, operating agreements are of great importance. According to one commentator, [t]he KRLLCA, continuing and extending the philosophy of its predecessor, is largely a set of default rules, subject to change by the operating agreement. It is this legislative philosophy that gives the LLC form one of its three most important features  flexibility. Hecker, The Kansas Revised Limited Liability Company Act, 69 J.K.B.A. 16, 20 (Nov.-Dec. 2000). Indeed, K.S.A. 2003 Supp. 17-76,134(b) provides: It is the policy of this act to give the maximum effect to the principle of freedom of contract and to the enforceability of operating agreements. In other words, the Act generally authorizes substantial powers. See K.S.A. 2003 Supp. 17-7668 (A limited liability company shall possess and may exercise all the powers and privileges granted by this act or by any other law . . . together with any powers incidental thereto.). The members of the LLC, however, may accept, reject, or modify many of the Act's provisions in their operating agreement, with a few exceptions. See Hecker, The Kansas Revised Limited Liability Company Act, 69 J.K.B.A. at 20 (listing subjects that may be affected by provisions in the operating agreement). Company members, though the facts in Investcorp I established they are sophisticated in business affairs, failed to provide in their operating agreement for the specific factual situation that they have created. By contrast, the KRLLCA invites them to do so. See K.S.A. 2003 Supp. 17-7688(b) (operating agreement may change the general rule regarding member's nonliability for LLC debt to provide that a member or manager may agree to be obligated personally for any or all of the debts, obligations, and liabilities of the company); K.S.A. 2003 Supp. 17-2003 76,134(c)(2) (Member's or manager's or other person's duties and liabilities may be expanded or restricted by provisions in an operating agreement); K.S.A. 2003 Supp. 17-7691 and K.S.A. 2003 Supp. 17-7696 (operating agreement may subject managers and members alike to specified penalties or specified consequences upon the happening of events specified in the operating agreement, or who fail to perform in accordance with, or to comply with, the terms and conditions of the operating agreement). Nevertheless, the withdrawing members argue various sections of the operating agreement can apply to their factual situation, generally Article VI, MANAGEMENT AND CONTROL. It provides in relevant part: 6.1 Designation of Managers. The Managers of the Company shall be those persons designated as such in the Company's Articles of Organization, each of whom shall serve until he resigns or is removed from such position. The Managers, or either of them, may be removed from such position at any time, with or without cause, by the vote of a Majority in Interest in favor of such removal. Any vacancy that may occur in the Manager positions shall be filled by a Member appointed or elected by a Majority in Interest. 6.2 General Powers of Managers. Except as otherwise provided herein, the right and authority to manage, direct, control and conduct the day-to-day business and affairs on behalf of the Company shall be vested exclusively in the Managers, and all decisions effecting or to be made by, and all actions to be taken and obligations to be incurred on behalf of, the Company shall be made, taken or incurred by any Manager. Any decision or act of any Manager within the scope of his power and authority granted hereunder shall control and shall bind the Company. 6.3 Actions Requiring Joint Decision of Managers. Notwithstanding the foregoing, the following actions may only be taken by a Manager on behalf of the Company upon the Agreement of a majority in number of the Managers: (i) the purchase . . . or the sale . . . or the creation of any lien . . . upon. . . (B) any real property; (ii) the creation of any obligation . . . in excess of $500; . . . . 6.4 Limitation of Powers of Managers. Notwithstanding anything herein to the contrary, the Managers shall not take any action or engage in any transaction not in the ordinary course of business without first obtaining the approval of a Majority in Interest. In determining whether a transaction is `not in the ordinary course of business,' the Members recognize that the purposes of the Company include developing and selling the Real Property. Accordingly, the sale or other disposition of any real estate by the Company shall not be considered `not in the ordinary course of business' unless it constitutes a sale of all or substantially all of the Real Property pursuant to a single transaction. 6.5 Powers of Other Members. No Member, other than the Managers, shall have any right or authority to enter into agreements, execute contracts or other instruments, incur obligations or otherwise bind or act for, in the name and on behalf of the Company in any manner, unless authorized to do so by a Majority in Interest. 6.6 Liability of Managers. Except in the case where Managers are guilty of fraud, gross negligence, misconduct or reckless disregard of duty, the Managers shall not be liable to the Company or to any other Member for any loss, damage, liability or expense suffered by the Company or any other Member on account of any action taken or omitted to be taken by him as a Manager. 6.7 Indemnification. (a) Except as provided in Section 6.6 above, each Member, including the Managers, shall indemnify and hold the Company and the other Members harmless from and against any loss or damage incurred by it or them as a result of any agreement, contract, instrument, obligation or act legally binding the Company that was incurred or performed by such Member outside the scope of the authority granted to such Member pursuant to this Agreement. (b) Except as otherwise contrary to the provisions of Section 6.6 or Section 6.7(a) above, each Member shall be indemnified by the Company against any liability, judgment, fine, amount paid in settlement, cost and expense (including attorneys' fees) asserted or threatened against and incurred by such Member in his capacity or arising out of his status as a Member, if such Member acted in good faith and in a manner he reasonably believed to be in the best interests of the Company and provided that such Member has not committed fraud, gross negligence or reckless disregard of duty with respect thereto. According to the withdrawing members' brief, they rely upon section 6.2, and the concept of ultra vires which they contend is found in sections 6.3 and 6.4. They argue no other provisions of the operating agreement need be considered to grant them relief from sharing in the expenses. For their argument regarding section 6.2, they point to the last sentence: Any decision or act of any Manager within the scope of his power and authority granted hereunder shall control and shall bind the Company. They claim that by negative implication, acts outside the scope of a manager's power and authority shall not control and bind the Company. They then argue that if such wrongful acts do not bind the Company, the resulting expenses cannot be imposed upon the withdrawing members. The problem with this argument based upon 6.2 is they do not dispute that the incurred expenses are binding Company obligations. As a result, they argue based upon a point that they have already conceded; their resultant argument must therefore fail. For their argument regarding sections 6.3 and 6.4, they claim these provisions preclude the Company from incurring expenses without a majority of the Managers agreeing to them and without a majority-in-interest of the members approving them. Among other things, they point out that the withdrawing members had not been included in the vote (1) removing Alfred and Mark as managers and (2) electing Reed who, together with fellow rogue manager Donald, had incurred the expenses. They then argue that under the ultra vires doctrine, these roguish acts do not bind the Company and the resulting expenses cannot be imposed upon the withdrawing members. The problem with the withdrawing members' argument based upon sections 6.3 and 6.4 is, once again, that they do not dispute the incurred expenses are binding Company obligations. Accordingly, they again argue based upon a point that they have already conceded; their resultant argument must therefore fail. The withdrawing members' ultra vires argument fails for additional reasons. According to the authority they cite: The term `ultra vires' means beyond the power. An ultra vires act or contract is one that is beyond the powers expressly or impliedly conferred upon a corporation. The act must be beyond the powers of a corporation as defined by its charter and the law.  (Emphasis added.) 18B Am. Jur. 2d, Corporations § 2009. Even if we assume, without deciding, that the ultra vires doctrine applies to limited liability companies, we note that the withdrawing members do not argue that the Company was without the power to incur these expenses. They only argue that the acts were taken without the allegedly required authority, i.e., permission. The ultra vires doctrine generally does not apply to this situation. See 18B Am. Jur. 2d, Corporations § 2012. We also observe that the Company is granted a large amount of general power under the Act. The KRLLCA replaces prior law's exhaustive list of specific LLC powers with a general statement that an LLC has and may exercise all powers and privileges granted by the KRLLCA, any other law, or its operating agreement, along with any incidental powers, insofar as necessary or convenient for its business, purposes, or activities. Hecker, The Kansas Revised Limited Liability Company Act, 69 J.K.B.A. at 17 (citing K.S.A. 1999 Supp. 17-7668[b]). Moreover, within the context of winding up, the Act provides the Company the specific power to perform a number of the particular acts in dispute in the instant case. The persons winding up the LLC have authority to litigate on its behalf, gradually settle and close its business, liquidate its property, pay or make provision for payment of its liabilities, and distribute its remaining assets to its members, all without affecting the liability of its members or managers and without imposing personal liability on any liquidating trustee. Hecker, The Kansas Revised Limited Liability Company Act, 69 J.K.B.A. at 39 (citing K.S.A. 2003 Supp. 17-76,118(b) and K.S.A. 2003 Supp. 76,119[b]). (Emphasis added.) In short, sections 6.2, 6.3, and 6.4 of the operating agreement fail to provide the withdrawing members any deviation from the general rule of liability. Although the withdrawing members advise that we need not consider any other sections of the operating agreement, they note that the district court also relied upon sections 6.6 and 6.7 to deny them relief. They suggest in passing, however, those sections could support their position because the managers who incurred the expenses did engage in misconduct and reckless disregard of duty. We disagree, and instead concur with the district court that these sections actually serve as additional grounds for denying the relief requested. Since the withdrawing members do not contest the binding nature of the Company obligations, the requirements of section 6.7(a) would at first blush appear to provide them some relief. It addresses the scenario where members have bound the Company but by acts outside the scope of their authority. It states that as a general rule, members, including managers, shall indemnify and hold the Company and the other Members harmless from and against any loss or damage incurred by it or them as a result of any agreement, contract, instrument, obligation or act legally binding the Company that was incurred or performed by such Member outside the scope of the authority granted to such Member pursuant to this Agreement.  (Emphasis added.) Even assuming the expenses were incurred outside such authority, however, the withdrawing members would be entitled to have the managers pay those members' shares, i.e., indemnify them, only if the managers were guilty of fraud, gross negligence, misconduct or reckless disregard of duty. See section 6.6 (Managers not liable to Company or members for loss suffered by Company or members except where guilty of fraud, gross negligence, misconduct or reckless disregard of duty). The district court held that the withdrawing members made no such claim and, even if so, there was no evidence to prove such a claim. Our careful review of the record confirms the district court in both respects. First, the closest to a claim on these grounds would have been the withdrawing members' 1996 request for the appointment of a receiver. However, they apparently only argued managerial incompetence and intransigence as their basis. 267 Kan. at 853. Moreover, the record does not reveal any efforts for appointment of a receiver after Investcorp I. Second, though the withdrawing members suggest on appeal the existence of proof of misconduct and reckless disregard of duty, the district court found Donald and Reed's actions were reasonable under the facts. Among other things, the court referenced its findings and conclusions contained in its June 30, 2000, journal entry  as quoted earlier in the opinion  which upheld the propriety of the expenses. Substantial competent evidence supports the court's findings. Additionally, the district court determined that there was no claim and no evidence to prove such a claim, that the remaining members (outside of the rogue managers) performed any act outside their scope of authority. After reviewing the extensive record on appeal, particularly the withdrawing members' motion for limited declaratory relief upon which the journal entry they appeal from is based, we agree. As mentioned, while their brief suggests that sections 6.6 and 6.7 also could apply because misconduct and reckless disregard of duty allegedly did occur, they make no reference to any conduct except the managers.