Tuesday, November 27, 2018

Not the Default Rule, But LLC Members Definitely Can Be Employees

Last week I posted Can LLC Members Be Employees? It Depends (Because of Course It Does), where I concluded that "as far as I am concerned, LLC members can also be LLCs employees, even though the general answer is that they are not. " I thought I would follow up today with an example of an LLC member who is also an employee.  

I am not teaching Business Associations until next semester, but it galls me a little that I did not note this case last week, as it is a case that I teach as part of the section on fiduciary duties in Delaware.  

The case is Fisk Ventures, LLC v. Segal and the relevant facts excerpted from the case are as follows: 
Genitrix, LLC, is a Delaware limited liability company formed to develop and market biomedical technology. Dr. Segal founded the Company in 1996 following his postdoctoral fellowship at the Whitehead Institute for Biomedical Research. Originally formed as a Maryland limited liability company, Genitrix was moved in 1997 to Delaware at the behest of Dr. H. Fisk Johnson, who invested heavily. 
Equity in Genitrix is divided into three classes of membership. In exchange for the patent rights he obtained from the Whitehead Institute, Segal's capital account was credited with $500,000. This allowed him to retain approximately 55% of the Class A membership interest. . . . 
Under the [LLC] Agreement, the Board of Member Representatives (the “Board”) manages the business and affairs of the Company. As originally contemplated by the Agreement, the Board consisted of four members: two of whom were appointed by Johnson and two of whom were appointed by Segal. In early 2007, however, the balance of power seemingly shifted. . . . 
Dr. Andrew Segal, fresh out of residency training, worked for the Whitehead Institute for Biomedical Research . . . [and when he] left the Whitehead Institute and obtained a license to certain patent rights related to his research.
With these patent rights in hand, Dr. Segal formed Genitrix. Intellectual property rights alone, however, could not fund the research, testing, and trials necessary to bring Dr. Segal's ideas to some sort of profitable fruition. Consequently, Segal sought and obtained capital for the Company. Originally, Segal served as both President and Chief Executive Officer, and the terms of his employment were governed by contract (the “Segal Employment Agreement”). Under the Segal Employment Agreement, any intellectual property rights developed by Dr. Segal during his tenure with Genitrix would be assigned to the Company.

Fisk Ventures, LLC v. Segal, No. CIV.A. 3017-CC, 2008 WL 1961156, at *2 (Del. Ch. May 7, 2008) (emphasis added) (footnotes omitted).  

So, for my purposes, that's a solid example of an LLC member who is also an employee, and it is from a case featured in more than one casebook, I might add.  

Co-blogger Joan Heminway noted in a comment to last week's post that what it means to be an employee can vary, based on statutory and other conditions, which is certainly true. I stand by my prior conclusion that it depends on the case whether a particular member of an LLC is an employee, and even that can vary based on context.  Thus, LLC members are not inherently employees, and perhaps most of the time they are not, but it's also true that LLC members can be employees. 

Finally, as to the Fisk Ventures case, in case you're curious, the short of it is that Fisk decided not to provide additional financing to Genitirx, and Segal sued claimed that not doing so breached certain fiduciary duties under the LLC agreement and further various acts "tortiously interfered with the Segal Employment Agreement."  Ultimately, Chancellor Chandler determined that there was no duty breached, the obligation of good faith and fair dealing did not block certain members from exercising express contractual rights, and the agreement's clause disclaming any fiduciary duties was valid.  



Contracts, Delaware, Joshua P. Fershee, LLCs | Permalink


Great post. I often suggest to students that having LLC members enter written employment contracts with the LLC is a great way of protecting against certain kinds of actions by majority owners, and it can be useful for tax planning purposes.

Posted by: Frank Snyder | Nov 29, 2018 9:56:08 AM

Respectfuly, I must disagree.
First, a mea culpa. I accidentally posted the draft of the case review to which Joshua responded. I'll get the corrected one up shortly.
That said, and it is a broader topic that I have covered in a recent article in the Journal of Passthrough Entities, a member of an LLC (or a partner in a partnership) is typically not an employee. But here context matters. An "employee" for what purpose or, to put it another way, how does this context define who is an "employee."
That there is a case that used "employee" language does not I think alter the conclusion that members/partners are at lesat generally not employees.

Posted by: Tom Rutledge | Dec 3, 2018 8:26:48 AM

Thanks for the comment, Tom. I absolutely agree that members/partners are not usually employees simply by virtue of being members/partners and that context matters. My point is simply that while status as a member/partner does not usually make one an employee, one cannot assume a member/partner is NOT an employee, either, without looking at the whole situation. Some of the cases seemed to imply that a member/partner cannot be an employee, and that's not true. But lacking an employment agreement or some other overt and specific evidence of employment, odds are the member/partner is almost certainly not an employee. I'm just reacting to what I see as a risk that some may believe a member/partner cannot be an employee, which is not the case.

Posted by: Joshua Fershee | Dec 3, 2018 8:37:54 AM

Post a comment