Monday, October 28, 2019
[Not] Usurping an LLC Opportunity: A Tale of Two Brothers
The recent Tennessee Court of Appeals decision in Mulloy v. Mulloy has me thinking. Here is the case synopsis:
Two brothers formed a limited liability company to own and lease a commercial property. When the tenant sought to expand, both brothers sought to find a suitable space for the tenant to lease. The younger of the two brothers found a property that would ideally suit the tenant’s needs, a fact that was communicated to his brother. The older brother purchased the property through a newly created limited liability company without his younger sibling’s involvement. The older brother’s new limited liability company then leased the new property to the tenant. The younger brother brought a derivative suit against his brother and the newly formed limited liability company, claiming usurpation of a corporate opportunity belonging to the limited liability company that the brothers had formed together and tortious interference with business relationships. The younger brother also claimed unjust enrichment. Following a trial, the chancery court found in favor of the older brother and his newly formed limited liability company and dismissed the complaint. After our review of the record, we affirm.
The facts are quite a bit more complex than that. But you get the idea.
First, let me make Josh Fershee's point for him: limited liability company (LLC) members cannot usurp "corporate" opportunities, since they are not corporations. Indeed, the court in Mulloy repeatedly refers to the doctrine in that way and cites to corporate law precedent we all know and love. This despite an accurate citation to Tennessee's statutory standard for the usurpation of LLC opportunities: requiring members to hold in trust for the LLC "any property, profit or benefit derived by the member in the conduct . . . of the LLC’s business, or derived from a use by the member of the LLC’s property, including the appropriation of any opportunity of the LLC.” Tenn. Code Ann. § 48-249-403(b)(1).
But the big surprise for me was "we affirm." Why? I just kept thinking of Meinhard v. Salmon. Apart from he fact that this case involves a Tennessee LLC and two brothers, the material facts are substantially similar. Yet, the result is different. The Mulloy court reasons that the property acquisition opportunity at issue was not the LLC's, but rather the older brother's (even though the brothers' jointly owned LLC existed to lease property to a specific tenant--the same tenant to which the older brother rents the new property--property that the younger brother originally identified). The court references facts that do help the older brother here. But something just smells wrong about this. The lack of candor in this situation is particularly disturbing.
So, that set me to wondering if there was a way to get that "punctilio of an honor, the most sensitive" back into the judicial sightline. Immediately, I thought of Anderson v. Wilder--a 2003 Tennessee Court of Appeals case in which the court applies the close corporation shareholder fiduciary duties under Massachusetts corporate law to members in a Tennessee LLC. However, it then occurred to me that Anderson was decided under Tennessee's "old" LLC Act; but the LLC in Mulloy opted into Tennessee's modernized, "new" LLC Act, which became effective on January 1, 2006. The new LLC Act is modeled in part on the Revised Uniform Limited Liability Company Act and provides as follows, in pertinent part (in Tenn. Code Ann. § 48-249-403(a) and (b) (emphasis in italics added)):
- "The only fiduciary duties a member owes to a member-managed LLC and the LLC's other members and holders are the duty of loyalty and the duty of care . . . ."
- "A member's duty of loyalty to a member-managed LLC and the LLC's other members and holders of financial rights is limited to the following: (1) To account to the LLC and to hold as trustee for it any . . . benefit derived by the member in the conduct . . . of the LLC's business, or derived from a use by the member of the LLC's property, including the appropriation of any opportunity of the LLC . . . ."
These statutory provisions would appear to foreclose an argument that members of an LLC organized under the new LLC Act have a fiduciary duty of utmost good faith and loyalty to each other under Anderson (or otherwise at common law). Much as I hate to admit it, that's the way a court should, and likely would, see this.
What do you think? Is my concern about the holding in the appellate court opinion in Mulloy warranted? Or do we treat the Mulloy brothers like "big boys" and agree with the appellate and trial courts? Your views are welcomed. I am looking for some creative arguments here . . . .
Nice thought, Gianfranco. Of course, noncompete claims can often coexist with business opportunity claims. Based on the facts related in the opinion in this case, I suspect that the court would draw a picture of the business of the jointly held LLC narrowly--as owning a single property for rental. The history is somewhat indicative of that, even if the more current relations and course of conduct might suggest otherwise. Having said that, I do not think the competition argument is outside the realm of possibility. Thanks for contributing this idea to the mix.
One might similarly make a good faith and fair dealing argument. I suspect it might also fail--both because of the deep discount probability of success generally with those claims under existing doctrine and because of the same facts indicating a narrow business proposition.
Posted by: joanheminway | Oct 29, 2019 5:11:17 AM
I offer a couple of thoughts (though I have not read the Mulloy opinion):
First, based on the statutory language you've excerpted above, it looks like Tennessee's LLC statute adopted a non-uniform variation to the Revised Uniform Limited Liability Company Act (RULLCA). The RULLCA (2006), carried over to the RULLCA (2013), "uncabins" fiduciary duties (i.e. does not purport to exhaustively codify fiduciary duties). So, under the RULLCA, a court could adopt the approach you've suggested--impose some judicially created standard of fiduciary conduct above and beyond what is codified in the statute. The Tennessee LLC statute seems instead to follow the older ULLCA (1996) and RUPA (1997), both of which "cabin" fiduciary duties and preclude this type of judicial improvisation.
Second, putting aside momentarily the question of whether we want judges to create and apply new standards or facets of fiduciary conduct (I have my doubts about that), it seems like Tennessee's existing LLC statute (like RULLCA) still leaves lots of room for judges to determine how narrowly or broadly to apply the business opportunity doctrine in the LLC context. The statutes do not define what constitutes an "opportunity of the LLC," leaving that to judicial discretion. It sounds like in Mulloy the court chose to interpret that language more narrowly than you'd like. But the subjectivity (and resulting unpredictability) inherent in that question is an argument for limiting judicial discretion.
Posted by: Mohsen Manesh | Oct 29, 2019 9:01:54 AM
I always get confused about that language limiting the scope of the duty of loyalty. It occurs in some Uniform Acts but not others, so I went back to look it up (this is probably old news to you, Joan). That language is in the original ULLCA of 1996 but not the RULLCA of 2006. You say Tennessee adopted RULLCA--how did it come to use the older language?
I looked beyond the LLC acts to the partnership acts. Both RUPA and ULPA (2001) adopted the limiting language like Tennessee's LLC Act, but the 2013 harmonized versions of those acts dropped that language, going with the language in RULLCA. The commentary in the harmonization cites specifically to Meinhard as a principle the uncabined language is intended to reinstate, so your reading of Tennessee's cabined language seems right. That said, based on the facts you give, it does seem like the court goes out of its way to see the opportunity as belonging to the brother rather than the company.
Posted by: Brett McDonnell | Oct 29, 2019 9:14:35 AM
Also, this is incredibly timely, as I am covering the corporate opportunities doctrine in class today. Thanks for posting it!
Posted by: Mohsen Manesh | Oct 29, 2019 9:23:54 AM
Thanks, Mohsen and Brett, for these great comments.
Tennessee's modernized act was adopted in 2005, and the process was started much earlier. At the time we were working not he project, we looked at the then-amended version of the 1996 ULLCA and followed the process along the way as to what was happening with the RULLCA project. (Sorry that my post misleads on that point.) So, not all of the 2006 RULLCA--including the less restrictive language on fiduciary duties, made it into our act.
Frankly, I am not sure how folks might feel now about adopting the less restrictive language. We faced fiduciary duty waiver issues in our adoption of the RULPA, and I posted about them here, as you may recall. It was a tough battle to resist allowing for Delaware-style complete waivers.
And Mohsen, you are right that on appeal, the Tennessee Supreme Court could construe and apply the LLC opportunity doctrine differently. The Court of Appeals laid out standard versions of the doctrine as embodied in corporate law (and there is a question about whether that importation is a good idea), but the court seemed most enchanted with the four-part test in Guth v. Loft. (Honestly, that part of the opinion looked like it had been written by one of my former students!) The use of the corporate doctrine, and more specifically Guth, certainly is subject to challenge at the supreme court level.
Great stuff, guys. I am likely to bring this case up at our next Tennessee Bar Association Business Law Section Executive Council meeting. I am the Chair this year. Maybe something can be done about this . . . . We'll see.
Posted by: joanheminway | Oct 29, 2019 10:11:07 AM
I sided with Andrews and the other dissenters in Meinhard, so this case strikes me as correct in general. Nothing about the fact that two men inherited an asset and set up an LLC to hold it leads me to believe that this was to be a venture for future business. The idea that Chemical was supposed to be a company for future real estate investments strikes me unlikely, and the judge seems to have found that it was not.
Perhaps more important was the language of the agreement, as quoted by the court: “[T]he operating agreement permitted Gene, as chief manager, to ‘engage in whatever other activities he so chooses, whether or not such activities compete with the Company, without having or incurring any obligation to offer any interest in such activities to the Company or any Member.’ The operating agreement also authorized members to ‘engage in or possess an interest in other business ventures of every nature and description.’ By its terms, neither Chemical Properties nor the other member ‘shall have any rights in and to such independent ventures or the income or profits derived therefrom.’”
Posted by: Frank Snyder | Oct 29, 2019 10:16:51 AM
Thanks so much for this comment, Frank. Many agree with you on Meinhard, btw. I am on the fence. But I still see it as good and compelling law for consideration. The court here may well be rejecting Meinhard's premise as bad law, however, and I acknowledge that possibility.
Moreover, I fully understand the argument that owning one rental property does not mean a firm is in the real estate business. But there is more here. Other relevant facts include that the lessee is the same firm, the brothers independently cane to know of the need for expansion space, and each went out to find a suitable space. There was some communication along the way. It appears that the older brother was more secretive than the younger brother in his efforts. (And the younger brother brought the property to the older brother's attention.)
Does the lack of candor not strike you as objectionable under these facts? I may just be reading this too narrowly . . . .
Posted by: joanheminway | Oct 29, 2019 11:13:18 AM
Oh, and the court does reject the application of the broad noncompete/LLC opportunity provisions on these facts. I do not address that here, and the court's reasoning is rather thin on the point. But you are right to point out the potential for that to make a difference here, too.
Posted by: joanheminway | Oct 29, 2019 11:25:29 AM
There are scenarios where this would trouble me a little. But when (as here) people write clear language I would enforce it whether I'm troubled or not, as in McConnell v. Hunt Sports.
Here, I'm not troubled at all. The two brothers never had a choice in working together. They inherited it from dad. And apparently they never got along. They sold the manufacturing business because they couldn't agree on how to run it, and apparently Gene went on to make it much more successful. Chemical Properties continued to have its lease on the original facility on the same terms; CP simply didn't get to participate in the lease of a second factory. Gene made it clear he had no interest in future ventures with James. I don't see how James reasonably could have expected that Gene would put James's interests ahead of his own.
Great conversation, BTW. You guys always raise interesting stuff.
Posted by: Frank Snyder | Oct 29, 2019 11:46:26 AM
With respect to the lack of candor, the Uniform Acts have a section that requires LLC members, managers, and the LLC itself to disclose information which is material to the exercise of the member's right and duties (I don't have it in front of me so I am just paraphrasing), but if the court has already decided that this was not an LLC opportunity, I suppose the court would say that this issue was not material to the exercise of the younger's brother's rights and duties. In addition, if it is not part of the fiduciary duty of loyalty under your statute, what would the remedy be for a breach of the statutory duty to provide information?
Posted by: Doug | Oct 29, 2019 11:47:24 AM
Thanks, Frank. You make a nice case. I do love McConnell, and I believe in clear private ordering. But my reading of the facts of this case makes me squeamish here, for some reason. I think I may be hung up on the older brother leveraging off the younger brother's work in identifying the property . . . .
And Doug, I had a similar thought when I was typing the word "candor" into my comment. Tennessee law does have a provision on information rights: Tenn. Code Ann. § 48-249-308. I agree with your assessment of its potential utility on these facts, however. First, the claim would be against the LLC rather than the older brother, and second (more substantively) I am confident that the appeals court would not have found that information about the property sale was "information concerning the LLC's business or affairs reasonably required for the proper exercise of the member's rights and performance of the member's duties under the LLC documents or this chapter." Tenn. Code Ann. § 48-249-308(b)(1).
Posted by: joanheminway | Oct 30, 2019 8:03:07 AM
You know me--I love outside the box arguments. (As a caveat--I have only done a cursory read of the opinion.)
As an alternative argument, suppose one were to forget about the LLC and treat James and Gene as two individuals who are communicating about properties to buy and lease to the company. That seems to me that it could fall into the category of "two or more persons to carry on as co-owners of a business or other undertaking for profit."
An implied partnership to pursue a deal with this separate property would fall within the Court's ruling that the opportunity did no belong to the LLC because the business of the LLC was renting a different property. (I seem to recall the "unspoken partnership" showed up in a lot of cases in your business associations class.) And then you look to the fiduciary duties of partners to each other outside of the LLC context.
Not the easiest case to win (and it is likely waived on appeal) but at least it is some kind of argument after the ruling of the Court.
Posted by: Bryan | Oct 30, 2019 10:35:55 AM
Sorry for the delay in posting and responding, Bryan. I love that you are engaging with this, and yes, I do know you to be one who likes out-of-the-box arguments!
I find the partnership argument intriguing. I am not sure the facts support that the brothers were associated as co-owners of a for-profit business (buying a property to rent the the company) . . . . In other words, although your overall argument is consistent with the court's ruling, I just do not think the facts as reported support that type of relationship. And even if I could get over that factual hump, I would have to note that the same dang statutory fiduciary duties (including the limitations verbiage) that apply to members in a Tennessee LLC also apply to partners in a Tennessee partnership. See Tenn. Code Ann. § 61-1-404. So, I would be stuck with the court's LLC opportunity findings and otherwise would end up arguing the same points (competition, GFFD, etc.).
But I do love the creativity! Thanks for jumping into the game. Keep thinking on this . . . .
Posted by: joanheminway | Oct 31, 2019 5:06:22 PM
Posted by: Lombino | Nov 7, 2019 5:20:55 AM
Thank you. I appreciate your readership and feedback.
Posted by: joanheminway | Nov 7, 2019 7:57:27 AM
Why didn’t the older brother violate the duty of loyalty to refrain from competing with the LLC in the conduct of the LLC's business before the termination of the LLC? Puzzling.
Posted by: Gianfranco A. Pietrafesa | Oct 29, 2019 2:51:43 AM