Culling through LLC cases can be a discouraging business. I often find cases that are poorly argued by one side or the other or cited provisions of operating agreements that are poorly drafted. Too often the courts never are allowed to get to the heart of the matter.
Take these two recent cases. Please (apologies to Henny Youngman). In Lakes Region Gaming v. Miller,(No. 2011-394 S. Ct. N.H., February 13, 2013), a 5-member LLC was formed to purchase the Lakes Region Greyhound Park. One of the members, Johnston Development, contributed its right to
purchase the track and another member, Gistis, contributed the down payment to secure the purchase. What the other members contributed is not stated. The purchase of the track was never closed due to a grand jury indictment involving the track but not the LLC or its members. The members of the LLC decided to sell its right to purchase the track to recoup its expenses and maybe make a profit.
Unbeknownst to three of the members, Miller and Johnston Development negotiated and sold the right to purchase the track, pocketing the $900,000 profit for themselves and not the LLC. The other members and the LLC sued Miller and Johnston Development. A default judgment was entered against Johnston Development and the trial court found Miller breached his fiduciary duty to the plaintiffs, awarding them $900,000 in damages.
On appeal Miller argued that he did not owe the other members a fiduciary duty since he was a minority member and paragraph 10 of the operating agreement let him off the hook. A ruling on the fiduciary duty issue would have been of interest to all of us, but the appellate court refused to entertain it since Miller did not raise it at the trial level. What?! So Miller was left to argue that he “thought” Johnston Development owned the right to purchase the track (even though he was a member of the LLC along with Johnston Development) and the down payment was a loan, not a contribution to the LLC. Neither the trial court nor the supreme court bought that line of reasoning.
This left Miller with arguing that he and Johnston Development were competing with the LLC and paragraph 10 of the operating agreement allowed him to do it. Provisions like paragraph 10 are common in operating agreements. It provided in short that being a member of the LLC did not prevent a member from engaging in other businesses even businesses that “may be in competition with the Company” and doing so was not “a breach of any fiduciary duty” by a member. The court easily concluded that using assets of the LLC to enrich himself at the expense of the other members was not competition.
In the other case, McAteer v. Dugan, 5-11-0148, Ill. App., February 10, 2013, we have at issue another provision common to operating agreements, but this one is vaguely drafted. As a means to resolve disputes, typically between two members, operating agreements allow a member to offer to the other her membership interest at a proposed price. The other member has a certain number of days to accept the offer or turn the tables and sell his membership interest to the member who first made the offer. The chance that you might have to buy the other’s interest at the same price you offered to sell forces you to make a fair offer in the first place.
That is what happened in this case, but the applicable provision of the operating agreement was written with two conflicting ideas in mind. It started out like a clause of a typical buy-sell agreement, if a member wants to sell or otherwise transfer his interest to a third-party, it must first offer the interest to the other members, but ends up reading like a typical dispute resolution provision. It would have been interesting to see how the parties would have argued and the court would have discerned the proper interpretation of the confusing language, but because the defendant utterly failed to defend himself we are left with a judgment against the defendant more out of frustration than legal interpretation.
-Marc Ward
