Who Really Controls Your LLC?

Authored by Terence Thompson
Published by InBusiness Magazine

Who Really Controls Your LLC?

Nineteenth century British Prime Minister Benjamin Disraeli wrote that “all power is a trust; that we are accountable for its exercise.”

Here, we define three types of LLC management: the controlling member, the manager-managed company, and the member-managed company.

The “controlling member” of an LLC

Whether a member “controls” a limited liability company usually depends not merely on the profits percentage owned by the member, but also on such factors as, among other things, the terms of the operating agreement and whether the company is member-managed or manager-managed.

A “controlling member” has the full panoply of contractual obligations, fiduciary duties, and other duties imposed by the statute and the law of agency. The duty of loyalty – the duty most commonly under consideration in corporate “controlling shareholder” or “majority shareholder” cases – encompasses the duty to refrain from self-dealing. Thus, there is no reason to devise a special common law fiduciary duty for a controlling member in a member-managed company: The member already has every conceivable duty to the LLC.

However, the statute has a unique provision regarding what can be termed a “co-managing member” (that is, a member who has been formally granted authority by either a manager or the operating agreement). Whether and to what extent a co-managing member – which could include a controlling member – owes duties to the company or the other members depends on the extent to which the member participates in management. If there is such participation, the existence and scope of any duty of the co-managing member is to be determined in accordance with the “policies” of the statute and other laws. In short, the statute expressly requires reference to “other laws” (including the law of agency) when considering whether and to what extent a controlling member owes fiduciary duties.

To summarize, the controlling member has the full panoply of contractual obligations and, under the law of agency, the full panoply of fiduciary and other duties. In other words, there is no need to devise a special rule pertaining to controlling members. It becomes a matter of applying those obligations and duties.

The manager-managed company

In a manager-managed company, a member is not an agent of the company and is not engaged in management of the company -- except to the extent that authority has been delegated to the member by the manager or managers or by the provisions of an operating agreement.

In a manager-managed LLC, it might not be unusual for a member to purport to act on behalf of the company. With the best of intentions, the member might do so voluntarily and gratuitously -- but without clear authorization either under the operating agreement or granted by the manager.

As a basic rule, a member of a manager-managed company does not have a fiduciary duty to the company or to any other member solely by reason of being a member.  

Perhaps good advice for a member in a manager-managed company is to think of one’s self as being akin to a shareholder in a corporation: Exercise one’s right to vote and then get out of the way.

The member-managed company, or meddling member-managed?

In a member-managed company, each member is an agent and engaged in the company’s management. Further, a particular member might or might not be deemed to “control” the company, i.e., be a controlling member as defined above.

One question is whether the member, sometimes referred to as an “officious intermeddler” or a “volunteer,” has taken on some sort of duty. Another issue is the potential liability of the meddling member and to whom. Too, the question arises as to what area of the law governs, such as the Arizona limited liability company statute or the common law of contracts, equity and restitution, agency, or torts.

The meddling member’s conduct potentially breaches the operating agreement. For example, the operating agreement in a manager-managed company typically provides that the manager is vested with the power and authority to manage the company, with the members having no management role other than appointing the manager and voting on certain matters.

Depending on the circumstances, the meddling member’s conduct might also breach the contractual obligation of good faith and fair dealing. Relevant factors might include the parties’ bargained expectations that the manager would run the operation and that the other members were reasonable in believing that the meddling member would not meddle.

In addition, the meddling member might have taken on certain non-contractual duties. Whether that is the case depends on the “policies” of the statute and other laws. Given the existence of the contractual relationship, it is possible that a tort “duty of care” is owed by the meddling member to the company, the members, and any other party to the operating agreement. That would appear to be, though, a case of first impression in Arizona.

Too, the statute’s liability shield might not protect the member. The company might not be bound by the member’s conduct, but the member might be liable under the law of agency for breach of the “warranty of authority.” The liability shield might not protect the meddling member, for the liability is arguably the member’s personal liability, not a “debt, obligation, or other liability of the company” and not an act of another member or manager.

As William Hazlitt advised, it is wise to be watchful, but to exercise self-restraint, “to take a thoughtful, anxious interest in what is passing in the world, but not to feel the slightest inclination to make or meddle with it.”

Of course, some people just cannot sit still.

This article describes in broad strokes some of the nuances of three types of LLC management. It is important that entrepreneurs and startups seek qualified legal counsel when forming their companies and drafting operating agreements.

Click here to read the article published by In Business Magazine.