In Arizona, a limited liability company can sue its members and managers for breach of fiduciary duty, although the LLC’s operating agreement can lawfully limit fiduciary duties, according to the Arizona Supreme Court in answer to questions certified by two bankruptcy judges.
On the other hand, the Arizona high court held that an LLC operating agreement cannot eliminate the covenant of good faith and fair dealing. Together, the rulings mean that a debtor, a bankruptcy trustee or a liquidating trustee can chase members and managers of an LLC for their misdeeds.
The Certified Questions
Arizona Bankruptcy Judges Daniel P. Collins and Paul Sala certified three questions to the Arizona Supreme Court because there were no answers in the state statutes and no definitive court opinions. Both cases arose from post-confirmation lawsuits asserting claims of the companies against managers and members of LLCs. As Judge Collins said, there was no controlling authority to say “whether a member or manager of an Arizona LLC owes a fiduciary duty to the LLC and whether that duty can be limited or eliminated in the LLC’s operating agreement.”
In a June 25 opinion, Arizona Supreme Court Chief Justice Bales answered the three questions one by one, beginning with the issue of whether a manager of an Arizona LLC owes fiduciary duties to the company.
Justice Bales said that the Arizona LLC statute “does not expressly impose any fiduciary duties on members or managers.” Indeed, he noted that his court had said only last year that members of an LLC do not owe fiduciary duties to one another absent express inclusion in the LLC’s operating agreement.
Nonetheless, Justice Bales said, the law of agency applies by statute to the entire LLC Act. The state supreme court’s prior opinions, he said, did not consider the common law of agency.
Quoting the Restatement, Justice Bales said that “‘an agent is a fiduciary with respect to matters within the scope of his agency.’” He went on to say that the fiduciary relationship includes duties of loyalty, good faith, and care.
By default, Justice Bales said that the statute says that members are agents to carry on business “‘in the usual way.’” On the other hand, members are not agents automatically if management is given over to a manager, except to the extent they are given managerial responsibilities by the manager or the operating agreement.
Therefore, those who have been designated as manager are agents with common law fiduciary duties to the LLC.
Next, Justice Bales addressed whether members owe common law fiduciary duties to the LLC.
The answer, he said, depends on whether management has been vested in one or more managers. If not, “then all members are deemed agents of the LLC and thus owe common law fiduciary duties to the LLC.” If the LLC is managed by one or more managers, then members are agents with fiduciary duties to the extent they were delegated managerial authority by the manager or the operating agreement.
Thus, Justice Bales said, “a member owes common law fiduciary duties to the LLC if the member acts as an agent of the LLC.”
The third question required Justice Bales to say whether an LLC operating agreement can limit fiduciary duties.
Although state law does not prohibit an operating agreement from limiting fiduciary duties, Justice Bales said that implied covenants of good faith and fair dealing “cannot be eliminated by an operating agreement.”
Consequently, Justice Bales ruled that an operating agreement “may lawfully limit or eliminate common law fiduciary duties owed to the LLC by its members or managers.” Nonetheless, he held that “it may not erase the covenant of good faith or fair dealing implied in every contract.”
N.B.: The Arizona legislature adopted amendments to the LLC statute dealing with the questions answered by Justice Bales. The amendments will become fully effective in September 2020.
Standing Issues
Although members and managers may have violated their fiduciary duties, standing is a tricky issue when creditors sue. For instance, Bankruptcy Judge Kevin J. Carey of Delaware ruled in early May that creditors of a limited partnership or a limited liability company do not have standing to sue for breach of fiduciary duty in Delaware and states with similar laws. See Gavin/Solmonese LLC v. Citadel Energy Partners LLC (In re Citadel Watford City Disposal Partners LP), 17-50024, 2019 BL 158928, 2019 Bankr Lexis 1375 (Bankr. D. Del. May 2, 2019). For ABI’s discussion of Citadel, click here.
When there are claims for breach of fiduciary duty against members or managers of an LLC, creditors or liquidating trustees must ensure they are suing based on rights of action conveyed by the LLC.
In Arizona, a limited liability company can sue its members and managers for breach of fiduciary duty, although the LLC’s operating agreement can lawfully limit fiduciary duties, according to the Arizona Supreme Court in answer to questions certified by two bankruptcy judges.
On the other hand, the Arizona high court held that an LLC operating agreement cannot eliminate the covenant of good faith and fair dealing. Together, the rulings mean that a debtor, a bankruptcy trustee or a liquidating trustee can chase members and managers of an LLC for their misdeeds.