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CALIFORNIA CORPORATE & SECURITIES LAW

Court Rules LLC Members May Be “Fiduciaries In Fact”

U.S. District Court Judge Tena Campbell’s ruling in Strong v. Cochran, 2017 U.S. Dist. LEXIS 170073, is a reminder that sometimes what you do matters more than what you say.  The case involved claims by the liquidating trustee for a failed real estate firm, Castle Arch Real Estate Investment Company, LLC, a California limited liability company (“CAREIC”).  The trustee sued the members of CAREIC for among other things, breach of fiduciary duty.  The members moved to dismiss that claim on the basis that “Amended Complaint does not allege the existence of a fiduciary duty, much less the breach of any such duty”.

Judge Campbell rejected the the defendants’ motion with the following explanation (footnote omitted):

California courts have applied such a “fiduciary duty in fact” concept. Under that approach, an individual, regardless of title, owes a fiduciary duty to a company when the individual “participates in management of the corporation” and “exercis[es] some discretionary authority.” GAB Bus. Servs., Inc. v. Newsom Claim Servs., Inc., 83 Cal. App. 4th 409, 99 Cal. Rptr. 2d 665, 672 (Cal. Ct. App. 2000), overruled in part on other grounds by Reeves v. Hanlon, 33 Cal. 4th 1140, 17 Cal. Rptr. 3d 289, 95 P.3d 513 (Cal. 2004).

While a limited partner normally would not be involved in the management or otherwise participate in the partnership . . . so as to incur fiduciary obligations to other partners, we believe there can be factual scenarios where a limited partner might be involved in the partnership in such a manner . . . so as to create fiduciary duties.

Tri-Growth Centre City, Ltd. v. Silldorf, Burdman, Duignan & Eisenberg, 216 Cal. App. 3d 1139, 265 Cal. Rptr. 330, 335 (Cal. Ct. App. 1989) (emphasis added) (leaving for resolution at trial the factual issue of whether a fiduciary duty in fact existed); see also Mission W. Props., L.P. v. Republic Props. Corp., 197 Cal. App. 4th 707, 129 Cal. Rptr. 3d 14, 22 n.8 (Cal. Ct. App. 2011) (holding that, notwithstanding the California statutory law and the limited partnership agreement, a limited partner may have a fiduciary duty if he engages in management of the company) (citing Tri-Growth).

The Trustee rightfully insists that “[t]he Moving Defendants cannot hide behind the CAREIC Operating Agreement to claim that they did not owe a fiduciary duty to CAREIC or its investors. The realities of how a company is operated govern rather than its formal structure.” (Combined Opp’n at 12, ECF No. 126.) The Amended Complaint alleges actual circumstances, not typical circumstances, and that is adequate under California law.

While it remains to be seen whether the liquidating trustee can prove his allegations, the case is a reminder that member involvement in the management of manager-managed LLCs can be perilous.

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