Fiduciary Duties of Members of Colorado LLCs

The limited liability company (LLC) enabling statutes in some states expressly set forth affirmative duties that LLC members owe to one another.[1]  Other state LLC enabling statutes expressly negate such duties.[2]  The Colorado Limited Liability Company Act[3] is silent as to whether LLC members owe a fiduciary duty to one another.  No published Colorado opinion has yet addressed this issue.  When legal questions are not addressed in Colorado’s LLC statutes, Colorado courts have consistently looked to corporate and limited partnership case law to fill in the gaps.[4]  A review of case law inside and outside of Colorado illustrates that LLC members with a majority or controlling stake owe fiduciary duties to minority members, even when such majority or controlling members are not managers of the LLC.

A majority member of an LLC or a member that exercises de facto control over an LLC owes a fiduciary duty to the LLC’s minority members.  Although no Colorado appeals court has addressed this issue in the LLC context, courts have exhaustively addressed the issue in the corporate context.  Colorado courts look to “[c]ases from Colorado and elsewhere on corporate or limited partnership” to address legal questions not addressed in the LLC statutes.[5]  Corporate and limited partnership case law is instructive because Colorado “created its LLC statute by combining features of its existing limited partnership and corporation statutes.”[6]  Choosing between a corporation, a partnership or an LLC is primarily a tax decision and does not change protections the common law has created for individuals in business relationships.[7]  And there is “growing consensus that common law fiduciary duties should apply to the operations of LLCs.”[8]

In Colorado, a majority or controlling[9] shareholder owes a fiduciary duty to a minority shareholder.[10]  This principal applies not only to a single majority shareholder, but also to “members of [the] dominant group of stockholders.”[11]  Given this principle, a majority or controlling member of an LLC also should owe a fiduciary duty to a minority member.

State and federal courts from other jurisdictions have applied corporate common law to the LLC context to find that a majority member of an LLC owes a fiduciary duty to a minority member.[12]  For example, in Anderson v. Wilder, the minority members of an LLC were expelled from the LLC by a vote of the majority members.  The minority members argued that “a majority of the members of an ‘LLC’ should owe a fiduciary duty to the minority members just like the duty a majority of the shareholders of an ‘Inc.’ owe the minority shareholders.”[13]  The majority members of the LLC argued that because an LLC is a “creature of statute” and because the LLC statute did not explicitly recognize such a duty, the court should not recognize it.[14]  The Court of Appeals of Tennessee analyzed Tennessee case law regarding common-law fiduciary duties in the corporate context and held that “finding a majority shareholder of an LLC stands in a fiduciary relationship to the minority, similar to the Supreme Court’s teaching . . . regarding a corporation, is warranted.”[15]  The court rejected the majority members’ argument, stating that because applying the common-law duty did not conflict with the LLC statute, the statute’s silence on the issue did not prevent application of the duty.[16]

This decision and others like it reinforce what Colorado case law in the corporate and limited partnership arena makes clear and demonstrate how Colorado courts will likely rule:  majority or controlling members of LLCs owe a fiduciary duty to minority members.

 

 


[1] See, e.g., Minn. Stat. § 322B.833, subd. 4 (setting forth the “duty that all members in a closely held limited liability company owe one another to act in an honest, fair, and reasonable manner in the operation of the limited liability company”); N.D. Cent. Code, § 10-32-119 (same).

[2] See, e.g., Ga. Code. Ann. § 14-11-305(1) (“Except as otherwise provided in the articles of organization or a written operating agreement, a person who is a member of a limited liability company in which management is vested in one or more managers, and who is not a manager, shall have no duties to the limited liability company or to the other members solely by reason of acting in his or her capacity as a member.”); Ark. Code. Ann. § 4-32-402(3) (“One who is a member of a limited liability company in which management is vested in managers . . . and who is not a manager shall have no duties to the limited liability company or to the other members solely by reason of acting in the capacity of a member.”); N.M. Stat. Ann. § 53-19-16(A) (“[A] member who is not a manager and is not vested with particular management responsibilities by the articles of organization or an operating agreement shall not be liable to the limited liability company or to the other members solely by reason of his act or omission in his capacity as a member.”).

[3] C.R.S. § 7-80-101, et. seq.

[4] Young v. Bush, 2012 COA 47, P48 (Colo. App. 2012).

[5] Id.see also C.R.S. § 7-80-107(1) (directing courts to apply case law on piercing corporate veil to LLC cases); Sheffield Servs. Co. v. Trowbridge, 211 P.3d 714, 721 (Colo. App. 2009) (extending corporate veil-piercing doctrine to managers of an LLC).  Cf. Colt v. Mt. Princeton Trout Club, Inc., 78 P.3d 1115, 1119 (Colo. App. 2003) (comparing the relationship between directors and shareholders of a closely held corporation to the relationship among partners); Hirsch v. Jones Intercable, Inc., 984 P.2d 629, 634 & n.8 (Colo. 1999) (looking to cases and rules regarding demand requirements in corporate derivative actions for guidance in determining demand requirements in limited partnership derivative actions).

[6] LaFond v. Sweeney, 2012 COA 27, P31 (Colo. App. 2012).

[7] See Water, Waste & Land v. Lanham, 955 P.2d 997, 1000-01 (Colo. 1998).

[8] Exec. Ctr. III, LLC v. Meieran, 2011 U.S. Dist. LEXIS 114696, at *20-22 (E.D. Wis. Oct. 4, 2011) (citing cases from Indiana, Kentucky, California, Connecticut and Idaho that have applied common law fiduciary duties from the corporate and partnership context to LLCs).

[9] Colorado courts have not yet defined what constitutes a “controlling” shareholder.  But courts in other jurisdictions have done so.  See Jensen v. Oliver, 1998 U.S. Dist. LEXIS 15407, at *14-15 (N.D. Ill. Sept. 22, 1998) (citing Lewis v. Knutson, 699 F.2d 230, 235 (5th Cir. 1983), for the proposition that a shareholder is deemed a majority or controlling shareholder if they own a majority of shares in a corporation or are a minority shareholder who exercises actual control and direction over corporate management; and Kearney v. Jandernoa, 979 F. Supp. 576, 579 (W.D. Mich. 1997), for the proposition that a minority shareholder can be controlling if, through personal or other relationships, the directors are beholden to the controlling person); Drobbin v. Nicolet Instrument Corp., 631 F. Supp. 860, 899 (S.D.N.Y. 1986) (explaining that control exists if the minority owner’s holdings gives it “working control” of the corporation); Dugan v. Orthopaedic Inst. Of Ohio, Inc., 2004 U.S. Dist. LEXIS 7583, at *3-4 (N.D. Ohio, April 8, 2004) (explaining that fiduciary duties apply to minority shareholders who dominate the corporation to the exclusion of other minority shareholders); Riebe v. National Loan Investors, L.P., 828 F. Supp. 453, 456 (N.D. Tex. 1993) (explaining that a controlling shareholder’s holdings give it working control of the corporation).  It follows that in a close corporation context, an owner may exercise control (and therefore owe fiduciary duties to minority shareholders) regardless of whether that controlling owner holds a majority of the voting interest.

[10] River Management Corp. v. Lodge Properties Inc., 829 P.2d 398, 404 (Colo. App. 1991); Van Schaack Holdings, Ltd. v. Van Schaack, 867 P.2d 892, 897 (Colo. 1994); Polk v. Hergert Land & Cattle Co., 5 P.3d 402, 405 (Colo. App. 2000); Colt v. Mt. Princeton Trout Club, Inc., 78 P.3d 1115, 1119 (Colo. App. 2003).

[11] River Management Corp., 829 P.2d at 405.

[12] See, e.g.Brazil v. Rickerson, 268 F. Supp. 2d 1091, 1097, 1099 (W.D. Mo. 2003) (citing corporate case law regarding the obligations of majority shareholders to minority shareholders and stating that “the majority interest [in the LLC] holds a fiduciary duty toward the minority interests”).

[13] 2003 Tenn. App. LEXIS 819, at *9 (Tenn. Ct. App. Nov. 21, 2003).

[14] Id. at *16.

[15] Id. at *17-18.

[16] Id.  Similarly, the Court of Appeals of Texas recently analyzed corporate and partnership common-law duties in determining whether a manager and majority member of a closely held LLC owed a fiduciary duty to a non-participating minority member.  The court held that the “nature of this relationship supports recognizing a fiduciary duty.”  Allen v. Devon Energy Holdings, L.L.C., 2012 Tex. App. LEXIS 2110, at *87 (Tex. App. Houston 1st Dist. Mar. 9, 2012).

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