By Rebecca L. Reed, Attorney
A. Operating Agreements should be specific and set forth contributions
The Operating Agreement controls the respective obligations of the LLC’s members. It is an important document. Among the various provisions that should be set forth in the Operating Agreement, are the manner and amount of contributions made by each member, which establishes their interest in the LLC.
B. Case in Point “Bishop of Victoria Corp. Sole v. Corporate Business Park LLC (Unpublished 2007 WACA 33579-4″ 050807)
In 2007, the Court of Appeals, Division II, examined the question of whether a manager-member of an LLC who failed to make a mortgage payment on behalf of the LLC, which was owed by the LLC, causing the LLC to default and contributing to its business failure, was a breach of fiduciary duties owed to the other members of the LLC.
The Court looked at the Operating Agreement to determine whether the members had provided for contributions to the LLC. The Operating Agreement stated “Except as provided in a Contribution Agreement, the Company has no right to require any Member to make additional contributions.” Unfortunately, a “Contribution Agreement” did not exist. The members had failed to specify what contributions they were obligated to make to the LLC.
The Court found that a member’s obligation to contribute to the LLC arises from the parties contractual agreements. The Court refused to allow parole evidence (terms or evidence outside the contract) to alter any of the terms of the Operating Agreement and therefore, the Operating Agreement controlled. Therefore, the Court found that the manager-member did not have an obligation to make payments on behalf of the LLC.
C. Fiduciary Duties are Owed to other Members but Will not Fully Satisfy Absence of Contribution Terms in Operating Agreement
The Court also examined the issue of whether the manager-member’s failure to make a mortgage payment on behalf of the LLC, which caused the LLC to default, constituted a breach of fiduciary duties.
LLC members owe each other fiduciary duties, which do not arise out of the Operating Agreement but rather out of the parties relationship. Members must deal with each other with candor and good faith and owe each other duties of loyalty, and due care. A member must not self-deal and avoid conflicts of interests.
The Court found that the manager-member did not breach a fiduciary duty. Although the manager-member owed a duty of loyalty to the other members, his obligation to contribute arose from the Operating Agreement and without more evidence, there was no showing of a breach of fiduciary duty.
D. Lessons Learned
Operating Agreements should specifically set forth the method and amount of contribution each member is obligated to contribute to the LLC, which adequately reflects their interest in the LLC. Failure to do so may be catastrophic to the LLC in the future.
Regardless of the terms of the Operating Agreement, members owe each other strict and serious fiduciary duties of loyalty, due care, good faith and candor and should always be reminded to avoid conflicts of interest and self-dealing.
The Revised Code of Washington 25.15 sets forth the statutes governing Limited Liability Companies in Washington State.
DISCLAIMER: This Article is not intended as legal advice. It is merely purposed to provide an overview of a particular legal issue. This information should not be relied upon nor serve as a substitute for legal advice. You should seek competent legal counsel for advisement for any of the issues raised herein.
