Who Really Controls Your LLC?

Nineteenth-century British Prime Minister Benjamin Disraeli wrote, “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 only on the profits percentage the member owns but also on factors such as 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. Because 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, 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 a “co-managing member” (a member who has been formally granted authority by 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. 

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 unless that authority has been delegated to the member by the manager or managers or by the provisions of an operating agreement. 

With the best of intentions, the member might voluntarily and gratuitously purport to act on behalf of the company — 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 oneself as a shareholder in a corporation: Exercise one’s right to vote and then get out of the way.

The Member-Managed Company

In a member-managed company, each member is an agent and engaged in the company’s management. Furthermore, 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 could 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. 

The meddling member might also have taken on certain non-contractual duties, depending 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. 

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. 

Terry Thompson, a shareholder at Gallagher & Kennedy, advises businesses, governmental entities, nonprofits, and civic and community organizations in all aspects of governance and operation, mergers and acquisitions, financings, and public-private projects, including strategic joint ventures, water/wastewater infrastructure development, sports facility financing, and physician-hospital contracts.