Real estate development ventures often begin with the formation of a limited liability company (“LLC”). This entity structure has the benefit of protecting its members from personal liability “under any judgment of a court, or in any other manner, for any debt, obligation, or liability of the limited liability company, whether that liability or obligation arises in contract, tort, or otherwise, solely by reason of being a member of the limited liability company.” California Corporations Code (Corp. Code) § 17101.
Unfortunately this liability shield is not an iron-clad protection from liability. As the country has struggled through the current economic crisis, real estate developments that may have been viable when conceived are no longer feasible. Increasingly, in an effort to recover their losses, LLC members have begun pointing a finger at fellow members claiming that they have breached their fiduciary duties or engaged in fraud or other misdeeds. The accusing member in effect seeks to establish that, as a result of another member’s misdeeds, he or she should be allowed to hold the other member personally liable for the losses of the LLC. While the limited liability statute may protect against third-party creditor claims, it does not protect against claims that a member has breached his or her fiduciary or contractual obligations to the LLC.
If management is vested in the LLC’s members, each of them is subject to all duties and obligations of managers as set forth in the California Corporations Code (the “Code”). Corp. Code § 17150. The fiduciary duties a manager owes to the LLC and to its members are those of a partner to a partnership and to the other partners. Corp. Code § 17153. These duties include the duty of loyalty and the duty of care. Corp. Code § 16404.
Specifically, a member owes the following duties to the LLC:
• To account to the LLC and hold as trustee for it any property, profit, or benefit derived by the member in the conduct and winding up of the LLC business.
• To refrain from dealing with the LLC in the conduct or winding up of the LLC business as or on behalf of a party having an interest adverse to the LLC.
• To refrain from competing with the LLC in the conduct of the LLC business.
• To discharge his or her duties to the LLC and the other members under the Code or under the operating agreement and exercise any rights consistently with the obligation of good faith and fair dealing.
According to the Code, a member’s duty of care to the LLC and the other members in the conduct and winding up of the LLC business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law. Further, a member does not violate a duty or obligation under the Code or under the operating agreement merely because the member’s conduct furthers the member’s own interest.
However, when a member of an LLC diverts LLC funds or assets to another project, fails to provide required accountings of LLC assets to the other members, or treats the LLC assets as his or her own, it is possible that a court may find that member liable for losses sustained by other members of the LLC as a result of such conduct. There are simple ways to help avoid personal liability attaching to a member of an LLC in the context described here, including maintaining the separation of LLC accounts and assets from personal or other project accounts and carefully drafting LLC governing documents to specify each member’s rights and obligations.
Reuben & Junius, LLP is a full service real estate law firm. We specialize in land use, development and entitlement law. We also provide a wide range of transactional services, including leases, purchase and sale agreements, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.