N.C. Business Court Declines to Impose Fiduciary Duties among Sibling Managers of an LLC and Declines to Extend Any “Control Group” Exception to LLCs, but allows Dissolution Claim to Survive, which Creates a Possible Ruling on Meiselman’s application to LLCs.
In Bennett v. Bennett, 2019 NCBC 18 (N.C. Super. Ct. Mar. 15, 2019), Judge Conrad considered a dispute between two groups of six siblings who are current or former members of family-owned real estate company. The case pits Plaintiffs Bert and Terry Bennett against four of their siblings, Defendants Graham, Ann, Jim, and Louise Bennett, for their alleged improper actions concerning Bennett Linville Farm, LLC (“Bennett Farm”), which the parties formed with their parents to facilitate the latter’s estate planning. The Court granted the controlling group’s motions to dismiss certain breach of fiduciary duty claims and constructive fraud claims, but denied the group’s motions to dismiss a claim for judicial dissolution. See Order and Opinion.
- Infringement of an LLC member’s voting rights (including the right to elect managers and the residual right to vote in the absence of proper managers) is a distinct harm and supports a direct claim against fellow members.
- Dilution of an LLC member’s relative ownership interest is a distinct harm to the member which can confer standing.
- Judge Conrad held that a group of minority LLC members alleged to exercise control of the company did not owe fiduciary duties to minority members, and he is reluctant to grant such rights when minority members fail to include them in the operating agreement.
- Judge Conrad did not dismiss an LLC member’s assertion of Meiselman claims in the LLC context because it would be “prudent” (at this juncture) to address the issue after discovery.
Plaintiffs allege that Defendants Graham, Ann, and Jim gained control of the company to the exclusion of the other sibling members and nearly all actions they took were unauthorized. Plaintiffs assert direct claims against Defendants Graham, Ann, and Jim, alleging they conspired to control the company; that they fraudulently amended the operating agreement to consolidate their control; and that they engaged in unauthorized activity. Defendants Graham, Ann, and Jim moved to dismiss, challenging Plaintiffs’ standing and the merits of their claims. Plaintiffs dismissed their monetary demands against Louise, but kept her in the case as a necessary party.
For years, the siblings owned an equal share of Bennett Farm. The Plaintiffs alleged that the limited liability company was designed to be member managed. The original Operating Agreement, however, required management by certain managers listed on its Schedule II, or by others elected by the membership. Plaintiffs allege the Operating Agreement included no Schedule II when executed, and no managers were ever elected. They further allege that Defendants Graham and Ann were later listed on a document labeled as Schedule II, but without membership approval.
Amended Operating Agreement
Plaintiffs allege that in 2010, Defendants Graham, Ann, and Jim amended the Operating Agreement without the knowledge of the other members, and made significant changes. The Amended Operating Agreement:
- designated Jim as a third manager,
- authorized the managers to make capital calls without member consent, and
- permitted Bennett Farm to redeem any member’s interest upon the consent of members owning at least 75% of the company.
While Plaintiffs acknowledged that they executed the signature page for the Amended Operating Agreement, they allege they did so without seeing the document and as a result of brother Graham’s trickery.
In 2012, the Bennett parents’ ownership interest in Bennett Farms passed to their children, leaving the six siblings in sole ownership. Thereafter, a seventh Bennett sibling (John) granted Bennett Farm a right of first refusal to his 35-acre tract at the request of Defendants Graham, Ann, and Jim. When he requested termination of the right, conflict erupted.
Plaintiffs Bert and Terry (together with Nominal Defendant Louise) claimed they knew nothing of Bennett Farm’s purported acquisition of brother John’s property right, but they would have granted it. Defendants Graham, Ann, and Jim disagreed and, “claiming managerial authority, decided to exercise and enforce the right of first refusal even in the absence of majority approval of the members.” Op. ⁋ 10.
Plaintiffs allege that Defendants Graham, Ann, and Jim used the controversy to force sister Plaintiff Terry out. Graham allegedly informed Terry that she would have to make a capital contribution of over $100,000, or she could sell her interest to the other siblings. Terry alleges she could afford a capital contribution only with access to a trust fund, for which Defendant Ann served as trustee. Ann allegedly refused to assure Terry that she could dip into the fund for the contribution. Thereafter, Terry sold her interest to the five sibling owners remaining.
Nominal Defendant Louise (allegedly weary from the conflict) sold her ownership interest to the remaining sibling owners in 2018, giving Defendants Graham, Ann, and Jim a combined 80% of the company, and leaving Plaintiff Bert with the remaining 20%.
Plaintiffs Bert and Terry alleged that Defendants Graham, Ann, and Jim breached their fiduciary duties to them as fellow LLC members. Defendants argue Plaintiffs lack standing and the claim lacks merit.
Plaintiffs Alleged Sufficient Distinct Harm to Confer Standing.
The Court held that Plaintiffs Bert and Terry alleged distinct injuries so as to confer standing.
Barger v. McCoy Hillard & Parks, 36 N.C. 650, 658 (1997), provides the rules for shareholder standing for corporations. These rules apply “equally to LLCs.” Op. ⁋ 24. While normally, “shareholders cannot pursue individual causes of action against third parties for wrongs or injuries to the corporation that result in the diminution … of the value of their stock,” Barger’s exceptions allow direct claims when members are owed a special duty, or if the injury is separate and distinct from the harm to other shareholders or to the corporation. Op. ⁋ 24 (citing Barger, 36 N.C. at 659).
Plaintiffs alleged that Defendants deprived them of their voting rights, which include the right to elect managers and the residual right to vote in the absence of proper managers. The Court held that infringement of the voting right is a distinct harm and the subject of a direct claim.
Plaintiffs alleged additional harm to support standing. Plaintiff Terry properly alleged distinct harm caused by Defendant Graham’s alleged wrongful inducement that she sell her ownership interest. Plaintiff Bert properly alleged distinct harm caused by the alleged improper sale of Nominal Defendant Louise’s membership interest, which diluted Bert’s relative share. Op. ⁋ 27 (citing Corwin v. British Am. Tobacco PLC, 821 S.E.2d 729, 735-36 (N.C. 2018) (corporations case)). (See Blog Post Smoke ’em if You Got ’em, dated June 2, 2019).
Plaintiff Alleged Insufficient Facts to Impose a Fiduciary Duty.
While Plaintiffs had standing, their claims based on Defendants’ corporate actions failed on the merits.
Fiduciary Duties Excluded By Operating Agreement
Generally, LLC members do not owe fiduciary duties to each other or to the company. Perhaps because of that rule (and because the original Operating Agreement disclaimed fiduciary duties concerning its members), Plaintiffs based their claim on other factors: the sibling relationship and their disparate business acumen.
The Court had no trouble dispensing with the claim. The Court questioned whether a fiduciary duty could attach in light of the original Operating Agreement’s express language precluding it. But, the Court did not have to decide that issue because the allegations failed to show the requisite control needed. Under North Carolina law, a fiduciary duty can arise only when one party “holds all the cards.” Op. ⁋ 32. As no individual sibling was alleged to wield all the power in the company, no fiduciary duty could attach. Id.
No Control Group Exception for LLCs
You may wonder: could the collective interest of the Defendant siblings form a control group that owes a fiduciary duty to a minority member? When Terry liquidated her membership interest, Defendants Graham, Ann, and Jim together owned more than 50% of the company. They could use their collective interest against Plaintiff Bert, a minority owner.
The Business Court has recognized the possibility that multiple minority shareholders in a corporation who act in concert to control the corporation may owe a duty to a minority shareholder. See, e.g., Brewster v. Powell Bail Bonding, Inc., 2018 NCBC 74, *19-32 (N.C. Super. Ct. Jul. 26, 2018) (Judge Conrad).
(In Brewster, Judge Conrad cited the Court of Appeals decision in Corwin v. British Am. Tobacco PLC, in which the Court determined that a minority shareholder of a corporation exercising actual control may owe a fiduciary duty to other shareholders. See 796 S.E.2d 324 (N.C. Ct. App. 2016). When the North Carolina Supreme Court considered the issue in the Corwin appeal, it left the matter undecided. (See Blog Post Smoke ’em if You Got ’em, dated June 2, 2019).)
Judge Conrad noted that some recent Business Court cases “have stated that a holder of a majority interest who exercises control over the LLC owes a fiduciary duty to minority interest members.” Op. ⁋ 35 (citing Fiske v. Kieffer, 2016 NCBC 22, ⁋ 35) (N.C. Super. Ct. Mar. 9, 2016) (emphasis added) (Judge McGuire)). But, he also noted that the “scope of the [control group] exception … remains unsettled” and that “[t]his Court has cautioned against a broad application because of the fundamental differences between LLCs and corporations.” Id. Minority members of LLCs have “much greater” ability to negotiate for protections in the operating agreement. Id. Thus, “this Court has routinely refused to extend the control group exception to LLCs.” Id.
Judge Conrad was unwilling to grant such a right here. He determined that Defendants Graham, Ann, and Jim owed no fiduciary duty to Plaintiffs for their actions related to Bennett Farm.
Plaintiffs also seek judicial dissolution of Bennett Farm. They argue it is not practicable to conduct business in conformance with the operating agreement and governing statutes, and liquidation is necessary to protect their rights and interests. They seek dissolution based on the frustration of their reasonable expectations (rights enjoyed by shareholders of closely held corporations). See Meiselman v. Meiselman, 309 N.C. 279, 299 (1983).
The Court held that Plaintiff Terry lacks standing to seek the remedy because she is no longer a member of Bennett Farm.
But, Plaintiff Bert remains a member. If he develops evidentiary support for his claims, a jury might face “thorny questions” about the company’s ability to bring itself into compliance with its operating agreement after a decade of what would be unlawful management. The Court did not state whether Meiselman’s dissolution standards would apply to LLCs. It decided it would be “prudent” (at this juncture) to address the issue after discovery. Op. ⁋ 70 (citing Pure Body Studios Charlotte, LLC v. Crnalic, 2017 NCBC LEXIS 98 ⁋ 27-8 (N.C. Super. Ct. Oct. 18, 2017) (Judge Robinson)).
This leaves open the possibility that the Court could apply Meiselman in the LLC context.