LLC Law section 409 and New York case law impose fiduciary duties of care and loyalty on member-managers of limited liability companies.  Less clear are the duties of non-managing LLC members who fall outside the ambit of section 409.

The duty of loyalty encompasses an obligation to maintain the confidentiality of company trade secrets which are broadly defined as information not generally known or reasonably ascertainable by which a business can obtain an economic advantage over competitors or customers.  Do non-managing LLC members have a duty not to disclose company trade secrets?  How can an LLC protect itself against the risk of disclosure by LLC members?

Two recently decided cases provide some answers.  The first, Kuroda v. SPJS Holdings, LLC, 2010 Del. Ch. LEXIS 57 (Del.Ch. Mar. 16, 2010), decided by the Delaware Chancery Court, held that the implied duty of good faith and fair dealing under Delaware law does not obligate LLC members to keep company information confidential.  The second, Strix, LLC v. Buckley, 2010 NY Slip Op 30927(U) (Sup Ct Nassau County April 7, 2010), decided by a New York court but also involving a Delaware LLC, granted a preliminary injunction against LLC members under the confidentiality provisions contained in their employment agreements. 

The Kuroda case has been thoroughly reported in posts by Francis PileggiProfessor Larry Ribstein and, most recently, the LLC Law Monitor blog, so I’ll keep it brief.  The case involved various disputes between a non-managing member of an investment firm LLC and the managing member.  The former, Kuroda, provided consulting services pursuant to a separate consulting agreement that contained confidentiality provisions along with an arbitration clause requiring arbitration in Japan.  Kuroda initiated litigation in Delaware Chancery Court after he left the company and started his own competing firm allegedly using the LLC’s investor lists and market strategy.

The LLC  counterclaimed for misappropriation of trade secrets, but instead of relying on the confidentiality provisions in the consulting agreement — which would have required arbitration in Japan — the LLC relied exclusively on the implied duty of good faith and fair dealing arising under the LLC’s operating agreement.  Chancery Court rejected the LLC’s position, reasoning that because the parties had included an express confidentiality provision in the consulting agreement, using the implied duty to create the same duty in the LLC agreement “would be an override of the express terms of that agreement.”

In Strix, unlike Kuroda, there was no practical limitation on the LLC’s willingness to enforce employment agreements with former executive officers of the LLC containing confidentiality provisions.  The Delaware LLC involved in Strix operated four Hooters restaurants in New York.  The amended operating agreement appointed the two minority members, who held a combined 22.6% interest, as CEO and COO.  The minority members also entered into separate employment agreements with the LLC.  Paragraph 14(c) of the employment agreements provided:

During and after the Employment Term, the Executive shall hold in a fiduciary capacity for the benefit of the Company all secret, confidential or competitively sensitive information, knowledge or data relating to the Company and its business, including any confidential information as to customers of the Company, (i) obtained by the Executive during his employment by the Company and (ii) not otherwise public knowledge or known within the Company’s industry.

After certain restaurant renovation and construction projects exceeded their budgets, the majority member terminated the minority members for cause on the basis of various instances of alleged misconduct by each of them.  Within a day of each other, the majority and minority members filed dueling lawsuits asserting multiple claims including breach of employment contract and breach of fiduciary duty.  The complaint filed by the minority members contained allegations about the LLC’s financial health as well as what the court describes as “internal strategic information” and other “confidential financial data” including employee salaries and certain financial ratios.

The complaint also included allegations of the dirty-linen variety, such as an allegation that the majority member had discussed trying to “swindle” the LLC’s lender, General Electric, by submitting inflated construction invoices, and another allegation that the LLC was in default under its loan and franchise agreements.  The minority members acknowledged giving a copy of their complaint to GE and informing the Hooters franchisor of their termination and the filing of their complaint.  They also acknowledged contacting the LLC’s attorney requesting removal of their names from the company’s liquor license.

The LLC and its majority member moved for a preliminary injunction restraining the minority members from communicating any confidential or proprietary statements concerning the company to any non-party, other than their litigation counsel.  In his decision granting the injunction, Nassau County Commercial Division Justice Ira B. Warshawsky rejected the minority members’ argument that their communications were privileged, stating that “[c]ommunications unconnected with the judicial proceeding are not cloaked with the absolute privilege” and also rejecting any privilege under New York’s Civil Rights Law.  Justice Warshawsky found that the complaint “contain[s] confidential information about Strix” and that “providing GE with a copy of the  . . . complaint is a breach of paragraph 14(c) of the employment agreement.”  The judge also cited paragraph 14(g) of the employment agreements stating that the company is “entitled to injunctive relief (in addition to other remedies at law) to have the provisions of section 14 enforced.”  

Unlike in Kuroda, the ex-officers in Strix were not accused of using confidential company information for their own competitive advantage.  Both cases nonetheless serve as important reminders to counsel who draft LLC operating and employment agreements of the need to include appropriate confidentiality provisions that will prohibit LLC members and employees from disseminating or improperly using trade secret information during and after their association with the company.

Finally, Strix also underscores the risks and, to some extent, the futility of litigating trade secret cases in the internet age when court decisions are routinely posted online and, in a growing number of jurisdictions, absent a sealing order the parties’ pleadings, affidavits and other court filings are scanned, posted and accessible remotely to anyone who knows the case index number or a party name.  Throw in the growing number of bloggers like me, on the prowl for interesting cases to write about, and the risk of publicity sought to be avoided becomes even greater by the very act of trying to avoid it via litigation.