Can LLC members walk away from fiduciary duties? That was the question posed but not answered in a post I wrote two months ago about a decision by Nassau County Commercial Division Justice Timothy S. Driscoll, denying a preliminary injunction in a case called Gilbert v Weintraub involving a two-member, 50/50 LLC with no written operating agreement.
The defendant member, Weintraub, had sent the plaintiff, Gilbert, a notice stating that he was withdrawing from all management responsibilities and, six days later, formed and began operating a new, competing company. Without commenting directly on the parties’ arguments for and against the ability of a member of a member-managed LLC unilaterally to renounce management responsibility and the appurtenant fiduciary duty of loyalty, the court denied preliminary relief on the grounds that Gilbert had not provided sufficient evidence to establish a likelihood of success on the merits of his claims or a balancing of the equities in his favor.
Two months and one motion to dismiss later, we have the answer to the fiduciary-duty question left open. In his decision dated January 29, 2016 (read here), reconciling the fiduciary’s duty of undivided loyalty with a manager’s right to resign under the LLC Law’s default rule, Justice Driscoll held that “further factual development” was needed to determine whether it was reasonable for Weintraub’s fiduciary duty to extend beyond his resignation as manager and, if so, for how long it should extend.
The decision came on a motion to dismiss Gilbert’s amended complaint (read here) alleging that Weintraub breached his fiduciary duty after resigning his role as manager and employee of the subject LLCs by setting up a competitive business to solicit the LLC’s vendors and sales representatives, many of whom then terminated their relationship with the LLC “at the specific request” of Weintraub.
Weintraub argued that upon his resignation he had no duty to refrain from competition in the absence of a non-compete agreement or allegations of misappropriation of trade secret. He also argued that under LLC Law § 401 (b), a member may, or may not, choose to exercise management powers, therefore relieving him of his fiduciary duty upon resignation.
Gilbert opposed the dismissal motion, arguing that, unlike in other cases where the defendant member never had a managing role, the applicable precedent does not permit Weintraub, who admittedly was a managing member of the LLC from its inception, to rid himself of fiduciary responsibility by resigning for the purpose of setting up a competing business.
Justice Driscoll began his analysis with a review of the statutory provisions and common law principles at play, namely:
- LLC Law § 401 (a), which vests management powers in the members of an LLC unless the articles of organization or operating agreement provide to the contrary. Gilbert and Weintraub had no operating agreement, thus both were vested with management powers.
- LLC Law § 401 (b), which provides that, if management of an LLC is vested in its members, as in the case at hand, then such members “shall have and be subject to all of the duties and liabilities of a manager.”
- LLC Law § 415, which permits a manager to resign at any time upon written notice, absent contrary provision in the operating agreement. Weintraub therefore was permitted to resign.
- A fiduciary is under a common-law duty of undivided loyalty not to set up a competing business with the person or entity to whom that duty is owed. The court rejected Weintraub’s contrary argument.
Justice Driscoll proceeded to frame the key question as “whether Weintraub’s fiduciary duty to Gilbert, which undoubtedly existed up to the moment of his resignation, ceased automatically upon his resignation.” He then answered his own question, not with a categorical yes or no, but with a more nuanced, fact-dependent approach under which the duty may or may not extend beyond resignation, and which attempts to strike a balance between a manager’s fiduciary obligations and right to resign. Here’s how the judge explained it:
The difficulties that arise from such a conclusion [that Weintraub’s fiduciary duty ceased automatically upon his resignation] are not difficult to fathom; a manager/member of a two-person LLC without any operating agreement who may be unable to successfully seek judicial dissolution of the entity in light of Matter of 1545 Ocean Ave. LLC v Ocean Suffolk Props. LLC, 72 A.D.3d 121 (2d Dept. 2010) could nevertheless create leverage by resigning his management position and immediately setting up a business competing with that LLC upon his resignation as manager. Conversely, the manager/member of an LLC without any operating agreement who resigns his management position must, at some point, be able to make a living without being shackled by his now-former management role with the LLC.
Focusing next on the allegations of Gilbert’s Amended Complaint, sparse as they were, Justice Driscoll ruled against Weintraub’s dismissal motion based on the need to further develop the factual record, writing as follows:
Here, Gilbert alleges that Weintraub was the “schmoozer” of the two members-managers and thus had closer relationships than Gilbert had with the LLCs’ vendors and sales representatives. Gilbert thus essentially alleges that the LLCs were not “turnkey” operations, and thus perhaps Weintraub would be reasonably expected to cooperate with Gilbert for a brief period as the LLCs transitioned to Gilbert as sole manager of the LLCs. That assertion does not appear worthy of summary disposition without further factual development, particularly where, as here, Weintraub formed a competing venture less than one week after resigning as a manager of the LLCs. In short, the fiduciary duty Weintraub undoubtedly owed to Gilbert until the moment of his resignation as a manager may have continued at least six days later when Weintraub formed the competing LLC. Discovery will shed light on whether it is reasonable, under the circumstances in this case, for such a duty to extend beyond Weintraub’s resignation as manager, and if so, for how long it should extend.
This is definitely a case to watch, assuming it doesn’t settle sometime soon. Future questions to be addressed include: How will the court determine a reasonable transition period to single member-management? Will it depend on the actual willingness of the business’s vendors and sales representatives to continue a relationship with Gilbert? Will expert testimony be required? Does the fact that Gilbert himself declared that Weintraub had no managerial authority after he gave notice of his resignation come into play? Assuming the court finds that Weintraub’s fiduciary duty continued into the period after he began competing, what is the appropriate remedy and, if damages, how will they be computed? Stay tuned.
Update June 18, 2016: I’m afraid we won’t get answers to the preceding questions. Earlier this month, the parties filed a stipulation discontinuing the litigation presumably in connection with a settlement of some sort.