Judicial Exceptions to Limited Liability Protection Provided by Florida LLCs
Florida law generally provides for limited liability for owners and managers of an entity. For example, Florida law provides that a “member or manager [of a limited liability company] is not personally liable, directly or indirectly, by way of contribution or otherwise, for a debt, obligation, or other liability of the company solely by reason of being or acting as a member or manager.”1 The separation of a legally organized entity from its owner and the prohibition of piercing the corporate veil, absent proof that the entity was organized or used to mislead creditors or to work a fraud on them, has been Florida’s common law for decades.2 The Florida Revised Limited Liability Company Act (the LLC Act) goes further and even protects the owners when corporate formalities are not observed.3 The ability of a member or manager to evade personal liability for the obligations of a limited liability company (LLC) is a fundamental principle of LLC law, and is one reason why attorneys comfortably suggest — and clients choose — the LLC form of ownership.
This article discusses well-known exceptions that impose personal liability on a member or manager and explains the developing law that extends personal liability of a managing member or manager of an LLC (and other parties who indirectly control the LLC) based upon a breach of a fiduciary duty. This liability is imposed without the need to pierce the corporate veil of the LLC. This article also examines ways to minimize such potential personal liability.
General Exceptions to Limited Liability
Well-known exceptions to the general rule of no personal liability include 1) a member’s written obligation to make future contributions;4 2) execution of an agreement for a to-be-formed LLC prior to its organization;5 3) the two-year clawback for distributions approved and made, including by way of purchase, redemption, or other acquisition, in violation of §605.0405, which liability can be imposed on the transferee as well as the members of a member-managed LLC (managing members) or the managers of a manager-managed LLC who consented to the distribution;6 4) responsible person liability for taxes owed to the United States;7 5) similar responsible party liability for Florida sales or use taxes;8 and 6) tortious conduct individually committed by a member or manager.9 Two Florida bankruptcy courts have also extended an officer or director’s fiduciary duties to the creditors of a company that operates in the “vicinity of insolvency” creating another exception for potential personal liability.10
Developing Law Exception to Limited Liability Applicable to Control Persons
Lesser known court-created exceptions to the general rule of no personal liability also exist and have been applied to structured LLCs. A “structured LLC” has an operating LLC that is owned and operated by one or more other entities creating multiple entity layers before an individual decisionmaker exists. Entities are intentionally used in this manner to legally protect each entity from having personal liability for the obligations of the lower-tier entities within the structure that it owns or manages. Faced with a corporate trail of entities and trying to determine responsibility without abrogating the law regarding the separateness of entities, courts have crafted exceptions to the general rule of no personal liability for members and managers. They have expanded fiduciary duties owed at the lower entity level to an individual officer, director, or manager at a higher entity level that is the ultimate decisionmaker or have extended the tortious conduct exception to the ultimate decision-maker regardless of the fact that the person serves as an officer, director, or manager of a different entity.
In re USACafes, L.P. Litigation, 600 A.2d 43 (Del. Ch. 1991), started the expansion of fiduciary duties in the context of a limited partnership managed by a corporate general partner.11 At issue was whether the individual directors of the corporate general partner owed the fiduciary duties of loyalty and due care to the limited partnership and the limited partners when, as a matter of corporate law, their duty of loyalty ran to their own corporate general partner and its shareholders. The directors argued that the assertion that they owed a fiduciary duty to the limited partners was a legal nullity inconsistent with the duty they owed to their own entity and its shareholders. The court rejected that argument, and relying on trust law held that the directors had the “duty not to use control over the partnership’s property to advantage the corporate director at the expense of the partnership.”12 USACafes has been relied upon extensively to extend the fiduciary duty of loyalty down the corporate trail to persons in control,13and has been followed in Florida by the Fifth District Court of Appeal in a case that the court found to be “close in point” when deciding that an individual manager of a corporate trust owed fiduciary duties individually to the beneficiaries of the trust.14 The Delaware courts have consistently relied on USACafes to expand the duty of care to the control individual.15
Similar to the court’s purpose in expanding the duty of loyalty in factual circumstances to the individual that exercises control, the tortious conduct exception can also be imposed down the corporate trail to the individual who has control.16
Need for Planning with LLCs
The extension of fiduciary duties down the corporate line together with a recent change to the LLC Act imposes a requirement for attorneys drafting an operating agreement to specifically address the fiduciary duties owed by a managing member or manager of an LLC. In 2015, §605.04091(2) of the LLC Act was revised to adopt the “uncabined” approach used in §409 of the Revised Uniform LLC Act by the National Conference of Commissioners on Uniform State Laws. Under the pre-2015 version, Florida used the “cabined-in” approach. The statute specifically limited the fiduciary duty of loyalty to 1) accounting to the LLC and holding as trustee for the LLC any property, profit, or benefit derived by the manager or member in the conduct or winding up of the LLC’s activities and affairs, from the use by the member or manager of the LLC’s property, or from the appropriation of an LLC opportunity; 2) refraining from dealing with the LLC in an adverse interest; and 3) refraining from competing with the LLC. However, after the 2015 change, §605.04091(2) provides an “uncabined” approach in that the duty of loyalty includes, but is not limited to, such specific acts. Accordingly, now a court has greater flexibility to impose liability upon a managing member or manager under the LLC Act for a breach of the fiduciary duty of loyalty.
Sections 605.0105(2)(e), 605.0105(4)(a)1, and 605.0105(4)(c)1 and 2 allow for the operating agreement to 1) specify the method to approve a specific act that would otherwise violate the duty of loyalty; 2) alter or eliminate the stated duty of loyalty under §605.0491(2) provided it is not manifestly unreasonable; or 3) identify specific types of activities that do not violate the duty of loyalty under §605.0491(2) provided it is not manifestly unreasonable. Pursuant to §605.0105(5), the court shall decide as a matter of law whether the term of the operating agreement is manifestly unreasonable based upon the law at the time the term that altered the duty of loyalty becomes part of the operating agreement considering only circumstances existing at that time. In McCoy v. Durden, 155 So. 3d 399 (Fla. 1st DCA 2014), pursuant to a majority opinion, the First District Court of Appeal examined whether an extensive waiver of any breach of fiduciary duty in an operating agreement was manifestly unreasonable. Importantly, the claim for a breach of a fiduciary duty was dismissed on summary judgment by the trial court before it was reversed by the First District Court of Appeal. The operating agreement provided:
“To the maximum extent provided by the LLC Act, the LLC and each member waive any claim against each manager and member of the LLC and their affiliates for breach of fiduciary duty to the LLC or its members, including claims as may result in conflict of interest among the LLC, the managers and the members.
The members agree (i) that the standard of duty of care and duty of loyalty, as well as the obligations of good faith and fair dealing, required by the LLC Act will be satisfied so long as a [m]anager or [m]ember believes that the terms of any contract or transaction giving rise to a conflict of interest were not unfair or unreasonable to the LLC, (ii) the rights and interests of all other parties in interest may be taken into account in discharging such duties and obligations, including members and affiliates who may be creditors or employees of the LLC or persons contracting therewith, and (iii) comply with Section 608.423 of the Act [now Section 605.04091].”
The First District Court of Appeal held that the trial court subjugated the role of the jury to determine issues of fact as to the commission of willful misconduct and reversed the trial court’s summary judgment ruling. However, the dissent relied on the exculpatory language set forth above to vote in favor of affirming the trial court — so, similar language in the operating agreement may be determinative in a different case.
In addition, the operating agreement executed by all of the members could include specific actions that do not breach the duty of loyalty, such as a real estate rental entity allowing one of its managers to use a unit rent-free to manage the LLC and store the records of the LLC.
Alternatively, the attorney could recommend that the client consider organizing the LLC in Delaware. The Delaware Limited Liability Act allows members pursuant to the operating agreement to eliminate all fiduciary duties that may otherwise be owed.17 In Fisk Ventures LLC v. Segal, 2008 Del. Ch. LEXIS 158 (Del. Ch. May 7, 2008),18 the operating agreement included the following exculpatory language that the court determined waived any fiduciary duties:
“Performance of Duties; no Liability of Officers. No [m]ember shall have any duty to any [m]ember of the [c]ompany except as expressly set forth herein or in other written agreements. No [m]ember, [r]epresentative, or [o]fficer of the [c]ompany shall be liable to the [c]ompany or to any [m]ember for any loss or damage sustained by the [c]ompany or to any [m]ember, unless the loss or damage shall have been the result of gross negligence, fraud or intentional misconduct by the [m]ember, [r]epresentative, or [o]fficer in question.”
If your client’s goal is to limit exposure to a potential claim for breach of fiduciary duties, then formation of a Delaware LLC with an operating agreement that includes exculpatory language may be an alternative to consider. However, if the Delaware LLC operates in Florida, an issue may arise regarding whether and how a Florida court would apply the Florida LLC Act in determining the enforceability of contractual exculpatory clauses.19
Conclusion
The formation and operation of an LLC entity does not insulate its members and managers from all potential liability exposure. In addition, layering entities with a structured LLC also does not necessarily insulate the ultimate control person from potential liability exposure. The operating agreement should be drafted to thoughtfully consider restrictions on fiduciaries’ duties, identifying conduct that the members agree does not constitute a breach of fiduciary duty by the managers or managing members, and exculpatory language that a Florida court would accept as not violating the “manifestly unreasonable” standard. Example exculpatory language to consider is found in McCoy and Fisk Ventures.
1 Fla. Stat. §605.0304(1) (“A debt, obligation, or other liability of a limited liability company is solely the debt, obligation, or other liability of the company. A member or manager is not personally liable, directly or indirectly, by way of contribution or otherwise, for a debt, obligation, or other liability of the company solely by reason of being or acting as a member or manager. This subsection applies regardless of the dissolution of the company.”).
2 Dania Jai-Alai Palace, Inc., v. Sykes, 450 So. 2d 1114 (Fla. 1984); see also Bellaire Sec. Corp. v. Brown, 168 So. 625, 633 (Fla. 1936) (Forming a corporation to “limit one’s risk to the amount of his investment…so far as future liabilities…are concerned…is legitimate and an everyday occurrence.”).
3 Fla. Stat. §605.0304(2).
4 Fla. Stat. §605.0403(1) and (5) (Liability for member contributions must be in a writing signed by the member to be enforceable or in the operating agreement, but the penalty for nonpayment of a contribution obligation under the operating agreement may be to reduce or eliminate the defaulting member’s interest in the LLC in lieu of an obligation to pay money.).
5 See, e.g., The Florida Bar, Asset Protection in Florida §§4.24 (4th ed.).
6 Fla. Stat. §§605.0405 and 605.0406.
7 26 U.S.C. §§3505 and 6672 (any “person required to collect, truthfully account for, and pay over any tax” and who “willfully” fails to collect or pay or “truthfully” accounts is personally liable to the United States).
8 Fla. Stat. §212.12(2)(e).
9 See, e.g., Buckner v. Campbell, 2010 U.S. Dist. LEXIS 128022 n.8, 2010 WL 5014411 (S.D. Fla. Dec. 3, 2010) (“Florida courts uniformly hold that if an officer, director, or agent commits or participates in a tort, whether or not his actions are by authority of the corporation or in furtherance of the corporate business, that individual will be liable to third persons injured by his actions, regardless of whether liability attaches to the corporation for the tort.”); Quail Cruises Ship Mgmt. v. Agencia De Viagens CVC Tur Limitada, 2011 U.S. Dist. LEXIS 122830, 2011 WL 5057203 (S.D. Fla. Oct. 24, 2011) (liability extends to person who acts outside of Florida).
10 In re Trafford Distribution Center, Inc., 431 B.R. 263 (Bankr. S.D. Fla. 2010) The authors represented a client in this case. In re Sol, LLC, 2010 Bankr. LEXIS 2047 (S.D. Fla. 2012) (citing Trafford).
11 See Feeley v. NHAOCG, LLC, 62 A.3d 649, 670-672 (Del. Ch. 2012); CMS Inv. Holdings, LLC v. Castle, 2015 Del. Ch. LEXIS 169, *68, 2015 WL 3894021 (Del. Ch. June 23, 2015) (“As a general matter, corporations and other business entities can owe fiduciary duties, as most easily exemplified in the situation where a corporation, LLC, or other entity is the managing member of an LLC or the general partner of a limited partnership.”). Feeley held that a managing member of a second LLC could be personally liable for the first LLC’s breach of fiduciary duty.
12 USACafes, 600 A.2d at 49.
13 See note 11.
14 Beaubien v. Cambridge Consol., 652 So. 2d 936, 938-39 (Fla. 5th DCA 1995).
15 Feeley, 62 A.3d at 671 (human controller of a corporate managing member could be held personally liable for breach of fiduciary duty in his capacity as the ultimate controller of the LLC). See also In re EZCORP Inc., 2016 Del. Ch. LEXIS 14 (Del. Ch. Jan. 25, 2016) (ultimate human controller who engages directly or indirectly in an interested transaction with a corporation is potentially liable for breach of duty, even if other corporate actors made the formal decision on behalf of the corporation, and even if the controller participated in the transaction through intervening entities); Kahn v. Lynch Commc’n Sys. Inc., 638 A.2d 1110, 1114 (Del. 1994) (holding that 43 percent stockholder that exercised actual control over subsidiary could be liable for breach of fiduciary duty); Virtus Capital L.P. v. Eastman Chem. Co., 2015 Del. Ch. LEXIS 34, 2015 WL 580553 at *18 (Del. Ch. Feb. 11, 2015) (holding that individual who controlled a complex family of funds that acquired control of corporation could be personally liable to corporation’s minority stockholders for breach of fiduciary duty); In re Primedia Inc. Deriv. Litig., 910 A.2d 248, 258 n.26 (Del. Ch. 2006) (holding that private equity firm could owe fiduciary duties to noncontrolling stockholders when firm controlled corporation through intervening entities); In re Emerging Commc’ns, Inc. S’holders Litig., 2004 Del. Ch. LEXIS 70, 2004 WL 1305745 at * 38-39 (Del. Ch. May 3, 2004) (holding that human controller of family of entities that executed an unfair squeeze-out merger was liable for breach of fiduciary duty in his capacity as majority stockholder).
16 See, e.g., Quail Cruises Ship Mgmt., 2011 U.S. Dist. LEXIS 122830, 2011 WL 5057203 (S.D. Fla. Oct. 24, 2011).
17 Del. Code, Title 6, §§18-1101(c), (d), and (e) (emphasis added) provides as follows: “(c) To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member’s or manager’s or other person’s duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement; provided, that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing. (d) Unless otherwise provided in a limited liability company agreement, a member or manager or other person shall not be liable to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement for breach of fiduciary duty for the member’s or manager’s or other person’s good faith reliance on the provisions of the limited liability company agreement. (e) A limited liability company agreement may provide for the limitation or elimination of any and all liabilities for breach of contract and breach of duties (including fiduciary duties) of a member, manager or other person to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement; provided, that a limited liability company agreement may not limit or eliminate liability for any act or omission that constitutes a bad faith violation of the implied contractual covenant of good faith and fair dealing.”
18 Fisk Ventures, 2008 Del. Ch. LEXIS 158 (Del. Ch. May 7, 2008) (an operating agreement may eliminate the fiduciary duty of a managing member or manager). E.g., Burtch v. Opus, LLC (In re Opus E., LLC), 528 B.R. 30 (Bankr. D. Del. 2015).
19 The internal affairs doctrine of corporate law applies the law of the state of formation to determine the liability among members, managers, and LLCs. See, e.g., Stuart R. Cohn & Stuart D. Ames, Florida Business Laws Annotated 2015-2016, referencing Guinan v. A.I. DuPont Hospital for Children, 597 F. Supp. 2d 485, 495 (E.D. Pa. 2009) (holding that an attempted piercing of the corporate veil was held to be determined by the law of the state of incorporation because such law is used to resolve the internal affairs of the entity rather than the state in which the litigation was brought). Accordingly, it is likely that the laws of Delaware allowing for the elimination of fiduciary duties would apply to a Delaware LLC operating in Florida under the internal affairs doctrine.
Thomas O. Wells, J.D., LL.M. in taxation, and CPA, practices tax, transactional, estate, and wealth preservation law in Coral Gables in the firm of Wells & Wells, P.A. Wells is board certified by The Florida Bar in tax law and was named 1999 CPA of the Year in Business and Industry by the Florida Institute of Certified Public Accountants. He is also the author of “Chapter 4 — Asset Protection Provided with Florida Business Entities” published by The Florida Bar in Asset Protection in Florida.
Diane Noller Wells practices commercial litigation, creditor rights, bankruptcy, and transactional law in Coral Gables in the firm of Wells & Wells, P.A. She is former chair of the Business Law Section of The Florida Bar.
This column is submitted on behalf of the Business Law Section, Jon Polenberg, chair, and Stephanie C. Lieb, editor.
