Critical Drafting Considerations for LLC Members' Operating Agreements
A SPECIAL REPORT featuring analysis from Tripp Scott's Paul O. Lopez and Brittany Hynes
As Published in the Daily Business Review
If an operating agreement is in place and not drafted correctly, the parties could inadvertently broaden this narrow exception under Florida law and create avenues for direct claims by and between one another which are not generally available to them under the Florida Revised Limited Liability Company Act (the Revised LLC Act).
Litigation between and among members of a limited liability company (LLC) can be, to say the least, complicated. Disputes over money usually are, but when a minority group of members believes that they are entitled to profits and they believe the majority in control are making mistakes in running the company, oftentimes these situations lead to litigation if agreements cannot be reached. One of those complications is whether a lawsuit relating to the distribution of profits or breaches of fiduciary duties is brought derivatively on behalf of the company or directly on behalf of the members themselves. Usually, aggrieved members would prefer to sue directly so that they can directly recoup money damages, but as will be discussed below, Florida law provides for a narrow set of circumstances when members can sue other members directly. That said, as will be discussed below, if an operating agreement is in place and not drafted correctly, the parties could inadvertently broaden this narrow exception under Florida law and create avenues for direct claims by and between one another which are not generally available to them under the Florida Revised Limited Liability Company Act (the Revised LLC Act). Depending on your role in an LLC, you will want to pay close attention to how your operating agreement is drafted.
There are two basic types of actions a dissatisfied member might bring. The first is a direct action to assert a member’s own injury by a manager, another member, or the LLC. Fla. Stat. Section 605.0801. The second is a derivative action on behalf of the LLC to assert an injury to it. The only statutory requirement for a member pursuing a direct action under this provision is that the member “must plead and prove an actual or threatened injury that is not solely the result of an injury suffered or threatened to be suffered by the limited liability company.” If this requirement is not met, the member has no standing to bring a direct claim. If standing is denied to bring a direct action, a dissatisfied member may turn to a derivative action.
The Revised LLC Act provides that a member “may maintain a derivative action to enforce a right of the limited liability company.” This is a mandatory rule as the LLC’s operating agreement may not “unreasonably restrict the right of a member to maintain” a derivative action. The Revised LLC Act provides that a member may maintain a derivative action only if it first makes a demand upon the other members or managers to make the LLC pursue its own rights unless a demand would be futile.
Whether a lawsuit is deemed a “direct action” or “derivative action” can have a significant impact on recovery. Members who successfully sue the LLC directly can normally recover all their damages. On the other hand, members suing derivatively can usually only benefit from the corresponding rise in value resulting from the derivative lawsuit. This is because, in a derivative action, the LLC is the true plaintiff even though it may be handled by an individual member.
The leading Florida case distinguishing between direct and derivative actions in LLCs is Dinuro Investments v. Camacho, 141 So. 3d 731 (Fla. 3d DCA 2014). The Third District Court of Appeal explained in the pertinent part:
Whether a particular action may be brought as a direct suit or must be maintained as a derivative suit can be a confusing inquiry. After all, a member or shareholder with a personal stake in a company or corporation necessarily sustains a loss when the company loses value, and determining which types of loss are directly compensable by direct suit requires fine lines to be drawn. These distinctions are even more difficult to draw for closely held corporations and LLCs, which typically have fewer individuals that possess an ownership interest because claims of mismanagement or self-dealing become a zero-sum game in which one party profits from the company’s loss, while the other is harmed due to the company’s reduced value.
Following a sweeping analysis of “nearly 50 years of apparently divergent case law,” the Third District Court of Appeal concluded that a direct action requires either direct harm and special injury or a separate duty.
Under the “duty owed” test, Dinuro‘s exception to the general rule that there must be both direct harm and special injury, a court “examines the statutory and contractual terms to determine whether the duty at issue was owed to the individual member … by a particular manager or member, or whether those duties were owed to the company generally.” A direct action may be brought when “it is based upon a primary or personal right belonging to the plaintiff” member. The “plaintiff may assert a direct action when there is a special duty owed even if the harm otherwise flows to the company.” (citing Harrington v. Batchelor, 781 So. 2d 1133, 1135 (Fla. 3d DCA 2001)). There is a fundamental question of whether a manager or member’s duties under an operating agreement run to the LLC, to the other members or both. The Revised LLC Act imposes a duty of loyalty and care on all managing members that are owed “to the limited liability company and all of the members of the limited liability company.”
Notably, the right to enforce an operating agreement is not included as a mandatory rule. Therefore, it can be contracted away. Nevertheless, a member’s right to bring a direct action, including one to enforce any rights enumerated in an operating agreement, cannot be unreasonably restricted. See Ferk Family v. Frank, 240 So. 3d 826, 838-39 (Fla. 3d DCA 2018). In Ferk Family, the Third District Court of Appeal decided whether the plaintiff had properly brought a “direct action” for breach of contract against the other members of an LLC. In that case, the plaintiff brought an action for an injury arising from a breach of an operating agreement. Ordinarily, this type of action would be derivative, because the injury is derived through the LLC.
However, the operating agreement in Ferk Family importantly contained a provision that stated that “nothing herein contained is intended to, nor shall it limit or affect, any other rights in equity or any rights at law or by statute or otherwise of any member aggrieved as against the other Members, for breach or threatened breach of any provision thereof.” The Third District Court of Appeal held that the plaintiff had the authority to sue directly because this provision fulfilled the “duty owed test” and provided a sufficient foundation to sustain a direct action. As such, the plaintiff would be able to recover from the other members directly, rather than the reduced recovery it would have received had it brought a derivative action.
Thus, what Ferk Family tells us and confirms is that the plain language of the Revised LLC Act affords members the right to sue another member directly where the operating agreement so provides. In other words, under Florida law, an LLC’s operating agreement can provide a method for an aggrieved member to sue another member directly, even when such a claim would traditionally be deemed a derivative claim on behalf of the LLC. Given the foregoing, while it is vitally important to have an operating agreement in place to govern the parties’ rights in an LLC, it is equally important to pay close attention to key drafting considerations, including when and how members can sue one another in connection with the management of the company. Failing to do so could create significant exposure between and among members that otherwise would not exist.