Understanding what a non-managing member is can be a bit complex. A member-managed LLC is an LLC in which all the members participate in the decision-making process. Where there is a dispute, the vote of a majority generally rules, while certain extraordinary actions require unanimous consent.
However, in a non-member managed LLC, the members do not participate in the day-to-day management. The LLC has one or more managers who make business decisions.
A member can also be one of the managers—just as a shareholder can also be one of a corporation’s directors.
Or the manager may be an outsider. Even a single-member LLC can be manager-managed if the member does not want to manage the business himself or herself.
Where Is The Decision Made?
The LLC statutes have a default rule under which an LLC will be member-managed. However, the non-member members can opt-out of that rule and provide for manager-management.
In some states the choice of member-management or non-member management must be set forth in the formation document (e.g., Articles of Organization or Certificate of Formation).
In others, it can be provided for in the operating agreement without providing notification in the formation document.
The choice of member-management or non-member management has important implications for the members. If the members choose manager-management, they will not have a say in ordinary business decisions and will have to rely on others to ensure their goals in investing in the LLC are met.
On the other hand, if they choose member-management they need to be prepared to make these business decisions.
Non-Managing Member And Fiduciary Duty
A business partner has a fiduciary obligation to others in the partnership or limited liability company which bars not only blatant self-dealing, but also requires avoidance of situations in which the fiduciary’s personal interest might possibly conflict with the interests of those to whom the fiduciary owes a duty of loyalty.
Consequently, based upon the foregoing analysis, New York courts have held that a managing member of a manager-managed LLC has a fiduciary duty to the other members of the LLC.
However, while the managing member of a manager-managed LLC owes a fiduciary duty to the non-managing members, non-managing members do not owe a fiduciary duty to each other or to the LLC.
The reason, say the courts, is the absence of a duty imposed on the non-managing members to act in good faith and with due care under Section 409 of the Limited Liability Company Law.
Duty of Good Faith Or Loyalty Of Non-Managing Members
Let’s understand this with an example. Alex and Tina are the sole members of 56 Cant Street, LLC with each having a 50 percent interest therein. The LLC owns a two-story building and ground lease for premises located at 56 Cant Street in New York.
The accounting firm, Tina, Company, LLC, in which Tina is a partner, is one of two principal subtenants in the building. The other principal subtenant was a separate business run by Alex.
Alex alleges Tina breached its fiduciary duty as a 50% member of the LLC. Specifically, the Plaintiffs seek to recover consequential and punitive damages flowing from: (a) Tina’s failure to timely advise, and to instead affirmatively mislead, Plaintiffs regarding his intention to have his accounting firm not renew its sublease which expired on April 30, 2013; (b) refusing to allow Plaintiffs the opportunity to show the lease space to potential tenants; and (3) damaging the premises by replacing a set of glass doors with a single wooden door.
Alex and Tina are members of the LLC with an equal interest in its profits and losses. However, the Operating Agreement of 56 Cant Street LLC (“operating agreement”) identifies Alex as the managing member. Specifically, paragraph 5 of the operating agreement, entitled “Powers”, states that the “business and affairs of the Company shall be managed by Alex in his sole discretion.
Alex shall have the power to do any and all acts necessary or convenient to or for the furtherance of the purposes described herein, including all power, statutory or otherwise possessed by the members”
The operating agreement specifically delineates Alex as the managing member of the LLC and omits any language granting management powers or duties to Tina. Tina, thus, is a non-managing member of the LLC. New York case law is replete with cases demonstrating that a managing member of an LLC has a fiduciary duty to other members of the LLC
It is noted that section 409(a) of New York’s Limited Liability Company Law sets forth the duties of a limited liability company manager, as follows, “A manager shall perform his or her duties as a manager, including his or her duties as a member of any class of managers, in good faith and with that degree of care that an ordinarily prudent person in a like position would use under similar circumstances”.
Noticeably absent from the Limited Liability Company Law, which expressly imposes a duty of good faith upon managers of an LLC, is any concomitant duty on a non-managing member
Given the Legislature’s intent to specifically omit any obligations of good faith or loyalty on behalf of a non-managing member of an LLC, coupled with the fact that the operating agreement gives Alex the sole discretion to manage the business and affairs of the LLC, Tina, as a non-managing member, did not breach any duty to the LLC or to Alex.
Berkovitch & Bouskila PLLC represents businesses and Non-Managing Members primarily in York City and Rockland County area in a wide range of commercial litigation. Our commercial litigation attorneys have successfully prosecuted and defended claims of all sizes in courts. Our attorneys have extensive experience handling sophisticated business issues at trial, arbitration hearings and on appeal.
These issues include:
- Shareholder and LLC member disputes
- Breach of Fiduciary Duty
- Business Collections
- Breach of Contract Claims
- Business tort claims
- Fraud Claims
- Consumer Fraud Claims
- Insurance coverage disputes & so on.