No Breach of Duty of Loyalty to LLC Where LLC Conducted No Business
Under California law, a limited liability company (“LLC”) is one of the options available for forming a corporate entity through which to operate a business. Other options include a corporation, various professional organizations, and various limited partnerships. If you want to form an LLC, there are three types — a single-member LLC, a member-managed LLC, and a manager-managed LLC. An experienced San Diego corporate attorney can provide advice and counsel on which corporate form might best suit your unique business circumstances.
One of the differences between various corporate forms relates to duties that are owed to the corporate entity by shareholders and members. In this article, we discuss the duties owed by a member to a member-managed LLC. Because of its small size, the California State Assembly has specified strict duties that a member owes to its member-managed LLC. Under Corporations Code, §17704.09(b), an LLC member has the following duties:
- Must act as though he /she were a “trustee” in the use of company assets, including company opportunities
- Must refrain from taking an adverse interest to the company and
- Must refrain from competing with the company
Note that if the member-managed LLC becomes manager-managed, then these statutory duties are not applicable; they are applicable only to the managers.
One interesting question is what happens if the LLC is merely a holding company that does not actually engage in any sort of business. In an unpublished opinion, the California Court of Appeals addressed that question in Maaskamp v. Wortrich, Case No. G050962 (Cal. App. 4th Dist. 2017). In that case, inventors, Messrs. Maaskamp and Wortrich, formed Surgin Surgical Instrumentation, Inc. (“Surgin”), which researched and developed products related to ophthalmic surgery. They also formed an LLC as a holding company to hold title and ownership to the ophthalmic products, inventions, and technology. The LLC holding company did not conduct any sort of business; it was just a holding company. At some point, Maashamp and Wortrich had a falling out and Wortrich bought out Maashamp’s shares and ownership interest in Surgin. However, they both continued to be members of the LLC holding company.
Shortly after leaving Surgin, Maashamp began developing competing products and began marketing them in competition with Surgin. Wortrich sued claiming that Maashamp was violating his fiduciary duties as a member of the LLC holding company. Maashamp defended by showing that the LLC holding company did not actually engage in any business. Therefore, he could not “compete” against his own LLC since the LLC did not actually engage in any sort of business. The trial court and the Court of Appeals agreed.
The LLC holding had no business and had no prospective business. Other than the patents to certain technology, the holding company had no assets, no resources and was deliberately set up as a means of passing royalty payments from patent licensing agreements through to the members (Maashamp, Wortrich, and others). Given the nature of the LLC holding company, it had no “corporate opportunities” and, therefore, it was not possible for Maashamp to redirect corporate opportunities to himself. Likewise, it was impossible for Maashamp to compete against the LLC holding company since it did no business. For these reasons, the court held that Maashamp did not breach the fiduciary duties that are set forth in Corporations Code, §17704.09(b).
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For more information, call experienced business attorney Michael Leonard, Esq., of San Diego Corporate Law. Call Mr. Leonard at (858) 483-9200 or contact him via email. Mr. Leonard’s law practice is focused on business, transactional, and corporate matters and he proudly provides legal services to business owners in San Diego and the surrounding communities. Like us on Facebook.