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Tennessee Member-Managed Limited Liability Companies: Liability Of Members To Other Members And/Or The LLC

This blog addresses Tennessee law regarding the liability of members of Tennessee limited liability companies to other members and/or to the LLC itself. In 1994, the “Tennessee Limited Liability Company Act” became law in Tennessee. In 2005, the “Tennessee Revised Limited Liability Company Act” became law. The Revised Act added statutes regarding the conduct of LLC members which would subject them to personal liability to other LLC members, the LLC, and to holders of financial rights.

Tennessee recognizes three types of LLCs: (1) member-managed LLCs; (2) manager-managed LLCs; and (3) director-managed LLCs. This blog focuses only on member-managed LLCs, though much of the law discussed herein is equally applicable to the two other types of LLCs.

The starting point for understanding the potential liabilities of members of Tennessee member-managed LLCs to other members and/or to the LLC is Tennessee Code Annotated §48-249-403. Even though that statute has been in effect for about seven years, there is no Tennessee case law interpreting that statute or discussing its application. In fact, a Westlaw search for all Tennessee cases in which the statute is mentioned turns up no cases.

Under T.C.A. §48-249-403, a member of a Tennessee member-managed LLC has only two fiduciary duties to the LLC, to other members, or to holders of financial rights: (1) The duty of loyalty; and (2) the duty of care. T.C.A. §48-249-403, after delineating those fiduciary duties, then goes on specifically to limit them.

How might a member of a member-managed LLC subject himself or herself to personal liability to the LLC or to its other members by violating his or her duty of loyalty? A member who is unscrupulousness enough to keep money, including profits, of the LLC for himself or herself without the knowledge or consent of other members, violates the duty of loyalty.

Less obvious violations of the duty of loyalty include situations where a member uses property of the LLC to make a profit which he or she does not remit to the LLC, or situations where the member appropriates an opportunity of the LLC. An example of the former would include a situation which a client informed us of some years ago— an LLC member was using equipment and employees of the LLC to make money “on the side.”

A member’s duty of loyalty can also be violated by the member’s competing with the LLC before it is terminated or dealing with the LLC as, or on behalf of, a person having an interest adverse to the LLC. In the Tennessee Revised Limited Liability Company Act, there is a specific statute dealing with conflict of interest transactions. That statute contains some “safe harbor” provisions, or specific conduct in which a member can engage without violating the duty of loyalty. In summary, the “safe harbor” provisions include transactions: (1) the other members authorized, ratified or approved; (2) “fair” to the LLC; and (3) with respect to which any conflict of interest was waived in the articles or operating agreement.

How might a member of a member-managed Tennessee LLC violate his or her duty of care? Under the statute, a member’s liability for violating his or her duty of care is limited to grossly negligent or reckless conduct, intentional misconduct or a knowing violation of the law. Using bad business judgment, without more, is not a violation of the duty of care.

The Tennessee Revised Limited Liability Company Act also has a provision which requires a member in a Tennessee member-managed LLC to discharge his or her duties to the LLC and to other members consistent with the obligation of good faith and fair dealing. There is no Tennessee case which discusses the application of the good faith and fair dealing standard of conduct of a member of a Tennessee member-managed LLC. For a case discussing that standard, take a look at Blair v. McDonagh, a decision of the Court of Appeals of Ohio. In that case, an LLC member of a two person LLC was determined not to have breached that standard by refusing to consent to the LLC’s opening a line of credit which had been negotiated by the other member.