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Bringing and Defending Breach of Fiduciary Duty Cases for Tennessee LLC Members

Members of Tennessee Limited Liability Companies (“LLCs”) have the right to file lawsuits to recover losses resulting from breaches of fiduciary duty committed by other LLC members or committed by officers or managers of the LLC.  In Tennessee, if the breach of fiduciary duty caused a loss to the LLC, as opposed to a loss directly to the LLC member, then the LLC member has the right to bring a derivative lawsuit on behalf of the LLC.  If, on the other hand, the breach of fiduciary duty caused a loss directly to the member and not to the LLC, the member cannot bring a derivative lawsuit.  In such a case, the member should file suit individually against the other member, officer or manager.

The Tennessee Limited Liability Company Act specifically provides the right to an LLC member to bring a claim for breach of fiduciary duty on behalf of the LLC.  Such actions are referred to as “derivative actions” or “derivative lawsuits.”   Derivative actions are simply actions brought by an individual member or members on behalf of the LLC.  Any recovery for breach of fiduciary duty resulting from a derivative action goes to the LLC, not to the LLC member who brought the lawsuit.

A Tennessee court may, under the provisions of the Tennessee Limited Liability Company Act, permit a successful plaintiff in a derivative action to be reimbursed from any recovery from the lawsuit for attorney’s fees and expenses paid by that plaintiff from his or her own funds.  The court may permit such reimbursement for fees and expenses even if the plaintiff member does not recover a monetary judgment, but obtains injunctive or other equitable relief.  Furthermore, the court may require the LLC to reimburse the plaintiff for attorney’s fees and expenses paid for by the plaintiff if the amount of the recovery is not sufficient to reimburse the plaintiff for such expenses.

In some situations, breaches of fiduciary duty may cause a loss directly to an LLC member, but not to the LLC.  In these non-derivative types of actions which are brought directly by LLC members, as opposed to derivative actions, the plaintiff LLC members cannot recover attorney’s fees and expenses even if they prevail by proving a breach of fiduciary duty and damages.

When can LLC members bring non-derivative lawsuits directly against other LLC members or officers for breach of fiduciary duty?  Under the laws of some states, LLC members and officers do not have any fiduciary duties to other LLC members – – – their only fiduciary duties are to the LLC.  Under Tennessee law, at least in some cases, LLC members do owe fiduciary duties to other LLC members.

For Tennessee lawyers who handle LLC disputes, there are two key cases to look at to answer the question of whether or not a member owes fiduciary duties to the LLC only or to the LLC and to other members.  In McGee v. Best, a 2002 decision of the Court of Appeals of Tennessee for the Middle section, the court laid down what appeared at the time to be a bright line rule:  LLC members do not owe any fiduciary duties to other members – – – only to the LLC.

A year or so after the McGee decision was rendered, the Court of Appeals for the Eastern Section distinguished it and allowed a breach of fiduciary duty case by minority LLC members against majority LLC members to proceed.  In that case, Anderson v. Wilder, the majority LLC members forced minority LLC members out of the LLC using provisions in the LLC’s operating agreement.  The minority LLC members were paid $150.00 per unit for their shares, which price was based on a formula in the LLC’s operating agreement.  Shortly after the minority members were expelled, the majority members sold 49.9% of the ownership units for $250.00 per unit.

The Anderson court found no good reason that LLC majority members should not have fiduciary duties to LLC minority members since LLCs are hybrids of partnerships and corporations.  The Anderson court pointed out that all partners in Tennessee partnerships have fiduciary duties to one another.  It noted that all shareholders of Tennessee closely held corporations owe fiduciary duties to other shareholders.  It further observed that, in Tennessee corporations which are not closely held, majority shareholders owe fiduciary duties to minority shareholders.

Lawyers who handle breach of fiduciary duty cases for LLC members should assume that the holding in the Anderson case might well be extended to allow members to assert claims for breach of fiduciary duty against other LLC members or LLC officers even when those members claims do not arise from some type of oppression of minority LLC members by majority members, as happened in the Anderson case.  Based on the reasoning of the court in the Anderson case, there seems to be no good reason that LLC members should not owe fiduciary duties to other members in just about all, if not all, circumstances.  My guess is that the McGee case will continue to be distinguished and its precedential force limited to factual circumstances similar to the ones in that case.