The Tennessee Revised Limited Liability Company Act (the “Act”) sets forth the circumstances under which a limited liability company (“LLC”) member or manager may be liable to the LLC or to other LLC members. An LLC member’s or manager’s potential liability can arise from two separate categories of conduct: (1) conduct that is a breach of the member’s or manager’s duty of loyalty (duty of loyalty cases); and (2) conduct in the operation or management of the LLC that is below the standards of care set forth in the Act (duty of care cases).
This blog deals strictly with the second category set forth above — liability resulting from failure to manage and to operate the LLC with the required degree of care. What level of care in the management and operation of the LLC must a member’s or manager’s care fall below before that member or manager can be personally liable? Under the Act, a member or manager may be personally liable where his or her conduct: (1) Is grossly negligent or reckless; (2) is intentional misconduct; (3) or amounts to a knowing violation of the law. In my opinion, the grossly negligent standard, in most situations, would be the easiest for a plaintiff bringing suit against another member or manager to prove.
The Act insulates LLC members and managers from liability for ordinary negligence. Why? Because the Act incorporates the policies of the Business Judgment Rule, which Rule predates the Act and has been an integral part of business law for decades. The Business Judgment Rule is meant to protect those in charge of managing and operating businesses, as long as they act in good faith and for proper purposes, from liability for business decisions that turn out to have been unwise. It recognizes that managers and operators of businesses would be deterred from taking calculated risks that might advance the organization if they had to worry about lawsuits from members or shareholders engaged in “Monday morning quarterbacking.”
Under Tennessee law, gross negligence is defined as “a conscious neglect of duty or a callous indifference to consequences” or “such entire want of care as would raise a presumption of a conscious indifference to consequences.” There is but one Tennessee case which addresses the issue of the liability of a member or manager for gross negligence. It does not shed much, if any, light on the subject. In that case, the Court of Appeals concluded, without much analysis or discussion of the facts constituting the alleged gross negligence, that the trial court had not erred in determining that the member’s conduct was not grossly negligent.
Not only is the Tennessee case law on the subject of the gross negligence of a member or manager of an LLC scant, but also, there is not much case law on it across the fifty states. There is a 2009 case from the Court of Appeals of Utah, Stevensen 3rd East, LC v. Watts, that is worth analysis. In that case, the court upheld a sizable verdict against an LLC manager for gross negligence. Here are the key facts of that case:
- The defendant was the manager of the LLC and held a fifty percent (50%) interest in it through another LLC
- The defendant had many years of experience with commercial developments, while the other member had virtually none
- The LLC’s purpose was to build and to operate a residential condominium called the “Club”
- Ultimately, the Club cost more than $2.75 million to complete than was estimated
- Experts for the plaintiff testified, at trial, that the defendant had failed to exercise care in myriad ways, including:
- not adhering to a budget
- not adhering to fixed construction plans
- constantly changing the design to make a higher priced product without a basis to believe that higher priced units would sell better
- constantly changing the design when the defendant should have known that doing so would delay the project
- failing to properly administer contracts with the architect and the company tasked with marketing the units
- failing to require the contractor to complete work by any deadline
- failing to use plans and bids that would allow the defendant to determine whether the project was overbudget
On the facts set forth above, it is not a stretch for a Tennessee LLC lawyer to conclude that a Tennessee jury could reach the same result as the jury in the above case, and that the Court of Appeals of Tennessee would uphold such a verdict. In the Utah case, the defendant was not held liable because he made a decision, even a risky one, that resulted in a $2.75 million loss. He was held liable because the LLC lost $2.75 million as a direct result of his lack of diligence in management and supervision. Thus, the outcome seems appropriate and not in contravention of the Business Judgment Rule.