1. © Warren P. Kean wkean@slk-law.com
“Misunderstood Aspects of LLCs” Association of Corporate Counsel (Charlotte) Duke Mansion September 12, :30 – 1:30
© Warren P. Kean

2. FUNDAMENTAL DIFFERENCES BETWEEN CORPORATIONS AND LLCs
Corporations are generally governed by statute (the BCA). LLCs are generally governed by contract (the operating agreement).

3. FUNDAMENTAL DIFFERENCES BETWEEN CORPORATIONS AND LLCs
Examples from the BCA
Notices must be in writing unless otherwise provided in the articles or bylaws, and the BCA does specifically require written notice in certain circumstances. §
Description of each class of stock and the number of authorized shares of each class must be stated in the articles of incorporation. §§ (a)(2) and
All shares of a class/series must be fungible; i.e., “identical” rights, privileges, and limitations. §
Limitations on the liability of directors need to be stated in the articles but can’t limit liability for a director’s intentional misconduct or acts or omissions in respect of which he or she derived an improper personal benefit.

4. FUNDAMENTAL DIFFERENCES BETWEEN CORPORATIONS AND LLCs
LLC’s Statutory Foundation (What is our destination/lodestar?).
Purpose: “provide a flexible framework under which one or more persons may organize and manage one or more businesses as they determine to be appropriate with minimum prescribed formalities or constraints.” § 57D (a) (emphasis added).
Policy Objectives: “give maximum effect to the principle of freedom of contract and the enforceability of operating agreements.” Id.

5. FUNDAMENTAL DIFFERENCES BETWEEN CORPORATIONS AND LLCs
The statute’s hub or fulcrum § 57D-2-30(a):
“The operating agreement governs the internal affairs of the LLC” (i.e., “rights duties and obligations of the “interest owners” and “company officials” “in relation to each other, the LLC, and their ownership interests”).
The NC LLC Act and common law apply “only to the extent contrary or inconsistent provisions are not made in, or are not otherwise supplanted, varies, disclaimed, or nullified by, the operating agreement.” Id.
Inserting toggle switches in operating agreements

6. FUNDAMENTAL DIFFERENCES BETWEEN CORPORATIONS AND LLCs
The statute’s hub or fulcrum § 57D-2-30(a):
Statutory limitations to freedom of contract with respect to the LLC’s internal affairs:
1) Eliminate right of “members” to information. § 57D-2-30(b)(4)
2) Eliminate right to judicial dissolution or to bring derivative actions unless alternative means of relief/resolution is provided. §§ 57D-2-30(b)(5) and (6). See also § 57D-2-32 concerning the ability of parties to formulate their own remedies, which may include penalties, under the operating agreement.

7. FUNDAMENTAL DIFFERENCES BETWEEN CORPORATIONS AND LLCs
Statutory limitations to freedom of contract with respect to the LLC’s internal affairs:
3) Certain limitations on enforceability under contract and agency law (not corporate law), such as unconscionability and implied contractual covenant of good faith and fair dealing. § 57D-2-20(e)
4) Equity and access to equitable relief: “Unless displaced by this Chapter, the rules of law and equity supplement” the LLC statute, without the presumption that the statute’s divergence or conflict with common law is to be strictly construed. § 57D-10-02(a) and (b)

8. FUNDAMENTAL DIFFERENCES BETWEEN CORPORATIONS AND LLCs
What is an operating agreement?
“Any agreement concerning the LLC or any ownership interest in the LLC to which each interest owner is a party or is otherwise bound as an interest owner.” § 57D-1-03(23).
Maybe written, oral or implied; contractual statute of frauds
Every North Carolina LLC has an operating agreement.

9. FUNDAMENTAL DIFFERENCES BETWEEN CORPORATIONS AND LLCs
Pooling agreements and voting trusts are valid only for 10 years. §§ and (a)
Shareholder agreements among all of the shareholders relating to internal affairs or a corporation are not invalid “on the grounds that it is an attempt by the parties thereto to treat the corporation as if it were a partnership or to arrange their relationships in a manner that would be appropriate between partners.”
Proposed legislation would state what matters under the BCA may be altered by shareholder agreements.

10. FUNDAMENTAL DIFFERENCES BETWEEN CORPORATIONS AND LLCs
Questions?

11. MEMBER DISPUTES Derivative Actions
Bringing a civil action “in the right of” a corporation. §
Generally, “shareholders cannot pursue individual causes of action against third parties for wrongs or injuries to the corporation that result in the diminution or destruction of the value of their stock.” Barger v. McCoy Hillard & Parks, 346 N.C. 650, 658, 488 S.E.2d 215, 219 (1997) (quoting 12B Fletcher Cyclopedia of the Law of Private Corporations § 5911, at 484 (perm. Ed. 1993)).
Direct v. indirect injury (injury not suffered by the entity). In re Medtronic, Inc. Shareholder Litig., (MN 2017): “distinction … easily stated, the line that separates the two claims is not easily drawn,” citing Agostino: “The distinction between direct and derivative claims is frustratingly difficult to describe with precision.”
− “[W]hen shareholders are injured only indirectly, the action is derivative; when shareholders show an injury that is not shared with the corporation, the action is direct.”
− “[W]ho suffered the injury and therefore who is entitled to the recovery for that injury?”

12. MEMBER DISPUTES
Barger v. McCoy Hillard & Parks (quoting Fletcher) exceptions:
1. “where there is a special duty, such as a contractual duty, between the wrongdoer and the shareholder,” and
2. “where the shareholder suffered an injury separate and distinct from that suffered by other shareholders.”
Tooley v. Donaldson, Lufkin & Jenrette, Inc. exceptions:
1. “who suffered the alleged harm (the corporation or the suing shareholders, individually)”? and
2. “who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually”?
Applying the corporate “glass slipper” to LLCs.

13. MEMBER DISPUTES Distinction between tort and contract claims
“The LLC is deemed to be a party to the operating agreement and, therefore, is bound by and may enforce the provisions…applicable to the LLC.” 57D (emphasis added)
To whom are the duties alleged to have been breached owed?
Exception for closely-held companies?

14. DERIVATIVE ACTIONS History of derivative actions
Pros and cons of derivative actions
1. Benefit − right to seek repayment of expenses
2. Barriers − prerequisites (demand and pleading requirements):
a) must be a “member” both currently and at the time of the complained act or omission occurred
b) must make written demand on management to take suitable action (Delaware-futility exception, not available in NC, § )
c) complaining shareholder either
(i) is notified of management’s rejection of the demand, or
(ii) no response is made by management within 90 days of the demand, or
(iii) establish that irreparable injury to the LLC will occur within 90 days of demand. 57D-8-01

15. RELEVANT PROVISIONS OF THE OPERATING AGREEMENT
Duties of members and company officials
Liabilities for breach
Right of members to bring direct or derivative actions for:
a) injunctive, specific performance or other equitable relief?
b) damages?

16. EL PASO GP COMPANY V. BRINKERHOFF
152 A.3d 1248 (Del. 2016), rev’g. In re El Paso Partners, L.P. Derivative Litig., 132 A.3d 67 (Del. Ch. 2015)

17. POLICY CONSIDERATIONS FOR NOT ALLOWING DIRECT, DUAL NATURE CLAIMS
Damage awards do not conform with preferences of creditors and preferred stockholders
Prejudicial to interests and claims of creditors
Multiplicity of actions and need for judicial efficiency

18. POLICY CONSIDERATIONS SUPPORTING DIRECT, DUAL NATURE CLAIMS
Stated policy of the LLC Act is to enforce operating agreements.
Historically, derivative actions supplemented, not supplanted, remedies.
NC LLC Act does not (as a default rule) allow economic interest owners to bring derivative actions.
NC LLC Act allows operating agreements to eliminate alternative remedies. Likewise, operating agreements may preclude direct, dual-nature claims or expressly authorize direct and derivative, dual-nature claims.
Should analogies be drawn to corporate law or partnership law?
Modern procedural rules (intervention, joinder) allow for fair, just, and efficient resolutions of overlapping claims.
Who does the claim belong to (is the right to bring a claim exclusive or nonexclusive)?

19. PLANNING Opportunity for agreement forensics after the fact.
Opportunity for drafting with precision and certainty before there is a dispute. Statutes and case law can change.

20. HELPFUL JUDICIAL INSIGHTS
“For Shakespeare, it may have been the play, but for a Delaware limited liability company, the contract is the thing. “Ultimately, it is the contract that compels the court’s decision in this case because it is the contract that ‘defines the scope, structure, and personality of limited liability companies.’”
“The flexibility of such an entity springs from its roots in contract; the parties have ‘the broadest possible discretion’ to set the structure of the limited liability company. Indeed, ‘LLC members’ rights begin with and typically end with the Operating Agreement.’” R&R Capital, LLC v. Buck & Doe Run Valley Farms, No CC. (Del. Ch. Aug. 19, 2008).
“With the contractual freedom granted by the LLC Act comes the duty to scriven with precision.” Willie Gary LLC v. James & Jackson, LLC, No. 1781—CC (Del. Ch. Jan. 10, 2006).

21. Questions?