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Operating Agreement’s Permission To Compete May Not Be Enough To Avoid Implied Covenants

Where the parties’ Operating Agreement permitted the member-managers to operate competing businesses, such allowance did not eliminate one member’s implied expectation of no competition with the business. Klos Construction, Inc. v. Premier Homes and Properties, LLC, 2020 NCBC 53 (J. McGuire).  As a result, while the harmed member could not maintain a claim for breach of the fiduciary duty of loyalty, the Business Court nonetheless held that it could maintain a claim for breach of the implied covenant of good faith and fair dealing based upon another manager-member’s competing business.

In 2008 Plaintiff Klos Construction, Inc. (“Plaintiff”) joined with Defendants Key Marco Consulting and Marketing, Inc. (“Key Marco”) and Alpat Properties, LLC (“Alpat”) to form Premier Homes and Properties, LLC (“PHP”).  Per PHP’s Operating Agreement, each member was also a manager, and each manager’s liability was limited to, inter alia, acts which conflicted with the interest of PHP.  The Operating Agreement nonetheless permitted the members to engage in business ventures that directly competed with PHP.  The Operating Agreement also provided that if the North Carolina Limited Liability Act (“Act”) were amended at any time in the future to further limit the liability of members or managers, “then the liability of a manager or member… shall be eliminated or limited to the fullest extent permitted by the Act as so amended.” (Agreement, §7.1).  In 2009, PHP entered into an agreement with Aftew Properties, LLC (“Aftew”) to build, market and sell residential homes in a development owned by Aftew known as The Village at Motts Landing (“Motts Landing”).  Alpat provided funding for the project, Key Marco oversaw marketing, and Plaintiff handled construction of the homes in Motts Landing.  Over the course of the next several years, PHP successfully marketed and built numerous homes inside the development.

In 2014, the Act was amended to “permit parties to an operating agreement to waive a manager’s duty of loyalty,” but did not require a waiver of the duty.  (Opinion, ¶47).  In 2015 Key Marco and another developer, T. Ando Construction (“Ando”), created Premier Homes and Communities, LLC (“Communities”). In July 2015, Communities entered into a contract with Aftew to further develop the remaining parts of Motts Landing which PHP had not yet developed, thereby displacing PHP from further activities within Motts Landing.  Unhappy with being displaced, Plaintiff filed suit and brought numerous claims individually and derivatively on behalf of PHP against Key Marco, Ando and others. Key Marco sought summary judgment on, inter alia, Plaintiff’s individual claims for breach of fiduciary duty and breach of the implied covenant of good faith and fair dealing in the Operating Agreement, contending the 2014 amendments to the Act eliminated both causes of action.

  As to the claim for breach of the fiduciary duty of loyalty, the Business Court agreed and held that the Operating Agreement was amended to eliminate the duty of loyalty even though the amendments merely permitted—but did not require—parties in an LLC to waive the duty of loyalty. However, the Business Court denied Key Marco’s motion on Plaintiff’s breach of the implied covenant of good faith and fair dealing, holding that even though the Operating Agreement was amended to eliminate the duty of loyalty, the implied covenant could not be waived by the terms of the Operating Agreement.  The Business Court held Key Marco’s diversion of the 2009 Motts Landing contract to Communities could be found to have “wrongfully deprived” Plaintiff of the Operating Agreement’s benefits. (Opinion, ¶61).  In reaching its decision, the Business Court was unpersuaded by Key Marco’s argument that, because an implied term cannot contradict an express term of a contract, no implied covenant could prevent Key Marco from competing against PHP because the Operating Agreement expressly permitted such competition.

Based upon this decision, an LLC should understand that even if its operating agreement permits competition, such competition may nonetheless be prohibited if one member has an expectation of no competition.

            Additional legal points from this decision:

  • A member-manager’s designee does not become the actual manager of the LLC merely by accepting the designee appointment. (Opinion, ¶36).
  • Where an operating agreement contains language incorporating any changes made to the Act, the operating agreement is automatically amended without need of further action by the members or managers.  (Id., ¶45).
  • A duty to disclose falls within the fiduciary duty of loyalty and not the fiduciary duty of care. (Id., ¶80).
  • A defendant’s conversion of a plaintiff’s assets does not support a plaintiff’s claim for unjust enrichment. (Id., ¶88-89).
Copyright © 2020 Womble Bond Dickinson (US) LLP All Rights Reserved.National Law Review, Volume X, Number 258

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About this Author

Phil Mohr Bankruptcy and Litigation Attorney Womble Bond Dickinson
Partner

Phil is a trial lawyer. Although he will search for creative legal and business solutions for his clients, his more than two decades of trial experience for both publicly traded and privately held companies in state and federal courts throughout the country have taught him that some cases simply have to be tried to verdict. Representing companies that have both been wronged and accused of wrongdoing, Phil has honed his trial skills in cases involving complex business litigation (including fraudulent transfer and equitable subordination cases in federal bankruptcy court)...

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