New York Permits Members of Limited Liability Companies to Disclaim Fiduciary Duties, At Least Sometimes
Transactional attorneys and their clients should pay attention to Pappas v. Tzolis, 2012 N.Y. Slip Op 8053 (2012), in which the New York Court of Appeals held that, at least under certain circumstances, members of a New York limited liability company (LLC) may agree among themselves that they owe no fiduciary duties to each other. Pappas is important because it allows members of an LLC to have greater certainty in their business relations with each other. The Court’s decision is a significant change in New York law. While it provides some guidance to transactional lawyers and clients who negotiate or draft LLC operating agreements and buyout agreements, and to litigators who bring suit on behalf of one LLC member against another, it leaves important questions unanswered.
Three individuals – Infantopoulos, Pappas andTzolis – formed a New York limited liability company in January 2006 to acquire and manage a long-term lease for a building in downtown Manhattan. Pappas and Tzolis each contributed $50,000 while Infantopoulos contributed $25,000. The parties’ operating agreement allowed each of them to engage in other business ventures, and to compete with the LLC.
Shortly after they formed the LLC, significant business disputes arose among the members, and in January 2007, Tzolis proposed to his partners that he buy them out for twenty times what they had contributed to the LLC only a year earlier. Both accepted.
In the buy-out documents, Infantopoulos and Pappas certified to Tzolis that:
- they had performed their own due diligence in connection with the buy-out,
- they had engaged their own legal counsel to advise them,
- they were not relying on any representation by Tzolis except as set forth in the documents, and
- Tzolis had no fiduciary duty to them in connection with the buy-out.
Seven months after Tzolis bought out his partners for $1.5 million, he assigned the LLC’s long-term lease to a developer for $17.5 million. Infantopoulos and Pappas then sued Tzolis, alleging that Tzolis was negotiating with the developer before the buy-out, and that Tzolis failed to disclose the negotiations in violation of his fiduciary obligation to them. Tzolis moved to dismiss this claim, primarily on the basis of the buy-out documents, and the issue ultimately found its way to the Court of Appeals.
The Courts of Appeals Decision
The Court of Appeals held that, at least on the particular facts of this case, the agreement by Infantopoulos and Pappas in the buy-out documents to absolve Tzolis of all fiduciary duties was binding, and so they could not a pursue a claim against him for failing to disclose his alleged negotiations with the developer. The facts that the Court found persuasive were:
- The parties were all sophisticated in business;
- They were all represented by counsel;
- They had already developed, at the time of the buy-out, an adversarial relationship that “was not one of trust and reliance”; blind reliance upon Tzolis under these circumstances was not reasonable;
- When Tzolis offered to pay Infantopoulos and Pappas twenty times their original investment after only a year, they were on notice that an appraisal of the leasehold interest might be warranted.
Although the Court decided this case on very narrow grounds – based upon the particular facts recited above – the decision could well presage that New York is joining states like Delaware, which expressly allows members of an LLC to disclaim fiduciary obligations in their operating agreement, at least where the parties are sophisticated, represented by counsel, and demonstrate an understanding of the relinquished rights. However, until New York appellate courts reach this issue post-Pappas, counsel should not assume that such provisions in an operating agreement will necessarily be effective.
Transactional attorneys should be particularly careful to discuss with their clients the implications of including such waiver language in LLC operating and buyout agreements in view of the uncertain state of the law. They should also insure their clients have, in fact, conducted sufficient due diligence before entering an agreement which states that they have done so.
Parties in litigation seeking to avoid dismissal of breach of fiduciary duty claims should draft pleadings in a manner that does not paint the defendant as so apparently unworthy of trust. In Pappas, plaintiffs might well have obtained a different result (at least on the motion to dismiss) if they had alleged facts to support the assertion that, when Tzolis obtained the fiduciary duty waivers, plaintiffs had no reason to distrust him.
For more information on the topic discussed, contact:
Business Litigation Bulletin is a newsletter of Tannenbaum Helpern Syracuse & Hirschtritt LLP’s Litigation and Dispute Resolution practice. It provides strategic perspectives on legal cases that impact the business community.