Mantle vs. North Star Energy & Construction LLC (Wyo.  2019) – Members of Insolvent LLC Do Not Owe Fiduciary Duties to Its Creditors, Unlike Principals of Insolvent Corporation

The following is a case update prepared by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, analyzing a recent decision of interest:

SUMMARY:

The Wyoming Supreme Court has held that the members of an insolvent LLC do not owe fiduciary duties to its creditors, unlike the principals of an insolvent corporation.  [Mantle vs. North Star Energy & Construction LLC, 437 P.3d 758 (Wyo.  2019).]

Facts: A bank extended credit to an LLC and a group of related entities.  Allegedly, the members of the LLC looted its assets.  An individual took an assignment of the bank’s position and then brought suit against the LLC and its members, alleging among other things that the members of the LLC had breached their fiduciary duty to him by virtue of their self-dealing.  The trial court entered summary judgment in favor of the members of the LLC.

Reasoning: the Wyoming Supreme Court affirmed, holding that the members of the LLC did not owe a fiduciary duty to its creditors.  The noteholder urged the court to adopt the “deepening insolvency” theory of liability, which permits damages for fraudulently prolonging life of an insolvent corporation.

The court first recognized that many courts have held that the principals of insolvent corporations do owe fiduciary duties to the corporations’ creditors.  Many states require that these types of claims be brought as derivative suits on behalf of the corporations themselves.  However, some other states have been reluctant to extend that rule to LLCs, on the ground that LLCs are not like ordinary business corporations.  The court held that the applicable Wyoming statute did not specifically authorize third party creditors to assert breach of fiduciary duty claims against the managers of an LLC:

Wyoming’s LLC Act specifies that managers of a limited liability company owe duties of loyalty and care “to the company,” and is silent as to any extension of fiduciary duties to creditors.

The court acknowledged that there was some contrary authority.  However, the court noted that in this case, the LLC’s operating agreement specifically said that the managers owed fiduciary duties to the company but did not mention the company’s creditors.  Reviewing earlier Wyoming cases involving the imposition of fiduciary duty in other contexts, the court held that “refusing to recognize a fiduciary relationship between an LLC’s managers and its creditors adheres to precedent concerning the creation of fiduciary relationships . . . .”

Author’s Comment:   The court’s distinction between ordinary corporations and LLCs is questionable.  This ruling means that even though the members of an LLC get to enjoy many of the protections (such as limited liability) that would apply to ordinary corporations, they also get extra protections from liability to the LLC’s creditors that would not be available to ordinary corporate officers and directors.  Is there a good policy-based reason to tilt the playing field in favor of the members of an LLC?  The court did not articulate one.

It is true that a creditor in a strong bargaining position could obtain the personal guarantees of the members of the LLC, which would provide a decent substitute for the imposition of fiduciary liability in the event of misconduct.  But that ex ante remedy is available only to sophisticated creditors holding relatively large claims.  It does not protect the small fry from insider misconduct.

For discussions of cases involving related issues, see:  

• 2017-42 Comm. Fin. News. NL 80, Under “Trust Fund” Theory, Insider Guarantors of Insolvent Corporation Who Defraud Lender Have Breached Fiduciary Duties.
• 2010 Comm. Fin. News. 25, Parent Entity That Engineers Ruinous Leveraged Spinoff May Be Liable for Actually Fraudulent Transfer and May Have Breached Fiduciary Duty to Subsidiary’s Creditors.
• 2009 Comm. Fin. News. 88, Corporate Directors Do Not Owe Fiduciary Duty to Creditors When Company Is in “Zone of Insolvency,” Unless Directors Have Dissipated Corporate Assets.
• 2007 Comm. Fin. News. 40, Creditors of Insolvent Delaware Corporation Cannot Assert Direct Claims for Breach of Fiduciary Duty against Corporation’s Directors.

These materials were written by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, for his Commercial Finance Newsletter, published weekly on Westlaw.  Westlaw holds the copyright on these materials and has permitted the Insolvency Law Committee to reprint them.