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Managers of insolvent Missouri LLCs have no fiduciary duty to creditors

David Warfield December 7, 2016

Two recent federal court decisions establish that managers of financially troubled Missouri limited liability companies do not owe a fiduciary duty to creditors of their troubled enterprises. Imperial Zinc Corp. v. Engineered Products Industries, L.L.C., No. 4:14-CV-1015-AGF, 2016 WL 812695 (E.D. Mo. Mar. 2, 2016); Imperial Zinc Corp. v. Engineered Products Industries, L.L.C., No. 4:16-CV-551-RWS, 2016 WL 6611129 (E.D. Mo. Nov. 9, 2016). These cases extend protections to managers of limited liability companies (“LLCs”) that are similar to those available to officers and directors of a financially troubled corporation.

Fiduciary Duties and Troubled Corporations. The Missouri Limited Liability Company Act expressly imports standard corporate law concepts into an analysis of a manager’s duties to a LLC. Absent agreement to the contrary in the Operating Agreement, the manager of a Missouri LLC should manage the LLC’s affairs with the “care a corporate officer of like position would exercise under similar circumstances.” R.S. Mo. §347.088.1.

Missouri, like all states, recognizes that corporate officers and directors owe a fiduciary duty to the corporation they represent and its shareholders About 25 years ago, however, some courts in other jurisdictions expanded the duty of their corporate officers and directors if the corporation was in financial distress. Like many corporate law developments, this movement began in Delaware. In Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., 1991 WL 277613 (Del. Ch. 1991), the Delaware Chancery court said: [D]irectors [should] recognize that in managing the business affairs of a solvent corporation in the vicinity of insolvency, circumstances may arise when the right (both the efficient and fair) course to follow for the corporation may diverge from the choice that the stockholder ... would make if given the opportunity to act." Id. at 35.

By the early 2000s, the notion was widely accepted in Delaware and many other jurisdictions that the duties owed by corporate officers and directors shifted from shareholders to creditors as the corporation neared the “zone of insolvency”. Missouri courts first faced the issue in Drummond Co. v. St. Louis Coke & Foundry Supply Co., 181 S.W. 3d 99 (Mo. App. 2005). Bucking the then national trend, the Drummond Court found that there was no statutory or fiduciary duty due from officers and directors to creditors of Missouri corporations. “Mere nonfeasance is not sufficient to impose individual liability upon corporate directors and officers; rather, active malfeasance or a specific statutory liability creating an individual cause of action for creditors is necessary to create such individual liability.” Id. at 103.

While it was an outlier at the time it was decided, the Drummond case was actually ahead of its time as it turns out. In 2008, the Delaware Supreme Court reformulated its Credit Lyonnais reasoning in North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 930 A. d 92 (Del. 2007) when it said that officers and directors of an insolvent corporation do not owe a fiduciary duty to creditors but instead owe a duty to the corporation itself. Creditors, however, as the true economic parties-in-interest of an insolvent corporation, could pursue derivative claims for breach of duty to the corporation. Throughout the next several years, additional Delaware decisions pared back the risk of personal liability for officers and directors of distressed Delaware corporations. Some other states followed, and by 2016, the general rule around the country was clear that the corporate officers and directors of insolvent corporations owed no direct duty to creditors. Instead, the officers and directors continued to owe their duties to the corporation, even when it became insolvent.

The issue was not nearly as clear in the context of limited liability companies. Relatively few cases around the country have addressed the issue. Until the Imperial Zinc cases, there were no cases on point in Missouri.

Facts of Imperial Zinc vs. Engineered Products. Between July and November of 2013, Imperial Zinc sold zinc goods to Engineered Products on open account. Engineered Products accepted the goods but did not pay for them. Imperial Zinc sued the Engineered Products for the unpaid goods, but it also named as defendants several others, including EFR, L.L.C. (“EFR”), a member and the manager of Engineered Products. Imperial Zinc argued that EFR continued to operate Engineered Products during the second half of 2013 after Engineered Products became insolvent in order to benefit creditors whose claims were personally guaranteed (primarily the secured lender) at the expense of those creditors whose claims were not guaranteed. Imperial Zinc complained that Engineered Products continued to purchase product after Engineered Products began workout discussions with its secured lender that culminated with the appointment of a workout consultant.

Imperial Zinc’s argument was based on some language in the Drummond case that mentioned (but did not endorse) older Missouri cases imposing liability on a corporation’s director when the creditor’s claim was incurred after the business was shut down or was clearly no longer a going concern. The theory of these old cases was that the directors of such a corporation occupied a trustee-like position for all creditors.

Engineered Products I. The first Engineered Products decision focused on whether Imperial Zinc had standing to bring a claim against EFR for damages incurred solely by Imperial Zinc. The Court ruled that Imperial Zinc could not purse a direct claim against EFR for its individual damages. The Court noted that “when a corporation is insolvent, ‘the beneficial interest of the stockholders clearly no longer exists . . . [I]n equity, as well as at law, the beneficial interest therein belongs to the creditors.” Since Missouri law does not permit an individual stockholder to pursue individual recovery against the corporation, the Court applied the same rule to creditors of an insolvent corporation. The court, however, left open the possibility that Imperial Zinc could bring a derivative action against EFR for damages suffered by all creditors.

Engineered Products II. Imperial Zinc then filed a new lawsuit against EFR on behalf of a purported class of all unpaid creditors of Engineered Products. The new litigation reiterated the claim that Engineered Products became insolvent in early 2013 and that it ceased to be a true ongoing concern after July of 2013 when EFR should have realized that trade creditors would not be paid. Imperial Zinc argued that EFR should have shut down Engineering Products as soon as it became insolvent because of EFR’s trustee-like duty to creditors. The Engineered Products II Court rejected the argument and dismissed the complaint. The Court said that the manager of an insolvent LLC does not have a duty to creditors to shut down and dissolve the business as soon as the LLC becomes insolvent.

Conclusion. These decisions are good news for managers of Missouri LLCs. They do not have a duty to shut down an LLC when it becomes insolvent. They can, for example, attempt to salvage an insolvent LLC by continuing to operate the business in a good faith effort to rehabilitate the LLC. One cautionary note: these decisions do not give managers carte blanche to engage in self-dealing or engage in fraudulent transfers. Managers may face personal liability under different theories for behavior of this sort.