Judge rules LLC documents outweigh state filings

Listen to this article

Typically, when someone puts information down in writing and then submits it to the government, they can be held responsible for whatever is in the document in question.
But a recent decision by Judge Louis Bledsoe of the North Carolina Business Court shows that’s not always the case.
Bledsoe’s decision came in a lawsuit filed by a group of investors, who claimed their investment advisor engineered a scheme to transfer $188,000 they had invested to help buy a stake in a Franklin County golf course and retirement community to in order to enrich himself.
The investor plaintiffs attempted to argue in their derivative action that Howard Jacobson had breached his fiduciary duty to the investment firms they had entrusted with their money by engaging in “blatant self-dealing.”
Their evidence? A 2009 annual report filed with the North Carolina Secretary of State, listing Jacobson as the manager of Lakebound Fixed Return Fund LLC.
However, the defendants pointed to a different document that did not list Jacobson as manager — the company’s operating agreement — to support their claim that no fiduciary duty existed.
The plaintiffs fired back by arguing the conflict between the two documents raised a material question of fact that should be decided by a jury.
Bledsoe initially sided with the plaintiffs, allowing several claims against Jacobson to proceed.
But just days before a trial was set to begin in Levin v. Jacobson, Bledsoe had a change of heart. The judge reversed his earlier decision and granted summary judgment to the defendants on the plaintiffs’ breach of fiduciary duty and constructive fraud claims.
The reason Bledsoe changed his mind had to do with the fact that the lawsuit was filed as a derivative claim, meaning the allegedly injured parties were the companies Jacobson was purported to manage, not the individual investors who filed the civil action.
Based on that fact, Bledsoe reasoned that the state’s Limited Liability Act should have been applied differently, to the investor’s detriment.
“We respectfully disagreed with that decision. But we were pleased it didn’t have an impact on our other claims,” said James White of Parry Tyndall White in Raleigh, who represented the plaintiffs in the case.
Shady deals?
Eric Levin, Howard Shareff and Shareff’s Chapel Hill dental practice filed their derivative claim lawsuit on behalf of Lakebound and SilverDeer Olde Liberty LLC in 2010.
The two companies were founded by Jacobson and were designed to serve as investment vehicles. According to court records, Lakebound was expected to establish a fixed return of 10 percent to investors.
The anticipated returns were significant, considering that by 2009 Levin and Shareff had invested $1 million in Lakebound and more than $300,000 in other investment companies created by Jacobson.
But according to Levin and Shareff, rather than return profits to the investment company’s members, Jacobson allegedly used a series of complex financial transactions to apply their investment to the purchase of a stake in the Olde Liberty Club Golf and Country Club, a master-planned golf community with a one-story “55+ Active Adult section” located just north of Wake Forest.
Levin and Shareff’s lawsuit claimed Jacobson misled them about how their money would be used and made a series of investments of “questionable value” without their knowledge. The lawsuit also accused Jacobson of directly benefitting from his alleged misuse of funds invested in Lakebound and SilverDeer.
The complaint included separate counts of constructive trust, breach of fiduciary duty, constructive fraud, conversion and unjust enrichment. The plaintiffs requested an injunction barring Jacobson and the investment companies from transferring funds until a constructive trust could be established.
On second thought…
The defendants moved for summary judgment on the breach of fiduciary duty claim on the grounds that Jacobson was not the manager of Lakebound and therefore had no fiduciary duty to the plaintiffs.
Bledsoe denied that motion after determining that the 2009 annual report filed by Lakebound, which listed Jacobson as the company’s manager, created a question of material fact. Bledsoe’s order allowed the derivative claims of breach of fiduciary duty claim and constructive fraud to proceed.
The judge based his decision on a provision in the LLC Act that allowed any person dealing with a limited liability company to rely conclusively upon its most recent annual report filed with the Secretary of State.
But as the trial date approached, Bledsoe reexamined the LLC Act, this time focusing on provisions in the statute that had been amended by the General Assembly since the lawsuit was filed.
The key provision under Bledsoe’s analysis was Chapter 57D, which supplanted an earlier provision and provided more clarity on which documents should control when deciding whether or not an individual should be considered an LLC’s manager.
Chapter 57D states that only those who are not party to the operating agreement may rely on documents filed with the Secretary of State. Otherwise, the operating agreement controls.
Here’s where the derivative claim becomes important.
Levin and Shareff filed their lawsuit on behalf of Lakebound as a derivative claim, which means they are not technically plaintiffs in interest — Lakebound is, Bledsoe said.
And because Lakebound is a party to its own operating agreement, that document, not the annual report, should take precedence, the judge ruled.
“That is, the section’s intent is in the nature of embodying a doctrine of apparent authority, and that doctrine is not appropriately applied in a claim by a member who has, or is deemed to have, knowledge of the operating agreement,” Bledsoe said. “Otherwise, a member would be allowed to ignore his own contractual agreement.”
The same day Bledsoe issued his ruling, the plaintiffs’ attorney filed a motion to reconsider. That motion failed to sway Bledsoe. The summary judgment order on the breach of fiduciary duty and constructive fraud claims remained in place.
Province Grande Olde Liberty, one of the defendants in the case, was represented by attorneys from Robinson Elliott & Smith in Charlotte. Jacobson represented himself. None of the defense attorneys could be reached for comment.
Adam Doerr, a business litigation partner with Robinson, Bradshaw & Hinson in Charlotte, said Bledsoe reached the correct decision, based on the text of Chapter 57C and 57D.
“It makes sense that third parties can rely on documents filed with the Secretary of State for the identity of an LLC’s manager. Because operating agreements are rarely public, third parties wouldn’t have access to them,” Doerr said. “But this situation is different because the plaintiff in this derivative action is the company itself. You have to presume the company knows what its own operating agreement says.”
Silver lining
While Bledsoe’s summary judgment decision was undoubtedly a setback for White’s clients, he still considers the case a win.
The jury sided with White’s clients on their claims of conversion against Jacobson, and awarded $188,000 to the plaintiffs. The jury also said the stake in the golf course and retirement community purchased with Lakebound’s money should be subject to a constructive trust controlled by Lakebound.
“We are pleased that Judge Bledsoe’s decision on the breach of fiduciary duty and constructive fraud claims didn’t affect the jury’s decision on the conversion and constructive trust claims,” White said. “Had Judge Bledsoe’s decision gone the other way, we could have had the potential to recover additional damages. But we are happy with how the jury verdict came out.”
White said he has not heard from his opponents on whether they intend to appeal the jury verdict. White said that at this point, he is waiting for a judgment to be entered and for more guidance about how the constructive trust will be structured.
“If the other side appeals, we are still not sure whether we’d also appeal the ruling on the fiduciary duty and fraud claims,” White said. “We’re just waiting to see what happens next.”