Okay, so maybe I am overstating that a bit, but it’s only a
bit.  This is not exactly timely, as the
following case was decided in the December 2012, but I was recently reviewing
it as I taught these cases and helped update Unincorporated Business Entities (Ribstein, Lipshaw, Miller, and Fershee, 5th ed., LexisNexis). (semi-shameless plug).  Despite the passage of time, this case has, apparently, gotten me riled up
again.  So here we go . . .    

Synectic Ventures I, LLC v. EVI Corp., 294 P.3d 478 (Or.
2012):  several investment funds organized as LLCs (the Synectic LLCs or
LLCs).  The LLCs made a loan to the
defendant corporation, EVI Corp. The loan agreement was secured by EVI’s
assets, and provided that EVI would pay back $3 million in loans, plus 8%
interest by December 31, 2004.  The loan
agreement provided that if EVI obtained $1 million in additional financing by
December 31, 2004, the loan amount would be converted into equity (i.e., EVI
shares) and the security interest would be eliminated. If the money were not
raised by the deadline, the LLCs could foreclose on EVI’s assets (mostly IP in
medical devices). 

To make things interesting, the LLCs appointed Berkman the
manager of the LLCs (thus, they were manager-managed LLCs). “At all relevant
times, Berkman—the managing member of plaintiffs—was also the chairman of the
board and treasurer of defendant [EVI].” 
In mid-2003, the Synectic LLCs' members sought to have Berkman removed, and Berkman signed
an agreement not to enter into new obligations for the LLCs without getting
member approval. 

In September 2004, before he was replaced as manager of the
LLCs, Berkman amended the loan agreement by extending the date for obtaining
financing by one year, to December 31, 2005. 
He did so by signing a consent resolution for EVI, as a director, and as
authorized the amendment for LLCs as manager. 
On December 29, 2005, EVI got a loan from another source for $1million,
and the loan was converted into EVI shares to be held by the LLCs. “Because the
conversion eliminated defendant's security interest in favor of plaintiffs,
plaintiffs lost their opportunity to foreclose on defendant's property and were
left as minority shareholders in defendant, holding less than five percent of
the outstanding stock.”

 In Synectic Ventures I, LLC v. EVI Corp., 251 P.3d 216 (Or.
Ct. App. 2011), the lower court granted EVI summary judgment find that Berkman
had extensive authority to control the LLCs under the operating agreement, but
even if he breached duties to the LLCs, he had authority to act on the LLCs’
behalf because the operating agreement stated:

“Right to Rely on Managing Member.
Any person or entity dealing with the Company may rely (without further
inquiry) upon a certificate signed by the Managing Member as to any matter
affecting the Company.” 

The Supreme Court disagreed, finding a conflict of interest
and finding that there was a genuine issue of material fact (making summary
judgment improper). The court determined it was possible that the operating
agreement did not grant authority for the LLC manager to proceed where there
was a conflict of interest, and explained, “If the factfinder concludes that
[the LLC manager’s] conflict of interest with plaintiffs deprived him of
authority to approve the amendment to the loan agreement, then defendant knew
about that conflict of interest, both in fact and as imputed by the knowledge
of its agent. Because defendant would have known that [the LLC manager] had a
conflict, defendant would have known that [the LLC manager, as a director of
defendant,] lacked authority to enter into the amendment on behalf of
plaintiffs.”

The Oregon Supreme Court got this wrong. 
Though I know there are those (in addition to the Oregon Supreme Court)
who disagree with me, if you respect freedom of contract and LLCs as entities, the lower courts had
this right. The contract permits the transaction and the outcome because the
fiduciary duties have been expressly disclaimed and authority granted to Berkman.  The Synectic LLCs' members made their bed, and they need to lie
in it. 

Note the following portions of
the operating agreement:

“4.1 Management of Company.

“(a) The management and control of the Company and its
business and affairs is vested
exclusively in the Managing Member of the Company[.] . . . The Managing Member shall have the authority
to undertake all actions on behalf of the Company without the consent of the
other Members, except to the extent expressly provided in this Agreement.
No Member other than the Managing Member shall have the authority to bind the
Company.  Without limitation of the foregoing, the Managing Member shall have the
without obtaining the consent of the other Members, to (i) invest the funds of
the Company in the securities of one or more issuers and to negotiate the terms
of such investment  . . . .”

3.2 Other Business of Members. Any Member . . . may engage
independently or with others in other business and investment ventures of every
nature and description and shall have no obligation to account to the Company
for such business or investments or for business or investment opportunities.  . . . The
Members acknowledge that each Member may own securities issued by or
participate in the management of companies in which the Company may invest and
that neither the other Members nor the Company shall have any claim or cause of
action against such Member arising from such ownership or participation.” 

The Supreme Court argues that section 3.2 allows members to
limit their fiduciary duties, but that this protection does not extend to a
managing member.  Instead, the court says
the loan amendment is only acceptable if the amendment was “fair” to the
plaintiffs, relying on Oregon RS 63.155:

 (6)
A member of a member-managed limited liability company may lend money to or
transact other business with the limited liability company, provided that any
loan or transaction between the member and the limited liability company must
be:

      (a)
Fair to the limited liability company;

      (b)
Authorized by an operating agreement; or

      (c)
Authorized or ratified by a majority of the disinterested members or by a number
or percentage of members specified in the operating agreement after full
disclosure of all material facts.

 Paragraph 9 of the same statute applies these requirements
to managers (including member managers). Because the court (I think
erroneously) determined the operating agreement did not permit the manager’s
actions, the transaction thus need to be fair. The court doesn’t seem to think
it is fair, either: 

In this case, the amendment to the
loan agreement that Berkman ultimately approved was at least arguably one-sided
in favor of defendant: defendant avoided foreclosure and obtained a one-year
extension of a 21–month loan, while plaintiffs received only an additional
year's interest on the extension. As a result, there is a genuine issue of
material fact whether the amendment was fair to plaintiffs.

Only a year’s interest?  That is most certainly valid consideration for
the extension and it is hardly uncommon to do such a thing.  It’s not like he added a year extension and
eliminated the foreclosure option.  The
foreclosure option went away when EVI fulfilled the obligation of adding
additional funds to  the company.     

I can see why the court doesn’t love this arrangement, but I
don’t see how they can say it was not exactly what was contemplated by the LLCs’
operating agreement.  Berkman was a
director of EVI when the whole thing started. There doesn’t seem to be any
concern that the original loan transaction was beyond the scope of his authority. If
it wasn’t, I don't see how the amendment is beyond his authority.  If the LLCs’ members wanted to terminate him
earlier and remove his authority, presumably they could have. They did
not. Further, if there is common-law fraud or other bases for liability, of course the LLCs should pursue those.  I just don't think they should be able to use the operating agreement as a defense.  

Further, is the court saying essentially that this kind of
arrangement is not permitted at all? Because Berkman did have fiduciary duties,
presumably, to EVI, too.  And as a
corporation, it’s likely he could not have disclaimed them, at least not to the
same degree (though the board could have approved his actions, I suppose).  It would be a reasonable
(though I think flawed) policy to say no such conflicts of interests can ever
be allowed, but then it would mean Berkman could not have his roles with both
EVI and  the LLCs ever.   And that’s not what is contemplated by the state
LLC law as I read it, and plainly that's not what the LLCs’ members intended. 

 Maybe the court is saying it's a conflict of interest when
LLC members get mad.  That can’t be it,
right?  

As I have argued previously:

Courts should put forth cogent reasons for their decisions,
rather than blindly applying corporate law principles in what are seemingly
analogous situations between LLCs and corporations. . . . The members of an LLC
chose the LLC as their entity, and they should enjoy both the benefits and
burdens of that choice. Where courts refuse to acknowledge the distinct nature
of LLCs, the promoters’ choice of entity is, at least in part, ignored.
(footnotes omitted)

Here, the court has ignored the text of the operating
agreement, the LLC act, and the unique nature of the LLC.  And that’s why they got this one
wrong.