Words Have Meaning: NJ Court Upholds Waiver of Duty of Loyalty in LLC
On Friday April 29, 2022, the Superior Court of New Jersey Appellate Division decided cross appeals in Lamme v. Client Instant Access, LLC et al., 2022 WL 1276123, affirming so much of the trial court’s decision that rejected Ms. Lamme’s claim that other businesses owned by Mr. Vaccarella (the 50 % owner of Client Instant Access, LLC[the “LLC”]), including one that competed directly with the LLC, evidenced a breach of Mr. Vaccarella’s duty of loyalty to the LLC and to Ms. Lamme, its other 50% owner. The LLC had been formed in 1997 by Mr. Vaccarella and the late Richard Lamme. Mr. Lamme died in 2013, and Ms. Lamme inherited his interest in the LLC. She and Mr. Vaccarella did not get along. He was appointed executor of Mr. Lamme’s estate; she sued seeking dissolution of the LLC and imposition of a constructive trust. That litigation was resolved by a settlement agreement recognizing her as, in the Court’s words, “a passive half owner of the LLC.” Peace did not last long, as a lawsuit by the LLC against Ms. Lamme was followed by an action brought by Ms. Lamme against Mr. Vaccarella and the LLC.
The LLC operating agreement contained an express waiver of the duty of loyalty as to each member. That provision read:
"Nothing in this Agreement shall be deemed to restrict in any way the freedom of any Member to conduct any business or activity of whatever nature including, without limitation, the acquisition, development, exploitation or sale of real property even if such activity is in conflict with the [LLC’s] activities…without any accountability to [the LLC] or to the other Members, and no Member shall have any interest in any such other business or activity by virtue of this Agreement."
The Court’s opinion notes that during Mr. Lamme’s lifetime he “gave … [Mr. Vaccarella] explicit permission to operate” a competing business and even “to use the LLC’s resources to service” the clients of that business.
Under New Jersey’s version of the Revised Uniform Limited Liability Company Act, 42: 2C-1, et seq., an operating agreement of a limited liability company formed under New Jersey law, like the LLC, may eliminate the duty of loyalty (and the duty of care, “or any other fiduciary duty”) Section 42: 2C-11, so long as the elimination is not [Subsection 2C-11 (d)] “manifestly unreasonable.” Additionally, the New Jersey statute [Section 2C-11(h)(1)] provides that a court may invalidate a term in an operating agreement only if it is “readily apparent” that the objective of the term is “unreasonable” OR that the term is an “unreasonable means to achieve the provision’s objectives.” The Court notes that in assessing whether “a term is manifestly unreasonable, a court must consider only the ‘circumstances existing at the time’ the operating agreement was formed.” Here the Court concurred with the trial court that the waiver was not “manifestly unreasonable,” citing in an extensive footnote law review articles reporting on the regularity and frequency of similar waivers. Further, the Court cites with approval another provision in Section 2C-11, namely subsection (i) that exhorts courts to liberally construe the NJ statute:
"to give maximum effect to the principle of freedom of contract and to the enforceability of operating agreements"
This part of the Court’s decision should prove helpful to New Jersey practitioners in drafting operating agreements, as it serves both to recognize and to support the capacities for careful design in a contract-based entity.
The remainder of the Court’s decision involves: i) claims by Ms. Lamme that Mr. Vaccarella violated a duty of care in lending funds to a 20-year employee to fund a buyout of the LLC, and ii) a claim by the LLC and Mr. Vaccarella that Ms. Lamme had wrongfully refused to sign an application for a Paycheck Protection Program loan, where anyone with a 20% interest in a business was required by the federal program to sign the application. The Court held that the loan to the employee without security for repayment may have been unwise, but did not rise to a breach of the duty of care. The Court also held that Ms. Lamme did not have to sign the PPP loan application, even though it meant that the LLC could not get a PPP loan. In the end a kind of “rough justice” resulted.
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