In A Fight Over Corporate Inspection Rights, A Quick Kick Beats The Trick Play

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A group of mostly powerless Class B members in a utility services firm suspected its only Class A member of self-dealing, but their suspicions did not mate with corporate authority to do much about it. However, blessed with wide-ranging inspection and audit rights under an operating agreement, they pushed forward with requests to determine the company’s financial health and investigate its management.  In Richardson v. Utili-Serve, LLC, 2020 NCBC 83, the Business Court considered the fate of this corporate inquiry when the managing member’s response to the requests was to attempt to take away the Class B members’ right to ask for the information in the first place.

Defendant C. Lee Dietrich, armed with “all voting rights on all matters,” found it “in the Company’s best interest” to amend the operating agreement to negate all audit rights and curtail the inspection rights it afforded. Id. ¶¶ 5, 9. Yet, to pull off the “Lucy with the football” maneuver you have to snatch it before Charlie Brown gets there to kick it.

Dietrich’s unilateral amendment spawned multi-layered concerns by Judge Conrad, but the cleanest issue spot was that, by its terms, the amendment to revise the Class B member inquiry rights was made effective ten days after they had already been exercised. Id. ¶ 18. The football already was sailing through a clear blue sky.

Examining the pre-amendment operating agreement in the context of Dietrich’s refusal to comply with plaintiffs’ exercise of their audit and inquiry rights, the Court allowed the plaintiffs’ breach, and good faith and fair dealing, claims to survive a motion to dismiss. Id. ¶¶ 19-20, 24. Moreover, plaintiffs’ breach of fiduciary duty claim survived the usual bar on LLC members having such a duty to one another based on the allegations of Dietrich’s control of the company. In aid of plaintiffs’ effort, Dietrich helpfully referred to his control as “plenary power” on brief. Id. ¶¶ 26-27.

While the purported amendment could not eradicate the Class B members’ inquiry rights because it was not retroactive, Judge Conrad noted it could well be an unenforceable contract because of the “unilateral rights” Dietrich reserved to later modify his performance obligations:

“In other words, construing the operating agreement to give Dietrich the power to amend it unilaterally and with no duty to do so in good faith would threaten the validity of the disputed amendment.

Id. ¶ 22. The Court observed that the North Carolina Court of Appeals has cast a wary eye at the validity of such provisions  See e.g., Sears Roebuck & Co. v. Avery, 593 S.E.2d 424, 432 (N.C. Ct. App. 2004) (“the power to unilaterally amend contractual provisions without limitation gives rise to an illusory contract.”).

The Business Court found it well within its mandamus authority to enforce the inspection requests whether under the statutory grant of N.C. Gen. Stat. § 57D-3-04(a), or under expanded rights – as here – that an operating agreement may afford. N.C. Gen. Stat. § 57D-2-30(b)(4). 2020 NCBC 83, ¶ 32. However, it declined to enter a mandatory preliminary injunction to require an audit because Judge Conrad identified no irreparable harm – particularly where the Class B members were receiving a broad production of data about the condition and conduct of the company through their inspection request.

Takeaways:

  • Unbounded manager authority in an LLC poses risks of unenforceability where performance benchmarks can be altered unilaterally.
  • When Charles Schulz retired from drawing Peanuts, even he felt a little bad about the illusory football kick: “You know, that poor kid, he never even got to kick the football. What a dirty trick.”

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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