In July, Maryland’s highest court published two decisions that could impact limited liability companies (“LLC”) and other entities which operate in the State. The first of these decisions, Plank v. Cherneski, provides clear guidance on breach of fiduciary duty claims in Maryland; the second decision, 7222 Ambassador Road, LLC v. National Center on Institutions and Alternatives, Inc., analyzes the ability – or lack thereof – of LLCs to file appeals in Maryland courts when the LLC has forfeited the right to do business in Maryland due to failure to make required filings and payments.
PLANK v. CHERNESKI
On July 14, 2020, the Court of Appeals published its unanimous decision in Plank. There are several key holdings and takeaways from the decision. What follows is a brief summary of the underlying case, followed by a discussion and analysis of the key holdings from Plank.
James Cherneski invented and patented a non-slip athletic sock intended for soccer players and other athletes. In April 2011, Cherneski formed Trusox, LLC (“Trusox”) to produce and sell the patented sock. By June 2013, Cherneski owned a 65% membership interest in Trusox, with the remaining interests being owned by William H. Plank, II (20%), Sanford Fisher (7.5%), and Jeff Ring (7.5%), all of whom made financial investments into Trusox. The members of Trusox, along with Trusox, entered into an Operating Agreement, which gave Cherneski, as the majority member, President, and CEO, general authority over most decisions relating to Trusox.
In June 2016, Plank and Fisher sued Cherneski and Trusox, alleging nine causes of action, including one independent count for breach of fiduciary duty. The basis for Plank and Fisher’s breach of fiduciary duty claim was the allegation that Cherneski placed their investments at risk by engaging in unlawful actions that exposed Trusox to potential future damages claims for regulatory violations and lawsuits. After a bench trial, the Circuit Court for Anne Arundel County entered judgment in favor of Cherneski on the breach of fiduciary duty count due to insufficient evidence while noting that there is no stand-alone tort for a breach of fiduciary duty.
Plank and Fisher appealed to the Court of Special Appeals, and oral argument was held in March 2019. A three-judge panel determined that the legal questions presented needed to be certified to the Court of Appeals. The Court of Appeals granted the Rule 8-304 Certification filed by the Court of Special Appeals and issued a writ of certiorari that included the entire action.
Ultimately, the Court of Appeals affirmed the trial court’s decision entering judgment in favor of Cherneski on the breach of fiduciary duty count holding that the trial court had made a factual determination that there was no breach and that determination was not clearly erroneous.
Key Holding #1: Breach of Fiduciary Duty Exists as an Independent Cause of Action in Maryland.
The Plank decision clarifies decades of Maryland jurisprudence by ruling that there is an independent cause of action for breach of fiduciary duty under Maryland law.
To establish a breach of fiduciary duty, a plaintiff must demonstrate:
- the existence of a fiduciary relationship;
- breach of the duty owed by the fiduciary to the beneficiary; and
- harm to the beneficiary.
In squaring prior decisions, such as Kann v. Kann, 344 Md. 689 (1997), with its new analysis outlined in Plank, the Court states that trial courts should consider the nature of the fiduciary relationship and possible remedies on a case-by-case basis. This is because Maryland has several different causes of action for all breaches of fiduciary duties that depend on the nature of the fiduciary relationship in question and the remedies available to address a breach of that specific fiduciary relationship. See Kevin F. Arthur, Breach of Fiduciary Duty: a Cause of Action in Maryland?, Federal Bar Association Maryland Chapter Newsletter (March 2013).
Furthermore, while Trusox is a limited liability company, the Plank holding applies to all other types of business entities that create fiduciary relationships. Thus, when a plaintiff can describe a fiduciary relationship, identify a breach, and request a remedy recognized by law or contract, the claim for breach of fiduciary duty should proceed under the specified cause of action because the remedy for a breach of fiduciary duty is dependent upon the type of fiduciary relationship. Litigants can plead a breach of fiduciary cause of action without limitation as to whether there is another viable cause of action to address the same conduct.
Key Holding #2: Managing Members of an LLC Owe Common Law Fiduciary Duties to the LLC and to the Other Members.
Trusox, as a LLC, needed to comply with the Maryland Limited Liability Company Act (“LLC Act”), Maryland Code Corporations and Associations Article, Title 4A, and the Operating Agreement. The Court of Appeals noted that the LLC Act is silent with respect to any fiduciary duties that the managing member(s) of an LLC owe to minority member(s) of an LLC. Meanwhile, the Trusox Operating Agreement was silent with respect to any fiduciary duties that Cherneski owed to the Minority Members.
The Plank Court held that managing members of an LLC owe common law fiduciary duties to the LLC and other members based on the principles of agency. Support for this determination is found in George Wasserman & Janice Wasserman Goldsten Family LLC v. Kay, 197 Md. App. 586 (2011), a case that found not only a common law fiduciary duty, but also acknowledged that the parties can alter or create duties within the operating agreement.
As a result, Maryland LLCs and their members should understand that there are common law fiduciary duties owed by the managing member(s) to the LLC and other members. Further, the operating agreement can alter this common law duty and/or add additional duties for the managing member(s). Managing and minority members should review any operating agreement to which they are a party to determine whether additional or different duties are contained therein.
7222 AMBASSADOR ROAD, LLC v. NATIONAL CENTER ON INSTITUTIONS AND ALTERNATIVES, INC.
On July 27, 2020, the Maryland Court of Appeals published its decision in 7222 Ambassador Road, LLC. Below is a brief summary of the relevant facts of the case and law, followed by a discussion of the holding from this case and important takeaways.
On July 27, 2020, the Maryland Court of Appeals dismissed an appeal filed by an LLC after the LLC forfeited its right to do business in Maryland. An LLC is forfeited when it does not complete annual statutory obligations, and therefore, loses its right to do business in Maryland and the right to use its name. This case establishes that if a forfeited LLC does not reverse the forfeiture within the statutory 60-day grace period, it is not permitted to file a writ of certiorari, or more generally, permitted to initiate an action in a Maryland court. The 7222 Ambassador Road, LLC decision impacts LLCs as plaintiffs or petitioners in Maryland, but does not affect LLCs as defendants or respondents.
On October 11, 2019, 7772 Ambassador Road, LLC (“Ambassador Road”) forfeited its right to do business when it failed to fulfill its statutory obligations under the LLC Act Section 4A-911. On November 6, 2019, Ambassador Road timely filed its petition for writ of certiorari with the Maryland Court of Appeals. Ambassador Road did not take any action to reverse the forfeiture until the opposing party filed a motion to dismiss, which was almost 6 months after the forfeiture, meaning Ambassador Road was a forfeited entity during the time in which it filed its petition. The underlying litigation of the case did not affect the decision of the Maryland Court of Appeals.
Forfeiture Risk: Statutory Obligations under LLC Act 4A-911
In this case, Ambassador Road was forfeited almost a month prior to filing its petition with the Maryland Court of Appeals. A forfeiture can occur, as it does here, when one of the statutory obligations are not met. There are three obligations under Section 4A-911 of the LLC Act. Prior to or on October 1 of every year, an LLC must make certain filings and payments to maintain its right to do business in Maryland and the right to the use of its name, or it is forfeited.
- Pay locally collectable taxes to the State of Maryland Comptroller;
- Pay an unemployment insurance contribution (or make a reimbursement payment) to the Secretary of Labor; and
- File an annual report with the State Department of Assessments and Taxation (“SDAT”).
Each organization will then certify a list to the SDAT of every Maryland LLC that did not make the filing or payments and notify the LLCs that their right to do business in Maryland and the right to the use of its name will be forfeited unless all payments, interests and penalties due by the LLC are paid.
The LLCs who receive notification of forfeiture have a 60-day grace period under LLC Act Section 4A-912 to reverse the affects and make all necessary payments and filings in order for their right to be retroactively restored as of the date of forfeiture. Thus, if the delinquent taxes and unemployment insurance contributions are paid, and the annual filing and articles of reinstatement are filed with the SDAT, the LLC may retain its right to do business in Maryland. Here, if Ambassador Road made the necessary payments and filings within 60 days of October 11, 2019, its petition for writ of certiorari may have been heard on its merits and not dismissed for lack of authority.
Key Holding: A Forfeited LLC Lacks Capacity to Initiate Actions or Appeals.
The 7222 Ambassador Road, LLC decision analyzes the scope of LLC Act Section 4A-920, the savings provision. Under the savings provision, a forfeited LLC is limited in its power but not completely restricted from action. A forfeiture does not impair the validity of a contract or act of the LLC entered into or done (either before or after the forfeiture), or prevent the LLC from defending any action, suit, or proceeding in a Maryland court. The Court found that because of the language allowing a forfeited LLC to “defend” itself in a suit, an “act” does not include the act of initiating a complaint or appeal. Therefore, a forfeited LLC may defend itself in a Maryland court case, but may not initiate any action. Additionally, the Maryland Court of Appeals stated that the savings provision allowances provide third parties protection from LLCs using forfeiture to avoid performance obligations and judicial remedies.
Takeaway: Maintaining an LLC’s Status is Critical for Initiating the Litigation or Appeal Process.
In order to retain the ability to initiate litigation and file appeals, LLCs should maintain its right to do business in Maryland by filing and paying the annual obligations. During Ambassador Road’s six month period of forfeiture, it lacked the authority to pursue an appeal and file the petition for writ of certiorari resulting in the case’s dismissal. If an LLC fails to perform one of the statutory obligations, it should act quickly to rectify the delinquency (no later than 60 days) to receive the full benefit of the grace period and for their status to be restored as of the date of forfeiture. This practice could preserve an LLC’s capacity to continue litigation in pursuit of a favorable judgement.