In Villareal v. Saenz, a district court magistrate judge for the Western District of Texas, San Antonio Division, has recognized that members exiting a limited liability company may continue to hold fiduciary duties despite not owning membership interests in such company.[1] The dispute in question concerns the business divorce of the eponymous Villareal and Saenz (the “Members”), who were each members in ZroBlack LLC (ZroBlack), a Delaware limited liability company the pair formed to provide technology consulting services.[2] Following ZroBlack’s execution of a services contract with an international customer and receipt of funds paid in advance, the Members found themselves in conflict over Saenz’s alleged failure to perform his day-to-day duties. Eventually, Villareal indicated to Saenz that the pair should part ways.
The Members subsequently executed a mutual release of claims (Release) incident to the divorce, which in turn included a consent reciting the assignment from Saenz to Villareal of Saenz’s membership interests in ZroBlack (Consent). Following the Members’ execution of the Release, Saenz allegedly failed to relinquish control of certain pieces of ZroBlack property, including its website domain and a laptop containing ZroBlack’s proprietary information. Villareal then filed a lawsuit against Saenz, alleging, among other causes of action, that Saenz had breached his fiduciary duties to ZroBlack as a member and officer. Saenz filed counterclaims, and the Members then filed motions to dismiss against one another.
Addressing the potential dismissal of the Members’ claims in a lengthy order, the Court found in part that Saenz’s actions following the execution of the Release could still give rise to breach of fiduciary duty liability despite the fact that Saenz owned no membership interest ZroBlack LLC at the time. Most importantly, the Court reminded the Members that “an assignor member does not cease to be a member merely by assigning the member’s interest.”[3] Indeed, §101.111(a) of the Texas Business Organizations Code states that “an assignor of a membership interest in a limited liability company continues to be a member of the company and is entitled to exercise any unassigned rights or powers of a member of the company until the assignee becomes a member of the company” (emphasis added).[4] From the Court’s perspective, it was unable to determine as a matter of law exactly whether and when Saenz ceased to be a member of ZroBlack (and thus, when Saenz’s fiduciary duties to ZroBlack stopped).[5] Accordingly, the Court denied Saenz’s motion to dismiss Villareal’s breach of fiduciary duty claim for Saenz’s post-release actions. The Court’s analysis of Saenz’s potentially lingering fiduciary duties focused on the terms of the LLCA.
The Court cited the LLCA’s treatment of “exiting members”, which the Court found to be unclear. Article VII of the LLCA included several provisions outlining the process by which one member could exit the business by assigning his or her interest the other following a price determination. However, the LLCA did not address specifically when and how an assignee (e.g. Villareal) could be admitted as an actual member of ZroBlack. Typically, limited liability company agreements specify the circumstances in which an assignee may be admitted as a member, which include, among other things, the member’s acceptance of the terms of the limited liability company agreement in writing.
The Release was not helpful in clarifying this point. The Release obligated the Members to execute the Consent, which contained a resolution stating the following: “RESOLVED, that John Saenz hereby assigns his entire interest in ZroBlack LLC to Jonathan Villarreal pursuant to Article VII of the ‘Limited Liability Company Operating Agreement for ZroBlack LLC’ dated January 14, 2019 and applicable laws” (emphasis added).[6] While the Court noted that “There is only one reasonable interpretation of Saenz’s ‘entire interest in ZroBlack LLC,’ …Saenz assigned his membership interest in the company itself,” the language of the Consent did not offer further guidance on when and how Villareal would succeed to Saenz’s interest as a member, thereby ending Saenz’s fiduciary duties as a member of ZroBlack. On the contrary, the Consent seems to have confused this point further by stating that the assignment was made pursuant to Article VII of the LLCA.
It seems possible that the Members assumed that Saenz’s assignment to Villareal was sufficient to cause Villareal to succeed to Saenz’s interest as the new, sole member of ZroBlack. However, unfortunately for Saenz, his pleadings combined with the uncertain wording of the LLCA, Release and Consent caused the Court to be unable to conclude this as a matter of law.
Although the outcome of Villareal’s breach of fiduciary action against Saenz is far from certain, the Order features some painful reminders for drafters of limited liability company agreements and related documents. First, assignments of membership interests (even between existing members) should affirmatively state when an assignor ceases to be a member, and include an acknowledgment by the company and the company’s governing authority on this point. Second, limited liability company agreements should include provisions addressing exactly whether and how assignees can be fully admitted to the company as members.
[1] 5-20-CV-00571-OLG-RBF, 2021 U.S. Dist. LEXIS 94183 (W.D. Tex. May 18, 2021). Docket entry No. 59 is referred to herein as the “Order”.
[2] The author notes that the Court analyzes the existence of Saenz’s fiduciary duties through Texas law despite the fact that ZroBlack is a Delaware limited liability company. Noting that the “Limited Liability Company Operating Agreement for ZroBlack LLC” (referred to herein as the “LLCA”) filed with the Court does not include a definitive choice of law provision, the author assumes that the Court determined that Texas law governs the Members’ relationship to ZroBlack given that each Member, and ZroBlack, are domiciled in Texas.
[3] Id. at 15, quoting Miller & Ragazzo, 13 Tex. Prac., Texas Methods of Practice § 59:2 (3d ed. 2021) (citing Tex. Bus. Orgs. Code § 101.111(a)).
[4] Tex. Bus. Orgs. Code § 101.111(a).
[5] Order at 15.
[6] Order at 12.
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