Sky Harbor Hotel Props., LLC v. Patel Props., LLC (In Re Sky Harbor Hotel Props., LLC)

IN THE
SUPREME COURT OF THE STATE OF ARIZONA
IN RE:
SKY HARBOR HOTEL PROPERTIES, LLC,
Debtor.
SKY HARBOR HOTEL PROPERTIES, LLC,
Plaintiff,
v.
PATEL PROPERTIES, LLC,
Defendant.
IN RE:
SWIFT AIR, LLC,
Reorganized Debtor,
MORRISANDERSON & ASSOCIATES, LTD., LITIGATION TRUSTEE FOR THE
REORGANIZED DEBTOR,
Plaintiff,
v.
REDEYE II, LLC, ET AL.,
Defendants.
Nos. CV-19-0033-CQ; CV-19-0034-CQ
Filed June 25, 2019
Certified Questions from the
United States Bankruptcy Court for the District of Arizona
Nos. 2:17-bk-08082-PS; 2:12-bk-14362-DPC
QUESTIONS ANSWERED
COUNSEL:
John R. Clemency (argued), Lindsi M. Weber, Maria F. Hubbard, Polsinelli
PC, Phoenix, Attorneys for Sky Harbor Hotel Properties, LLC
SKY HARBOR V. PATEL/MORRISANDERSON V. REDEYE
Opinion of the Court
Paul M. Levine (argued), Paul M. Levine, P.C., Scottsdale, Attorneys for
Patel Properties, LLC
Dale C. Schian (argued), Scott R. Goldberg, Schian Walker, P.L.C., Phoenix;
Kim. R. Maerowitz, The Maerowitz Law Firm, Scottsdale, Counsel for
MorrisAnderson & Associates, Ltd. Litigation Trustee
Thomas J. Salerno, Alisa C. Lacey, Christopher C. Simpson, Anthony P. Cali
(argued), Stinson Leonard Street LLP, Phoenix, Attorneys for Redeye II,
LLC, et al.
CHIEF JUSTICE BALES authored the opinion of the Court, in which VICE
CHIEF JUSTICE BRUTINEL and JUSTICES TIMMER, BOLICK, GOULD,
LOPEZ and PELANDER (RETIRED) joined.
CHIEF JUSTICE BALES, opinion of the Court:
¶1 These consolidated cases involve alleged breaches of
fiduciary duties. To address these claims, the United States Bankruptcy
Court for the District of Arizona certified the following questions to this
Court:
1. Does a manager of an Arizona limited liability company
(“LLC”) owe common law fiduciary duties to the company?
2. Does a member of an Arizona LLC owe common law
fiduciary duties to the company?
3. Can an Arizona LLC’s operating agreement lawfully limit
or eliminate those fiduciary duties?
¶2 We answer the first question in the affirmative. We answer
the second question in the affirmative, provided that the member is an
agent of the LLC. We answer the third question in the affirmative but note
that the operating agreement may not eliminate the implied contractual
duty of good faith and fair dealing.
I.
A.
¶3 Arizona enacted its first limited liability company act (“LLC
Act”) in 1992. See 1992 Sess. Laws 395 (2d Reg. Sess.). The statutory scheme
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Opinion of the Court
is codified at A.R.S. § 29-601 et seq. Last year, Arizona’s legislature enacted
a new Arizona Limited Liability Company Act (“ALLCA”) to eventually
replace the LLC Act. See 2018 Ariz. Sess. Laws 833 (2d Reg. Sess.) (to be
codified at A.R.S. § 29-3101 et seq.). ALLCA will first apply only to LLCs
formed on or after September 1, 2019, but will apply to all LLCs starting
September 1, 2020. Id. Thus, to address the certified questions, we analyze
only the LLC Act.
¶4 The LLC Act does not expressly impose any fiduciary duties
on members or managers. See generally Scott DeWald, James Reynolds &
Matthew Engle, Fiduciary Duties and Indemnification, Ariz. Att’y, Mar. 2019,
at 18-19 (contrasting the LLC Act with ALLCA, which recognizes fiduciary
duties). By statute, however, “the law of agency” applies to the entire LLC
Act. See A.R.S. § 29-854(B). We thus apply common law agency principles
to answer the certified questions.
¶5 Arizona case law has not addressed these issues directly. This
Court has observed that “unlike both corporations and partnerships, LLC
members do not owe each other fiduciary duties unless they are expressly
included in the LLC operating agreement.” Butler Law Firm, PLC v. Higgins,
243 Ariz. 456, 462 ¶ 23 (2018). As support for this proposition, Butler cited
TM2008 Investments, Inc. v. Procon Capital Corp., 234 Ariz. 421, 424-25 ¶ 15
(App. 2014), which declined to “mechanically apply fiduciary duty
principles from the law of closely-held corporations or partnerships to a
limited liability company created under Arizona law.” TM2008 Investments
involved an action for breach of fiduciary duty filed by one member of an
LLC against another, and the court of appeals found that the operating
agreement itself established certain duties. Id. at 422 ¶ 1, 425-26 ¶¶ 16-17.
Butler concerned whether an LLC is an “other corporation” for purposes of
Arizona’s venue statute. 243 Ariz. at 459 ¶ 6. Neither case considered
whether, based on the common law of agency, managers or members owe
fiduciary duties to the LLC.
¶6 “Absent controlling authority to the contrary, we generally
follow the Restatement when it sets forth sound legal policy.” CSA 13-101
Loop, LLC v. Loop 101, LLC, 236 Ariz. 410, 414 ¶ 18 (2014). Under traditional
agency rules, agency is the “fiduciary relation which results from the
manifestation of consent by one person to another that the other shall act
on his behalf and subject to his control, and consent by the other so to act.”
Restatement (Second) of Agency § 1 (Am. Law. Inst. 1958). The agent is the
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Opinion of the Court
one who acts on behalf of another, the principal. Id. Agents are
characterized by their “power to alter the legal relation between the
principal and third persons and between the principal and” themselves. Id.
§ 12. Importantly, “[a]n agent is a fiduciary with respect to matters within
the scope of his agency.” Id. § 13.
¶7 We have characterized a fiduciary duty as imposing “the
obligation of loyalty,” Ghiz v. Millett, 71 Ariz. 4, 8 (1950), “the obligation of
the utmost good faith in their dealings,” DeSantis v. Dixon, 72 Ariz. 345, 350
(1951), and “requiring a high degree of care,” Master Records, Inc. v.
Backman, 133 Ariz. 494, 497 (1982) (quotations omitted). Thus, the nature of
the fiduciary relationship for agents includes a duty of loyalty, a duty of
good faith, and a duty of care. Partnerships, joint ventures, and
corporations are all owed fiduciary duties by those empowered to act on
behalf of such businesses. See DeSantis, 72 Ariz. at 350 (describing the
fiduciary nature of duties owed by partners to a partnership); Ghiz, 71 Ariz.
at 8-9 (describing the fiduciary nature of those involved in a joint venture);
Monterey Water Co. v. Voorhees, 45 Ariz. 338, 347 (1935) (describing the
fiduciary duties owed by officers to a corporation).
B.
¶8 By default, the members of an LLC are agents of the LLC “for
the purpose of carrying on its business in the usual way.” A.R.S. § 29-
654(A)(1). However, if an LLC’s management is vested in one or more
managers, members are not automatically agents “solely by reason of being
a member except to the extent that authority has been delegated to the
member by” the manager or the operating agreement. § 29-654(B)(1). If
management is vested in one or more managers, by law they are deemed
agents of the LLC “for the purpose of carrying on its business in the usual
way.” § 29-654(B)(2). Thus, if an LLC is managed by one or more managers,
such managers are agents, and under § 29-854 and agency law, they would
owe common law fiduciary duties to the LLC.
¶9 The answer to the second question depends on whether
management has been vested in one or more managers. If not, then all
members are deemed agents of the LLC and thus would owe common law
fiduciary duties to the LLC. If, however, the LLC is managed by one or
more managers, members are considered its agents to the extent they have
been delegated authority by the managers or the operating agreement
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Opinion of the Court
under § 29-654(B)(1). Thus, a member owes common law fiduciary duties
to the LLC if the member acts as an agent of the LLC.
C.
¶10 Although the common law recognizes that an LLC’s
managers or members, when acting as agents of the LLC, owe fiduciary
duties to the company, these duties may be lawfully limited by a valid
operating agreement.
¶11 The LLC Act provides for an operating agreement to govern
relationships between members and managers and between managers,
members, and the LLC itself. See A.R.S. § 29-682(B). The agreement “may
contain any provision that is not contrary to law and that relates to . . . the
rights, duties or powers of its members, managers, officers, employees or
agents.” Id. However, an LLC is not required to adopt an operating
agreement. § 29-682(A) (stating that an LLC “may” adopt an agreement).
Neither the LLC Act nor any other applicable law broadly prohibits an
operating agreement from altering or limiting fiduciary duties that
otherwise would be owed to the LLC by its managers or members.
¶12 The defendants in both certified cases concede that,
regardless of their arguments relating to common law fiduciary duties, the
implied covenant of good faith and fair dealing cannot be eliminated by an
operating agreement. Based on public policy and case law, this is a well-
supported concession. See Rawlings v. Apodaca, 151 Ariz. 149, 163 (1986) (“A
covenant of good faith and fair dealing is implied in every contract . . . .The
covenant . . . may be breached even though the express covenants of the
contract are fully performed”).
¶13 Thus, we answer the third question in the affirmative. Under
the LLC Act, an operating agreement may lawfully limit or eliminate
common law fiduciary duties owed to the LLC by its members or managers,
although it may not erase the covenant of good faith and fair dealing
implied in every contract. We have no occasion here to address whether
the provisions of any particular operating agreement are contrary to law in
this respect or otherwise.
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SKY HARBOR V. PATEL/MORRISANDERSON V. REDEYE
Opinion of the Court
II.
¶14 For the reasons noted, the LLC Act imposes common law
fiduciary duties on managers and members serving as agents of the LLC.
The LLC Act permits an LLC to limit or eliminate such common law duties
through an operating agreement, except for the implied covenant of good
faith and fair dealing.
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