LLC operating agreement calls the shots
Ruling finds company statute’s protective provisions trumped by agreed-to managerial power
A September New Mexico court case contains important guidance for members of limited-liability companies, or LLCs.
LLCs combine the limited liability of a corporation with “pass through” taxation of a partnership. LLCs also lack the formality of corporate governance. An LLC’s “operating agreement” governs the management of the LLC and the rights of its members.
The operating agreement determined the outcome of BUKE LLC v. Cross Country Auto Sales LLC, Cross Country Auto Sales Westside LLC, Southwest Auto Wholesale LLC, John Chiado, Joe Chiado, John T. Reilly, and Bedo LLC in which the New Mexico Court of Appeals held that an LLC minority members’ rights were controlled by the LLC’s operating agreement, not by an LLC statutory provision limiting a manager’s authority over assets.
The key actor in the BUKE drama was Randall Eastburg, who ran Cross Country Auto Sales, a large Albuquerque used car dealer. Eastburg was the managing member of BUKE LLC. BUKE’s members were Turner Branch, a New Mexico attorney; Brian Urlacher, a professional football player; Bryce Karger, an associate of Urlacher; and Eastburg. Branch held a 20 percent interest in BUKE.
In 2006, BUKE bought a General Motors new-car dealership in Tucumcari, naming it as an Urlacher Cross County dealership. The GMC new-car dealership had benefits that most used-car dealerships do not have: rights to bid at special GMC low-mileage used-car auctions and a line of credit called a “floor plan.” Eastburg used BUKE’s access to GMC used-car auctions to buy low-mileage used cars for the Albuquerque Cross Country area dealerships, the BUKE dealership and a Lovington Cross Country dealership also named for Urlacher, which Eastburg, Karger and Urlacher owned.
Eastburg did not hide his use of the BUKE access to GMC used-car auctions. He freely disclosed his use of BUKE to buy low-mileage used cars for all the Cross Country-brand dealerships. He described his actions in an interview in the media. Karger knew of Eastburg’s activities. He knew the Lovington Urlacher Cross Country dealership was getting cars from BUKE. Eastburg reimbursed BUKE the auction price but nothing more.
In 2008, Branch discovered that the BUKE dealership in Tucumcari was behind on line-of-credit payments. When the recession hit, Eastburg’s used-car empire came crashing down. Through BUKE, Branch sued the Cross Country dealerships and the members of the Albuquerque Cross Country LLCs claiming their unjust enrichment from Eastburg’s use of BUKE assets. He did not sue Urlacher or Karger.
Eastburg had taken bankruptcy protection.
The Court of Appeals affirmed the district court’s summary judgment against BUKE. The court held that BUKE had no claim for Eastburg’s use of BUKE’s assets to benefit the Cross Country dealerships.
The operating agreement said only Eastburg had management power. In a vaguely worded provision, the agreement said he could use BUKE’s assets if a majority of members agreed.
Branch argued that the LLC statute required Eastburg’s use of assets be approved by a “disinterested majority” of the LLC members — much like a corporate legal requirement. Branch was the only disinterested member in BUKE, since Urlacher, Karger and Eastburg benefited from Eastburg’s dealings.
The court held that the operating agreement controlled Eastburg’s use of BUKE’s assets and not the LLC statute requiring a disinterested vote. The court relied on a key phrase in the LLC statute, “except as provided by the operating agreement” and said the operating agreement controlled. Since other BUKE’s members knew and approved of Eastburg’s use of BUKE’s assets, the BUKE-Branch action was dismissed. Although there was no evidence of Urlacher’s approval, the court said it was Branch’s burden to show his disapproval.
The lesson of the case is that any LLC member should carefully look at the manager’s power in manager-run LLCs. The BUKE case says that the operating agreement controls and overrides even protective provisions of the LLC statute.