It is no secret to anyone who has attended one of my asset protection workshops or read my book, that I prefer a Manager Managed form of LLC to its alter ego the Member Managed. My rationale is summed up in a few words: Control is everything and ownership means nothing. In writing this post I am making an assumption that as the reader you are aware that two forms do exist; although, from continuous polling of my students it would appear that the legal community has relegated the Manager Managed status to that of a discarded gold fish sacrificed to the porcelain god.
So after the candle has been lit and the dark is removed, does this information impart knowledge or can it result in more harm than good? This is an important question that must be gleaned from the four corners of your LLC operating agreement and those with whom you lied down with in business.
A manager managed LLC is preferable when creating a structure for immediately family members where trust is not a concern and liability for all plays like the 3 Musketeers. The game changer for this particular management structure is a business partner as was discovered by the members in Pitman Investments, LLC.
Background. A LLC was formed by three members, one of whom was the sole manager. The LLC’s operating agreement gave the manager authority to manage the LLC’s business, and in customary fashion the consent of the members was required for the manager to cause the LLC to encumber its property or to borrow more than $50,000. The manager, however, wanted money so he sought to borrow $525,000 without the knowledge of the members.
It can’t happen right? There is an operating agreement that prohibits the manager from borrowing more than $50,000 without the consent of the members. Everything should end like a Disney classic with the prince kissing the girl and she awakes from her slumber. Except, this time the wicked queen beat him to the kiss.
The crafty manager gave the bank a copy of the LLC’s operating agreement and omitted the pages that limited his ability to borrow or encumber property. The bank was not out foxed by Wile E. Coyote and caught the missing page. Upon request for the missing information the manager faxed the omitted and recently ALTERED pages to the bank. Of course, the alterations gave the manager the right to borrow up to $750,000 and encumber the LLC’s property. So the manager got his money and the LLC members were left holding property with over half a million in debt.
The malfeasance is discovered and the LLC members ride into to battle behind their Esquires to storm the bank walls demanding redress for its grievous error. The Kings court agrees to hear the case and finds that the bank reasonably relied upon the most unscrupulous of managers and his skullduggery will not invalidate the banks lien of the LLC’s property. The bank successfully repelled the invading LLC members by arguing the LLC manager acted with “apparent authority” and hence, their actions were above reproach.
Protective Steps. What else could the LLC members have done to prevent the manager from defrauding the bank and leaving the members with spoiled fruit? For one, they might have filed custom articles of organization that contained provisions from the LLC’s operating agreement specifically addressing the limits on the manager’s authority. Articles of organization are publicly available, and third parties cannot reasonably argue they had no way of knowing what actual limits existed on the manager. Only in a court of fools is ignorance or apathy a defense.
Alternatively, the LLC could file a memorandum against the LLC’s real estate. The memorandum would describe the manager’s limitations vis-a-vis the LLC’s real estate. Any attempted transaction by the manager involving the LLC’s real estate would pick up these limitations on a title search.
My preferred approach is to have more than one manager so there are checks and balances in place. Ultimately, this comes down to planning for the unexpected. “It’s usually the last ounce of effort that tips the scales of success.” – Rick Beneteau