When can a member, manager, director, or officer of a Tennessee limited liability company (“LLC”) expect the LLC to pay attorney’s fees when the member, manager, director, or officer becomes a defendant in a lawsuit or arbitration proceeding? If the individual is ultimately held individually liable in the lawsuit or arbitration proceeding, under what circumstances can he or she expect the LLC to provide indemnity for any judgment? The answers to those questions can be found in at least one place — §48-249-115 of the Tennessee Revised Limited Liability Company Act (the “Act”). If the LLC has an operating agreement, the answers might also be found in its provisions.
If an LLC has no operating agreement, then a member, manager, director, or officer must look exclusively to §48-249-115 to determine his or her rights to be advanced and reimbursed money for attorney’s fees and to indemnification for liability. If the LLC has an operating agreement that provides terms and conditions for indemnification and for the advancement and reimbursement of attorney’s fees, then those terms will supplant the provisions of the Act. The LLC’s operating agreement might provide terms and conditions that cover some situations, but not others, in which event the terms of the Act might apply along with the terms of the operating agreement.
While LLC members have the absolute right to provide, in an operating agreement, for terms and conditions related to the payment for attorney’s fees and to indemnification for liability which differ from the terms of the Act, the Act provides that an operating agreement can never waive certain provisions of the Act. The provisions that cannot be waived, T.C.A. §48-249-115(i)(1)(A)(B) and (C), prohibit an LLC from indemnifying a “responsible person” for a judgment which establishes that the responsible person breached a duty of loyalty to the LLC or its members; for a judgment for “acts or omissions not in good faith, or that involve intentional misconduct or a knowing violation of the law;” or for a judgment for an unlawful distribution under T.C.A §48-249-307. “Responsible person” includes a director of a director-managed LLC, a manager of a manager-managed LLC or a member of a member-managed LLC. That term does not include an officer of an LLC. (Officers’ rights, as distinguished from the rights of members, managers and directors, are discussed below).
The non-waivability of T.C.A. §48-249-115(i)(1)(A)(B) and (C) prevents, among other situations, a majority member who has been found liable in an LLC derivative action from using LLC assets to pay the judgment against him or her. Obviously, the non-waivability of those provisions is a critical protection for minority members.
T.C.A. §48-249-115 is a fairly complex statute the applicability, scope and effect of which cannot be adequately analyzed in a blog post. This post is meant to provide an overview of the framework of that statute, which, hopefully will be beneficial.
SECTION (b): “AUTHORITY TO INDEMNIFY”
This section provides a Tennessee LLC with the right, but not the obligation, to provide indemnification to a “responsible person against liability incurred.” The right exists only where the person to be indemnified has met certain standards of conduct. Under the statute, “liability incurred” includes attorney’s fees incurred since “liability” is defined to include “reasonable expenses with respect to a proceeding.” Under section (b), however, the LLC may not provide indemnity where the responsible person was held liable to the LLC in a derivative action or where the person was held liable for receiving an improper benefit in an action other than a derivative action. Keep in mind that, if the LLC has an operating agreement, it might have provisions in it which supplant this section and provide different terms for indemnification.
SECTION (c): “MANDATORY INDEMNIFICATION”
This section requires that the LLC indemnify a “responsible person” who was been “wholly successful” in defending an action. However, this obligation to indemnify is limited to indemnification for “reasonable expenses” incurred in defending the action. Of course, such person, having been successful in defending against a judgment, would not need indemnification for a judgment.
SECTION (d): “ADVANCES FOR EXPENSES”
This section provides for the advancement of reasonable expenses, most of which will no doubt be for attorney’s fees, before the lawsuit or arbitration proceeding is resolved. This section permits the LLC to advance such expenses provided that certain conditions are met and provided that the board of directors, the managers, or members have determined that those conditions have been met.
SECTION (e): “COURT ORDERED INDEMNIFICATION”
This section allows a court to order an LLC to indemnify a responsible person under two different scenarios. First, if the LLC has failed to provide indemnification where it was required to do so under section (c) (mandatory indemnification), the court may order it.
Second, this section gives a court expansive authority to order indemnification where fairness and reason dictate that the responsible person should be indemnified even though his or her conduct did not meet the standard required for him or her to be indemnified under section (b) an even though he or she may have been held liable. Where the responsible person was held liable, under this section, a court can only award indemnification for attorney’s fees and other expenses and not for liability for the judgment.
SECTION (g): “INDEMNIFICATION OF OFFICERS, EMPLOYEES AND AGENTS”
This section provides that an officer is entitled to apply for mandatory indemnification under section (c) and court ordered indemnification under section (e). It also provides that an LLC may indemnify and advance expenses to an officer to the same extent that it may do so for a “responsible person.”
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The above statute, as part of the Tennessee Revised Liability Company Act, applies only to Tennessee LLCs formed after January 1, 2006. Lastly, any officer, manager, director, or member of an LLC who is named as a defendant in an LLC lawsuit or arbitration proceeding should determine whether the LLC has coverage under an officers’ and directors’ insurance policy at the outset of any lawsuit or arbitration proceeding.