Tennessee Business Litigation Lawyers Blog

Liability of LLC Members and Managers for Gross Negligence under Tennessee Law

Published on: December 17, 2022 | by J. Ross Pepper

The Tennessee Revised Limited Liability Company Act (the “Act”) sets forth the circumstances under which a limited liability company (“LLC”) member or manager may be liable to the LLC or to other LLC members. An LLC member’s or manager’s potential liability can arise from two separate categories of conduct: (1) conduct that is a breach of the member’s or manager’s duty of loyalty (duty of loyalty cases); and (2) conduct in the operation or management of the LLC that is below the standards of care set forth in the Act (duty of care cases).

This blog deals strictly with the second category set forth above — liability resulting from failure to manage and to operate the LLC with the required degree of care. What level of care in the management and operation of the LLC must a member’s or manager’s care fall below before that member or manager can be personally liable? Under the Act, a member or manager may be personally liable where his or her conduct: (1) Is grossly negligent or reckless; (2) is intentional misconduct; (3) or amounts to a knowing violation of the law. In my opinion, the grossly negligent standard, in most situations, would be the easiest for a plaintiff bringing suit against another member or manager to prove.

The Act insulates LLC members and managers from liability for ordinary negligence. Why? Because the Act incorporates the policies of the Business Judgment Rule, which Rule predates the Act and has been an integral part of business law for decades. The Business Judgment Rule is meant to protect those in charge of managing and operating businesses, as long as they act in good faith and for proper purposes, from liability for business decisions that turn out to have been unwise. It recognizes that managers and operators of businesses would be deterred from taking calculated risks that might advance the organization if they had to worry about lawsuits from members or shareholders engaged in “Monday morning quarterbacking.”

Under Tennessee law, gross negligence is defined as “a conscious neglect of duty or a callous indifference to consequences” or “such entire want of care as would raise a presumption of a conscious indifference to consequences.” There is but one Tennessee case which addresses the issue of the liability of a member or manager for gross negligence. It does not shed much, if any, light on the subject. In that case, the Court of Appeals concluded, without much analysis or discussion of the facts constituting the alleged gross negligence, that the trial court had not erred in determining that the member’s conduct was not grossly negligent.

The Personal Liability of LLC Members to Third Parties Under Tennessee Law

Published on: November 15, 2022 | by J. Ross Pepper

It is helpful to think of the potential personal liability of members of Tennessee LLC’s falling into two categories. The first category is the personal liability of a member to the LLC itself for the member’s breach of the duty of care, breach of the duty of loyalty, or the breach of the duty of good faith and fair dealing. The personal liability of a member for breaches of those duties (which duties are set forth in T.C.A.§ 48-249-403) is typically addressed in a derivative proceeding brought by another member of the LLC on behalf of the LLC. The second category of personal liability of an LLC member involves claims by a non-member third party against a member, individually, for some action or omission related to the business of the LLC. That second category of potential personal liability is the subject of this blog.

The Tennessee Revised Limited Liability Company Act (the “Act”) expressly codifies a rule which limits the personal liability of LLC members related to LLC business (the “Limited Liability Rule”). (See T.C.A. §48-249-114) The Limited Liability Rule is set forth in three subparagraphs which provide, generally, that: (a) The obligations and debts of the LLC, regardless of whether they originate from a contract or from tortious activity, are “solely” the obligation of the LLC; (b) a member has no personal liability for debts of the LLC just because of his or her membership; and (c) a member is not liable for the acts or omissions of other members, or employees or agents of the LLC.

The limited liability rule for LLC members provides broad protection to members. If the LLC fails to pay a creditor, the LLC’s members are not personally responsible to that creditor. If an LLC employee causes a serious personal injury to a third party while doing his or her job for the LLC, the LLC’s members are not personally liable for it.

There are quite a few exceptions, however, to the rule of limited liability for LLC members. The exceptions fall into, at least, the following categories: (1) Where an LLC member commits an intentional tort, such as misrepresentation; (2) where the LLC’s veil is pierced; (3) where the LLC member has engaged in a fraudulent transfer of LLC assets to himself or herself; (4) where the member is held personally liable under the theory that he or she did not disclose that he or she was acting on behalf of the LLC; and (5) where the LLC member has personally guaranteed debts of the LLC.

The Duty of Commercial Landlords to Mitigate Damages Under Tennessee Law

Published on: October 17, 2022 | by J. Ross Pepper

Tennessee commercial landlord/tenant (lessor/lessee) law requires a lessor of a commercial property to act fairly and reasonably, under the circumstances, to mitigate its lost rental income resulting from a lessee/tenant abandoning the property before the expiration of the lease term or notifying the lessor that it no longer intends to comply with the lease. Obviously, this requirement means that the lessor must try to secure a new tenant for the subject property. However, what steps on the part of the lessor satisfy its obligation to act fairly and reasonably to find a new tenant to mitigate its damages necessarily must be decided on a case-by-case basis given the varying interpretations that can be applied to the “fair and reasonable” standard.

Since there are no bright lines to apply to determine whether a landlord has satisfied its obligation to mitigate its damages, it is helpful to look at a few cases on the subject to understand what factors might be important to a Tennessee court faced with an argument from a lessee that what it owes to the lessor should be reduced because the lessor’s attempts to find a new lessee fell short of satisfying the reasonable and fair standard.

Loans Yes v. Kroger Limited Partnership (Tenn. Ct. App. 2020): In this case, the court rejected the tenant’s argument that the landlord had failed to mitigate its damages. The tenant stopped paying rent six months before the lease expired. Within about one month after receiving the tenant’s notice that it wanted to terminate the lease early, the landlord signed a listing agreement with a commercial broker who agreed to undertake re-leasing the property. The broker, promptly thereafter, sent out an email blast to about 335 other brokers notifying them of the availability of the property. The broker also listed the property on several websites known to be used by brokers and by prospective tenants. Moreover, the broker placed the property on his company’s availability report which was accessible by about 500 other brokers.

Kahn v. Penczner (Tenn. Ct. App. 2008): In this case, the trial court determined that the landlord’s lost rental income damages should cut in half because it failed to mitigate its damages.

Tennessee Construction Defect Cases: Does the Three-Year or Six-Year Statute of Limitations Apply?

Published on: October 2, 2022 | by J. Ross Pepper

A recent construction defect case decided by the Court of Appeals of Tennessee illustrates how both the three-year statute of limitations for injury to real property and the six-year statute of limitations for breach of contract can both apply in a construction defect case. The trial court held that the claims of the Plaintiffs, the homeowners, were barred by the three-year statute of limitations. The court of appeals reversed the trial court holding that some of the Plaintiffs’ claims were subject to the three-year statute, but others were subject to Tennessee’s six-year breach of contract statute.

Here are the basic facts of the case:

The Plaintiffs bought a newly-constructed home built by Defendants
The Plaintiffs alleged that the home contained construction defects and substandard materials
The Plaintiffs asserted several different causes of action including negligence, breach of warranty and breach of contract
Plaintiffs alleged that Defendant had breached their contract with them in a number of ways, including by employing negligent construction practices, but also, by refusing to honor the warranty made by Defendants to make repairs pursuant to the one-year warranty made by Defendants
There was no dispute that the Plaintiffs’ claims were filed after the three-year statute of limitations for injuries to real property would bar them
The Plaintiffs’ claims had been filed such that there was no dispute that they were not barred by the six-year statute of limitations applicable to breach of contract actions

The resolution of the statute of limitations issues in this case, as with many cases, turned on the analysis and application of the “gravamen of the complaint” theory which has been adopted in Tennessee. The court of appeals wrote that the overarching issue in the case was whether the trial court had properly determined that the gravamen of the Plaintiffs’ complaint was injury to real property such that the three-year statute of limitations applied.

The leading modern case on the gravamen of the complaint theory is the Supreme Court of Tennessee’s opinion in Benz-Elliott v. Barrett Enters., LP. The most critical point to understand about the gravamen of the complaint theory is that the applicable statute of limitations is not determined by the cause of action asserted by a plaintiff, but by the type of damage alleged by the plaintiff to have resulted from that cause of action. Another fundamental factor to keep in mind in applying the gravamen of the complaint theory is that, under Tennessee law, a plaintiff can plead alternative causes of action. That factor, and how it affects the gravamen of the complaint theory, was expounded upon in the Benz-Elliott case.

Non-Compete Agreement Enforced Where Former Employee was Provided Specialized Training by his Former Employer

Published on: August 21, 2022 | by J. Ross Pepper

In a 2022 case, the Court of Appeals of Tennessee relied heavily on the specialized training the former employer (“Employer”) gave its former employee (“Employee”) in upholding a trial court’s decision that the non-competition agreement signed by the Employee was enforceable. Unlike many cases involving former employers trying to enforce non-compete agreements, in this case, the Employer made no argument that the Employee had become the “face of the company” because the Employer’s customers closely associated its business with Employee. The former Employer relied, successfully it turned out, on the specialized training it provided to the former Employee along with the former Employee’s access to trade secrets and proprietary information during his employment.

Many covenant not to compete cases involve facts that make them close calls as to whether the non-compete agreements at issue will be enforced. The case that is the topic of this blog post is worth a post, among other reasons, because it exemplifies a factual scenario in which, in my opinion, a Tennessee court would always enforce a non-competition agreement, if it followed the law.

Here are the key facts of the case:

Employer was a staffing company that worked exclusively to provide healthcare information technology (“HIT”) personnel to hospital systems
Before beginning work for the Employer, Employee had no experience or training in the industry served by Employer
In 2012, Employee began employment with Employer as a recruiter
At the time he began employment with Employer, Employee signed a “Confidentiality, Non-Competition and Non-Solicitation Agreement” with Employer
That agreement contained typical terms including a term prohibiting Employee from working for a competing business for one year after terminating employment
During his seven years of employment for the Employer, during which Employee advanced in responsibilities and was considered very valuable, Employer provided a substantial amount of training to Employee, including: (1) A week of classroom training on how to recruit HIT personnel; (2) a twelve to fourteen week class at a university, Belmont, regarding the healthcare industry; (3) a seminar in Chicago on leadership; (4) what the court described as “countless” lessons and mentoring from high-level executives at Employer; and (5) a variety of other HIT training
During his seven years of employment, Employee also had access to a variety of trade secrets, and proprietary and confidential information of Employer, including: (1) client lists; (2) financial information; (3) information about prospective clients; (4) budgets and forecasts; (5) compensation structures; and (6) billing rates for all the personnel placed by Employer
During his seven years of employment, Employee had also become an expert on unique software utilized by Employer

In 2019, Employee went to work for a direct competitor of Employer. Employer sued to enforce the non-compete agreement. The trial court upheld it. Thereafter, the court of appeals affirmed the trial court.

Recent Partition Case: A Reminder of How Tennessee Courts Divide the Proceeds of Jointly Owned Real Estate

Published on: July 31, 2022 | by J. Ross Pepper

In a recent partition case between former domestic partners, the Court of Appeals of Tennessee set forth some good reminders of the factors Tennessee courts are to consider when dividing up the interests of joint owners of real estate. While the case involved former domestic partners, the principles laid out in the opinion are equally applicable to cases involving joint owners other than those who are former domestic partners.

Although the case was not filed as a partition case, it should have been, and the Court of Appeals treated it as a partition case. The case is remarkable, not only because it contains a clear and concise review of partition principles, but also, because, in reversing the trial court, the Court of Appeals showed what is not a proper way for a trial court to adjudicate a partition case.

Here are the basic facts:

The man (“Man”) and woman (“Woman”) involved were domestic partners, but never married
The Man and Woman bought a home (“Property”) together in 2013 for $223,000
The Property was deeded to the Man and Woman as joint tenants with a right of survivorship
The Man paid a $50,000 down payment from the Property using proceeds from another property that Man and Woman had owned together
Woman testified that Man had received $200,000 from the sale of the other jointly owned property, but had never given her any of those proceeds
The Man and Woman financed the $171,000 purchase price balance
The Woman testified that she consistently paid $1,000 a month towards the mortgage loan for the Property
The Man denied that she had consistently paid $1,000 a month, but admitted that she may have paid around $7,000 in total over the course of the years
In 2015, Woman bought a home in Washington state
Man sent Woman a $5,000 check for the down payment on the Washington home and wrote “loan” on it
There was proof that Woman had, through her employer, provided valuable medical insurance benefits to Man for many years
Woman also testified that she had put a lot of work into the Property

The trial court described the circumstances as a “crazy mess.” It then took a simplistic approach to resolving the dispute. It found that the equity in the Property was $229,000 and that it should be divided equally except Man should receive $10,000 from Woman’s one-half for the money paid for the down payment for the Washington home and for attorneys’ fees.

Setting Aside a Default Judgment in Tennessee

Published on: June 20, 2022 | by J. Ross Pepper

A plaintiff may obtain a judgment against a defendant under Tennessee law, and under federal law, if the defendant does not file a responsive pleading within the required time. Under the Tennessee Rules of Civil Procedure, a defendant must file a written response to a complaint within thirty (30) days of being served with the complaint. If you are a defendant against whom a default judgment has been entered, be aware that it can be set aside. With frequency, default judgments are set aside by Tennessee courts.

There are several different grounds on which a default judgment may be set aside. First, if a defendant was not properly served, then a default judgment may be set aside on the grounds that it is void. Service of process on a defendant can be tricky, and, even the validity of personal service by an officer or private process server may be successfully challenged.

Second, a default judgment may be set aside, even where there was valid service on the defendant, if the defendant was not given adequate written notice that the plaintiff had filed a motion for a default judgment. Under the Tennessee Rules of Civil Procedure, in most cases, a defendant is entitled to receive written notice of the motion for default judgment at least five (5) days before the motion is heard.

Third, a default judgment may be set aside for “mistake, inadvertence, surprise, or excusable neglect.” In my experience, these grounds are the ones most frequently used to support a motion to set aside a default judgment. Under Tennessee law, the party moving to set aside a default judgment has the burden to prove that it should be set aside. However, Tennessee appellate courts have said, time and time again, that the law does not favor judgments by default, and, if there is any doubt as to whether one should be set aside, it should be.

The Rights of LLC Members, Managers, Directors and Officers to Receive Reimbursement and Advances for Attorney’s Fees and Indemnification for Liability

Published on: June 5, 2022 | by J. Ross Pepper

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.

Establishing Irreparable Harm in Non-Compete Cases

Published on: May 1, 2022 | by J. Ross Pepper

When an employer seeks a temporary restraining order (“TRO”) or temporary injunction in a Tennessee federal court against a former employee, or other person or entity with whom it had a non-compete agreement, to succeed, it must show irreparable harm will result to it if the TRO or injunction is not granted. (For purposes of this post, a non-compete agreement refers to an agreement that prohibits competition, use of confidential information, or solicitation of customers).

To obtain a TRO or temporary injunction, a federal district court in Tennessee must consider four factors: (1) The plaintiff’s likelihood of success as to the merits; (2) whether the plaintiff will suffer irreparable harm or injury if the relief is not granted; (3) whether substantial harm will be caused if the relief is granted; and (4) the effect of the injunctive relief on the interests of the public. The irreparable harm factor is indispensable. While a district court may grant a TRO or temporary injunction even where the plaintiff has not shown that it is substantially probable that the plaintiff will ultimately win the case on the merits, to grant either a TRO or a temporary injunction, a Tennessee federal district court must make specific findings that the plaintiff will suffer irreparable injury.

What is considered irreparable injury by Tennessee federal courts? An injury is irreparable if it cannot be compensated by money damages. In non-compete cases, a former employer or business cannot be compensated for lost revenues: From customers and contracts it can never prove it lost; from confidential information that was used by others to gain customers, sales or otherwise to increase profitability; or from lost customer goodwill. When someone breaches a non-compete agreement, the injured party will not be able to quantify its damages in many, if not most, cases. If it cannot quantify them, it cannot prove them and recover them. Thus, without injunctive relief, the injured plaintiff will suffer irreparable injury.

As a general rule, Tennessee federal courts recognize that irreparable harm occurs when a non-competition agreement is violated. In fact, they have recognized that, when a non-compete agreement is breached, in most cases, irreparable injury will result. The below are summaries of two instructive cases where former employees had signed non-compete agreements with their former employers. Continue reading

The Non-Existence of Liability for Libel of Title for Filing a Lien Lis Pendens

Published on: April 7, 2022 | by J. Ross Pepper

In Tennessee real estate litigation, frequently, a plaintiff will obtain a liens lis pendens at the time the complaint initiating the action is filed. Once recorded with the register of deeds in the county where the subject property is located, a lien lis pendens can effectively prevent the transfer of the property, its lease, or its use as collateral to secure a loan. Such liens may, in some cases, prevent the refinancing of a loan on the subject property. (For more on the basics of liens lis pendens, see my blog of January 21, 2018.)

Our firm has, over the years, had many clients against whose real estate liens lis pendens were obtained at the outset of litigation and against which those liens remained through the conclusion of our clients’ cases (months or years later). A defendant/property owner can move the court, before a decision on the merits of the case, to have a lien lis pendens dissolved and removed. Motions to dissolve liens lis pendens, when they are filed before decisions on the merits, are most often filed soon after the liens were obtained.

To succeed on a motion to dissolve a lien lis pendens, the defendant/property owner must prove that the plaintiff’s claims, as set forth in its complaint, are unrelated to any claim to an interest in the real estate. (In my previous blog on the subject, I gave some examples of cases where the claims did not relate to any interest in the real estate at issue and where courts found the lien lis pendens improper).

Even where a defendant, like some we have represented, is ultimately successful on the merits in real estate litigation and the lien lis pendens placed on its property is dissolved and becomes ineffectual, it can suffer a monetary loss. How can such a defendant/property owner seek financial compensation for such a loss? Is it possible to recover via a lawsuit for libel of title? The short answer is almost certainly “no.” A lien lis pendens is protected by an absolute privilege.