LLC Members Found to Owe Fiduciary Duty

Court Recognizes “Fiduciary in Fact”, Says Execs Must Face Suit Claiming They Violated Fiduciary Duty to REIT Investors


Whether there is a fiduciary duty is one of most hotly contested battles in lender liability cases. Often the answer to that question determines whether victims can be paid for their losses.


Definition of Fiduciary Duty


Cornell Law School’s online dictionary defines the term as follows:


“A fiduciary duty is the highest standard of care.  The person who has a fiduciary duty is called the fiduciary, and the person to whom he owes the duty, is typically referred to as the principal or the beneficiary. If an individual breaches the fiduciary duties, he or she would need to account for the ill-gotten profit. His or her beneficiaries are entitled to damages, even if they suffered no harm...  By imposing these duties, the law reduces the risk of abuse of a beneficiary by the fiduciary. “


Unfortunately, courts have been reluctant to set out bright line rules for when such a relationship exists. There are exceptions, however. For example, a lawyer owes a fiduciary duty to his client as do the executors of an estate to the estate’s heirs. But does an accountant owe a fiduciary duty to her clients or a bank to its borrowers? The answer is “maybe.”


It is the same thing with corporate officers and managers of LLCs. The lines simply aren’t clear. That gives a lot of gray area for fraudsters to operate. It’s worse in many states where state law often says LLC members as a matter of law owe no fiduciary duty to the members of an LLC.


The bad guys shouldn’t start cheering just yet, however. The story below shows how one’s actions and behavior can help courts decide close questions in favor of victims of fraud and corporate greed. The decision also shows how actions speak louder than words.


Utah Court Imposes Fiduciary Duty on LLC Members


The facts as outlined were pulled from court filings. Although we have very strong beliefs in this case, the lawsuit isn’t over.


Robert Geringer and Jeff Austin created CAREIC as a California LLC. CAREIC solicited investors and sought to operate a Real Estate Investment Trust (REIT). Like many LLCs, the company had an operating agreement but the investors say it was ignored.


Once formed, the company raised $73 million. Investors were told that the REIT would be investing in real estate projects. Instead, the investors say the REIT was a scam that was really set up so that Geringer and Austin could pay themselves high salaries. A jury hasn’t yet ruled on that portion of the case. The good news, however, is that a judge ruled that Geringer and Austin might owe a fiduciary duty to the investors. If the decision isn’t overruled, it’s probably game over for them.


CAREIC managed to lose its money and is now in bankruptcy. The bankruptcy trustee, however, has picked up the cause for investors. He agrees with the investors and says, “Defendants ‘brought no value to the Debtors’ investors, and that the entire CAREIC operation was merely a scheme to generate personal salaries and other compensation for [the Defendants], at investors’ expense.’”


The trustee says that one of the de facto officers and a member of CAREIC’s board was never disclosed in offering materials. Why? Probably because that individual was barred from the industry by the SEC because of fraud. Many investors might not have invested had they known that one of the decision makers of the REIT was a deemed a fraudster by the feds.


After the lawsuit was filed, Geringer and Austin filed a joint motion to dismiss. (Several of their cohorts filed their own legal challenges as well.) The men’s arguments largely focus on what duty they owed the investors as members of the LLC. CAREIC was created as a California Limited Liability Company (LLC). California law says a limited member does not owe a fiduciary duty to the LLC.


The two also argued that the LLC’s operating agreement also limits their liability. That agreement says that only the CEO has management responsibilities. All the men held titles in the organization but conveniently none had the title CEO or President or Managing Member. (Austin was named as CEO for a few of the months at issue in the lawsuit although he denied having duties that would impose a fiduciary duty.)


Do the investors lose? “No” said the court!


Fiduciary in Fact


California law recognizes the concept of Fiduciary in Fact. Under that concept, an individual, regardless of title, owes a fiduciary duty to a company when the individual participates in management of the company and exercises discretionary authority.


Here, despite the lack of management titles, Austin and Geringer were in fact running the company. They were also operating outside the company’s operating agreement since the company never bothered to name a person as formally in charge.


In the words of the court, “While a limited partner normally would not be involved in the management or otherwise participate in the partnership . . . so as to incur fiduciary obligations to other partners, we believe there can be factual scenarios where a limited partner

might be involved in the partnership in such a manner . . . so as to create fiduciary duties.”


The court was not going to allow Austin and Geringer to hide behind the operating agreement and the absence of formal titles. This is a good example where the court was willing to look behind an operating agreement and behind titles and instead examine how the business was really being run.


What is Next for Investors


The court’s decision on October 13th denied the many motions to dismiss filed by the officers and directors of the REIT. In our experience, many cases of professional malpractice and breach of fiduciary duty are won and lost long before a jury is ever empaneled. The court’s refusal to rule that Geringer and Austin were not fiduciaries means there is a substantial likelihood that the investors will prevail when the case is ultimately tried. 


REIT Fraud, Banks and Fiduciary Duty


Almost every lawyer that sues a bank or promoter claims breach of fiduciary duty. Proving that duty, however, is tricky. Many lawyers claim to be “lender liability” lawyers but most have little commercial experience and often no experience with CMBS backed loans, REITs, Tenant-in Common (TIC) structures and the like. MahanyLaw and Judge, Lang & Katers are different. We are a national boutique practice concentrating on high stakes, complex cases against lenders and fiduciaries


If you lost $5 million or more and believe that a banker, promoter, REIT operator or other professional violated a fiduciary duty to you, give us a call. We concentrate our practice on high stakes real estate, commercial foreclosures and claims against banks. (That also means we are plaintiff’s lawyers, unlike most lender liability lawyers we don’t defend banks.)


For more information, contact attorney Brian Mahany at [hidden email] or by phone at (414) 704-6731 (direct).  All inquiries protected by the attorney – client privilege meaning they are kept strictly confidential. 


Already have a lawyer and need a second opinion? Call us and we will see if we can assist or offer other strategies.

Related topics: fiduciary duty (12) | fraud (31) | lender liability (65) | trustee (8) | fiduciary in fact | llc