Denise Potter, et al. v. Ruby Potter (Md. Ct. of Spec. Appeals)

Filed: September 13, 2021.

Opinion: Christopher Kehoe

Holding: 

Decedent’s membership interest in a limited liability company (LLC) was “property” under Maryland estate law that passed to decedent’s estate where LLC’s operating agreement which required the membership interest to pass to named successor was not a valid will under Maryland law. 

Facts: 

James Potter (“James”) owned an interest in a Maryland LLC. The members executed an operating agreement and a members’ agreement. The LLC’s operating agreement distinguished between a member’s “interest,” which was defined as that member’s right to share in the profits and losses of the LLC, and the member’s “rights,” which was the right of a member to participate in the management of the LLC. The members’ agreement stated that, upon a member’s death, that member’s interest and right in the LLC shall be transferred to the individual identified in the members’ agreement. 

According to the members’ agreement, James’s membership interest was to be transferred to Ruby Potter, and James’s membership rights were to be transferred to two other members of the company. Although James signed both the operating agreement and the members’ agreement, the record showed that the signing of operating agreement was not witnessed and the members’ agreement was witnessed by only one individual. 

James acquired his LLC interest after his marriage to Ruby Potter (“Ruby”) in 1984. However, James and Ruby separated in 2016. Subsequently, James married Denise Potter (“Denise”). Despite his divorce and subsequent re-marriage, James did not amend the members’ agreement to remove Ruby as his successor.  In 2017, James died intestate. 

Denise opened a small estate and was appointed as personal representative of James' estate. In a document filed with the orphans’ court, Denise identified James’s membership interest in the LLC as an asset of the estate. Thereafter, Ruby filed a complaint for declaratory judgement seeking a declaration that she was entitled to James’s membership interest as she was listed as his successor in the members’ agreement. 

The Circuit Court held that Ruby was entitled the interest because the members’ agreement was a contract which controlled the passing of James’s membership interest. The Court of Special Appeals reversed, for the reasons stated below. 

Analysis:

The Court held that the membership interest was “property” as defined by the Estates and Trusts code which passed to James’s estate because the operating agreement and members’ agreement were not valid testamentary instruments under Maryland law. The Court reached its holding after considering three questions: (1) whether the operating agreement and the members’ agreement are testamentary in nature; (2) whether Maryland law permits an LLC to agree that a member’s interest can transfer by means of an agreement that does not satisfy the statute of wills; and (3) whether there is any conflict between the Estates and Trusts code and the article governing limited liability companies. 

(1) The operating agreement and members’ agreement are not testamentary instruments that control disposition of the membership interest.

As the operating agreement and members’ agreement were not witnessed in accordance with the Estates and Trust code, the Court held that such documents were not testamentary instruments under Maryland law. However, the Court also had to decide whether James’s membership interest was “property” that fell within the scope of the Estates and Trusts code. The Estates and Trust Code provides that all “property” of a decedent is subject to the estates and decedents law, and thus may only pass via will or intestacy absent other statutory exception. See Md. Code Ann., Est. & Trusts §1-301. “Property” is defined as any interest that a decedent has in real or personal property except for property “which does not pass, at the time of the decedent’s death, to another person by the terms of the instrument under which it is held, or by operation of law.” Id. §1-201(r). 

Ruby argued that the operating agreement and members’ agreements were “instruments” under which the membership interest was held that required the interest to pass to another person. The conclusion being that, as a result, the interest was not “property” subject to the provisions of the Estates and Trusts code. The Court rejected this argument on the basis that “the relevant legislative history and caselaw indicate that the General Assembly did not intend for the definition of ‘property’” to mean what Ruby asserted. 

Legislative history revealed that “property” was intended to include “those assets which traditionally constituted what is sometimes called in Maryland the probate estate.” Potter v. Potter, 252 A.3d 17, 32 (Md. Spec. App. 2021), cert. granted, 259 A.3d 787 (Md. 2021). The Court looked to case law that established what constituted a testamentary instrument at the time the Estates and Trust code was enacted. The court concluded that “a writing that purports to transfer the maker’s property at death is testamentary in nature unless it is both irrevocable and based on an otherwise enforceable legal obligation whose performance is deferred during the maker’s lifetime.” Id. As a result, the Court held that the membership interest was subject to the Estates and Trusts code because the designation in the members' agreement was not irrevocable. Id. Indeed, the Court observed that James could have changed his designation at any time, but simply failed to do so. Id. As the interest was not irrevocable during James's lifetime, the court concluded that it fell within what would have been considered the "probate estate," and was accordingly "property" as defined by the Estates and Trusts code.    

(2) The Limited Liability Act did not Subvert the Estates and Trusts Code

Ruby argued that the limited liability act authorized companies to agree that Maryland’s testamentary laws do not apply to membership interests. This argument was based on section 4A-606 of the Corporations and Associations article which provides that, unless otherwise agreed, a member’s membership in an LLC terminates at death. Ruby argued that this provision allows LLCs to alter the default provisions and to agree to the disposition of membership interests upon the death of a member. 

The Court rejected this argument based on the clear wording of the LLC Act. The LLC Act allows an LLC to make operating agreements that are “not inconsistent” with “the laws of this State.” Md. Code Ann., Corps & Ass’ns, §4A-203(15). As discussed above, Maryland law imposes strict requirements on the disposition of property that falls within the Estates and Trusts code. As an LLC cannot make agreements inconsistent with Maryland law, the provisions of the operating agreement and members’ agreement which sought to disposed of James’s property were invalid as testamentary interests due to their non-compliance with the Estates and Trusts code. 

Finally, the court held that there was no conflict between the Estates and Trusts article and the Corporations and Associations article based on its holding that, under Corps & Ass’ns, §4A-203(15), an LLC operating agreement cannot be inconsistent with other state law.  

The full opinion is available here.

The George Wasserman and Janice Wasserman Goldsten Family Limited Liability Company v. Kay (Ct. of Special Appeals)

Filed: February 9, 2011

Opinion by Judge James R. Eyler

Held: A claim brought by partners in a general partnership or members of an LLC against a managing partner or managing member will survive a motion to dismiss if they sufficiently allege they suffered harm directly and the managing partner or managing member violated duties owed to the partners or members.

Facts: Plaintiffs are partners in five real estate investment general partnerships and two real estate investment LLCs. Defendants are Mr. Kay, an individual that is the managing member or de facto managing member or partner of the partnerships and LLCs, and Kay Management Company, Inc. and Kay Investment Group, LLC, two entities controlled by Kay. Plaintiffs alleged Defendant took money from the partnerships and LLCs and invested the money with Kay Investment through Kay Management. In turn, Kay Investment invested the money with the Bernard Madoff entities. Plaintiffs brought suit following the Madoff ponzi scheme collapse.

The complaint set forth thirteen counts, including, among others, fraud, breach of fiduciary duties, conversion, civil conspiracy and negligence. The Circuit Court granted Defendant's motion to dismiss because none of the claims were individual, the derivative claims involving the partnerships were not agreed to by a majority of the partnership, and the failure to make demand on behalf of the LLCs was unexcused.

Analysis:

After a lengthy discussion of corporations, general partnerships and LLCs, the Court framed the principal issues on appeal as (1) whether Plaintiffs may assert individual claims against Kay and (2) whether Plaintiffs may bring derivative claims on behalf of the partnerships and LLCs against Kay.

(1) Individual Claims

Applying logic from Shenker v. Laureate Education, Inc., which permitted a shareholder to bring a direct action when the shareholder suffers the harm directly or duties owed to the shareholder have been violated, the Court extended the rationale to the law of partnerships and LLCs. The Court then concluded Plaintiffs sufficiently alleged (a) they suffered harm directly and (b) Kay violated duties owed directly to the Plaintiffs.

Plaintiffs alleged Kay took funds that were required to have been distributed. He also took funds required to be held in reserve, further injuring Plaintiffs by forcing them to replace the removed reserves.

Under the Revised Uniform Partnership Act, general partners owe each other, not just the partnership, fiduciary duties. Section 9A-405(b) of the RUPA "clearly provides a mechanism through which partners can sue other partners directly for breach of those obligations and others." However, there is no statute in Maryland expressly addressing LLC members' fiduciary duties. The Court, after finding managing members to be "agents for the LLC and each of the members, which is a fiduciary position under common law," again applied rationale from Shenker, to state where no statute precludes or limits fiduciary duties under common law, the underlying duties apply. Accordingly, the Court found Kay's fiduciary duties as the managing partner/member to run to the partnerships, the LLCs, the partners and the members.

(2) Derivative Claims

The Court found the term "derivative" inappropriate in a general partnership context. Derivative actions are necessary in a corporate and limited partnership context because shareholders and limited partners have no management rights. "Unlike shareholders and limited partners, however, general partners all have the ability to act on behalf of the partnership, and all have management rights." Accordingly, no need for a derivative action exists. The Court turned to whether minority general partners can bring claims against other partners. The Court cited many sections of RUPA to conclude all partners have equal ability to enforce rights involving partnership property. While section 9A-405(j) of RUPA requires unanimous consent of all the partners, the Court felt it should be tempered "when non-plaintiff partners have conflicts of interest." Instead, "the unanimity requirement should not apply to defendant partners and other interested partners."

However, based on the facts, the Court found a suit on behalf of the partnerships unnecessary because Plaintiffs adequately alleged an individual direct injury. If Plaintiff's prove the allegations, complete relief will be afforded. The derivative claims on behalf of the LLC were rejected for the same reason.

Note: In discussing fiduciary duties in the LLC context, the Court, citing section 4A-402(a) of the Maryland Limited Liability Company Act, notes that "one Maryland statute governing LLC operating agreements does suggest that provisions within operating agreements could alter existing duties or create other duties..." However, no such provisions were alleged in the case.

The full opinion is available in pdf.

Maryland Limited Liability Company Revision Act of 2011

The Maryland State Bar Association Business Law Section Committee on Unincorporated Business Associations has drafted a proposed set of revisions to the Maryland Limited Liability Company Act. The proposed revisions can be found here and the report of the drafting committee can be found here.

The proposed revisions have been approved by the Section Council of the MSBA Business Law Section. Needless to say, the proposed revisions are subject to amendment and modification at each step of the process, including modification before the bill is formally submitted to the General Assembly.