Editor’s Note: This article originally appeared in the Colorado Bar Association Business Law Section’s January 2015 newsletter. Click here for the Business Law Section webpage.
The Colorado Limited Liability Company Act was front-and-center in a January 2015 decision from the Colorado Supreme Court. The case, LaFond v. Sweeney, 2015 CO 3 (January 20, 2015) involved the dissolution of a law firm organized as a two-member LLC with no written agreement regarding the treatment of assets and liabilities on dissolution. Richard LaFond brought a contingent fee case into the law firm and performed a significant amount of work on that case before the firm dissolved. He continued his work on the matter after dissolution. His now former partner, Charlotte Sweeney, claimed an interest in the contingent fee.
Mr. LaFond brought a declaratory judgment action against Ms. Sweeney to obtain a judicial determination regarding her right to any portion of the contingent fee. The trial court entered judgment for Ms. Sweeney, finding that she would be entitled to one-half of the fees earned from the contingency case, up to a maximum of $298,589.24 potentially to be paid to Ms. Sweeney (based on the time spent by the LaFond & Sweeney law firm before dissolution and assumed billable rates).
Ms. Sweeney appealed the trial court’s decision to the Colorado Court of Appeals. Ultimately, the Colorado Supreme Court ruled that absent an agreement to the contrary, all profits derived from winding up the LLC’s business belong to the LLC to be distributed in accordance with the members’ or managers’ profit sharing agreement, and the LLC Act does not grant winding up members or managers the right to receive additional compensation for their winding up services.
Court of Appeals Decision
In its decision (2012 WL 503655, Feb. 16, 2012), the Court of Appeals recognized that it would have to decide:
[That since] there was no written agreement that specifically described how the contingent fee generated by the case should be distributed[,] we must look to other authority to decide the ultimate issue raised by this appeal: should the contingent fee be divided between LaFond and Sweeney, and, if so, how?
The Court of Appeals went on to decide that:
- Cases belong to clients, not to attorneys or law firms;
- When attorneys handle contingent fee cases to a successful resolution, they have enforceable rights to the contingent fee; and
- A contingent fee may constitute an asset of a dissolved law firm organized as a limited liability company.
The important conclusion by the Court of Appeals and affirmed by the Supreme Court was that when a limited liability company formed under Colorado law dissolves, the members/managers owe a duty to each other to wind up the business of the LLC, and unless otherwise agreed between the parties, no additional compensation is paid for winding up activities.
Supreme Court Decision
The statute in question is § 7-80-404(1)(a), which provides that members in a member-managed LLC and managers of a manager-managed LLC have a duty to:
Account to the limited liability company and hold as trustee for it any property, profit, or benefit derived by the member or manager in the conduct of winding up of the limited liability company business or derived from a use by the member or manager of property of the limited liability company, including the appropriation of an opportunity of the limited liability company.
The Supreme Court noted that, in 2006, the General Assembly added C.R.S. § 7-80-803.3 (entitled “Right to wind up business”) to Colorado’s limited liability company act, but did not include any provision allowing the person winding up the business of the LLC to be compensated for such actions, absent an agreement for such compensation. The Supreme Court also noted that the 1996 version of the Uniform Limited Liability Company Act did contemplate compensation to members who engage in winding up activities: (“A member is not entitled to remuneration for services performed for a limited liability company, except for reasonable compensation for services rendered in winding up the business of the company.” See Unif. Ltd. Liab. Co. Act § 403(d) (1996)). Colorado did not adopt this provision even though, as the Supreme Court noted, “the General Assembly’s 2006 amendments to the LLC Act incorporated some elements from the Model Act.”
The Supreme Court also noted that, in 1997, the General Assembly enacted the Colorado Uniform Partnership Act which, in C.R.S. § 7-64-401(8) “explicitly states that a partner is entitled to additional compensation for services performed in winding up the business of the partnership.” The Supreme Court went to the next logical conclusion:
If it wished, the legislature could have included language that would give members or managers the right to additional compensation for their services in winding up the LLC, but did not do so in the original LLC Act or its subsequent amendments.
Based on its analysis of the Colorado limited liability company act, the Colorado Supreme Court affirmed the Court of Appeals’ decision and concluded that:
- an LLC continues to exist after dissolution to wind up its business;
- upon dissolution, pending contingency fee cases are an LLC’s business;
- absent an agreement to the contrary, all profits derived from winding up the LLC’s business belong to the LLC to be distributed in accordance with the members’ or managers’ profit sharing agreement; and
- the LLC Act does not grant winding up members or managers the right to receive additional compensation for their services in winding up LLC business.
Members and Managers Fiduciary Duties?
In another portion of the opinion (at paragraphs 36–37), the Supreme Court addressed fiduciary duties in the LLC context in a manner that is inconsistent with the Colorado LLC Act. While acknowledging that the client has the right to choose legal counsel and to enter into and to terminate engagements with counsel, the Supreme Court said:
Under Colorado law, members and managers of an LLC cannot act to induce or persuade a client to discharge the LLC for the benefit of a particular member or manager of the LLC to the exclusion of the others; they breach their fiduciary duties to the LLC if they attempt to do so.
Unfortunately this misinterprets the Colorado LLC Act which carefully does not use the term “fiduciary duty” to define the duties of the members and managers. Furthermore the Supreme Court’s language treats the duties of members and managers as being identical, whether or not the LLC is member-managed or manager-managed. For example, the duty to “account to the limited liability company and hold as trustee for it any property, profit, or benefit derived by the member or manager in the conduct or winding up of the limited liability company business” (C.R.S. § 7-80-404(1)(a)) only applies to members of a member-managed LLC, not to members of a manager-managed LLC. Members of a manager-managed LLC only owe the obligation to “discharge the member’s … duties to the limited liability company and exercise any rights consistently with the contractual obligation of good faith and fair dealing.” (C.R.S. § 7-80-404(3)) The Supreme Court’s ultimate conclusion is not dependent on the fiduciary duty analysis which may, in fact, be applicable in other forms of ownership (such as a general partnership).
In this case, the articles of organization reflect that LaFond & Sweeney was, in fact, organized as a member-managed LLC and, therefore, the members did in fact have the duties to “hold as trustee” for the benefit of the LLC. In a trust as described in C.R.S. § 15-16-302, a trustee “shall observe the standards in dealing with the trust assets that would be observed by a prudent man dealing with the property of another, and if the trustee has special skills or is named trustee on the basis of representations of special skills or expertise, he is under a duty to use those skills.” This arises to a higher duty than the “contractual obligation of good faith and fair dealing. ” The Court should have reached a similar conclusion in the context of this case without using the overly-broad language referring to fiduciary duties.
In the end, Mr. LaFond is obligated to share the contingent fee with his former law partner under the same sharing ratio as the two had shared things during the existence of their law firm, and he was not separately compensated for his efforts in finishing the case as part of his obligation to wind up the business of the LLC. Is it fair that Richard LaFond took the case to a successful conclusion after the dissolution of LaFond & Sweeney while his former partner shares on a 50-50 basis in the award? Is it fair that had the decision been under CUPA or the Uniform Limited Liability Company Act the decision would likely have been different? Whether the Colorado LLC Act should be amended to provide for “reasonable compensation for services rendered in winding up the business of the limited liability company” is an open policy question.