Who Manages an LLC?

In California, Limited Liability Companies (“LLC”) are either managed by their members or designated managers, depending on how it is structured. These two kinds of management structures are the primary approaches to LLC management in California and are known as the (1) Member-Managed and (2) Manager-Managed structures. In member-managed LLCs, members are actively involved in daily operations, whereas members in manager-managed LLC’s, take a more passive role in the businesses’ management. Ultimately, the power to govern the LLC rests in its founders’ hands by allowing them to define how the business will be run in the LLC’s operating agreement. California law provides a flexible approach to LLC management through these two main structures. 

What is an LLC? 

“LLC” is the shortform name for a Limited Liability Company. LLCs are a form of business entities that combine corporation’s limited liability aspect with partnership’s tax benefits and operational flexibility. (CSHV 1999 Harrison, LLC v. County of Alameda, (2023) 92 Cal.App.5th 117.) LLCs are separate legal entities, meaning they are distinct from their members. (Ibid.) 

Who Manages an LLC?

Limited Liability Companies (“LLC”) are either member-managed or manager-managed. Each type of management structure carries its own formalities, requirements, and benefits. Whether an LLC is member-managed or manager-managed depends on the LLC’s operating agreement or articles of organizations. 

An LLC’s operating agreement plays a crucial role in establishing the businesses’ management structure. Operating Agreements govern relationships between members, the rights and duties of managers, and the conduct of the LLC’s activities (Corp. Code, § 17701.10.) In manager-managed LLC’s, the operating agreement also imposes fiduciary duties on members in addition to those duties imposed by default. (Samuelian v. Life Generations Healthcare, LLC, (2024) 104 Cal.App.5th 331.) 

Operating agreements are the primary document governing an LLC’s internal operations and can modify default statutory provisions to suit the LLC’s specific needs. Operating agreements typically include terms governing when and how the agreement can be modified. Generally, operating agreements cannot be modified by amendments without the consent of all members. (Corp. Code, § 17704.07.)

Member-Managed LLC

In member-managed LLCs, all members participate in the businesses’ management and control. (Corp. Code, § 17703.01.) Accordingly, each member acts as the LLC’s agent, meaning each member can bind the LLC in its usual course of business. (Ibid.) 

Members in member-managed LLCs owe each other fiduciary duties. Fiduciary duties are legal obligations arising out of certain professional relationships requiring one party to act in the other’s best interests. (Corp. Code, § 16404.) Under this structure, member’s fiduciary duties include the duties of care and loyalty including acting in the LLC’s best interest, avoiding conflicts of interest and refraining from competing with the LLC. (Corp. Code, § 17704.09.)

Manager-Managed LLC

Despite the member-managed structure’s existence, members do not gain the authority to manage or bind the LLC in its usual course of business solely by virtue of their membership. (Corp. Code, § 17703.01.) As such, manager-managed LLCs vest management authority in one or more managers who may, or may not, be members of the business. Under this structure, mangers are the individuals responsible for the LLC’s daily operations and strategic decisions while members fill more passive rolls like voting on general matters. (Swart Enterprises, Inc. v. Franchise Tax Bd., (2017) 7 Cal.App.5th 497.) 

Managers owe the LLC and its members fiduciary duties including the duties of care and loyalty. (Corp. Code, § 17704.09.) Members do not, however, owe fiduciary duties in this context unless the operating agreement specifies contrary obligations. (Ibid.) 

Likewise, members do not have the right to control the LLC’s management and conduct of activities unless the operating agreement specifies otherwise. (Swart Enterprises, Inc. v. Franchise Tax Board, 7 Cal.App.5th 497 at 510.) 

Why does an LLC’s Management Structure Matter?

An LLC’s managerial authority is important for many reasons, specifically in the context of its dealings with third parties. Under California’s general rule, agreements entered by an LLC’s true manager with third parties are binding, even if the manager lacked the authority to act under the LLC’s operating agreement. (Corp. Code, § 17703.01.) But, if the third party had “actual knowledge” of the manager’s lack of authority to act under the operating agreement, the agreement cannot be binding because neither party had any reason to believe the LLC would be bound by their agreement. (Ibid.) This rule commonly applies in cases where the manager requires member approval to sell LLC property or engage in similar transactions but fails to obtain it. 

Managers acting beyond the authority granted to them in the operating agreement risk exposing the LLC to an expanded scope of liability. For example, LLCs are at risk of incurring new liability when individuals who are not their designated manager, act as the LLC’s manager while ignoring competing claims to the “manager” title. 

In Sam v. Kwan, California’s Second Appellate District Court addressed this scenario and established the outcome of an LLC that sells its property to a third party during ongoing disputes regarding the identity of the LLC’s manager. Here, the LLC’s operating agreement designated Sam, the plaintiff, as the LLC’s manager and he acted accordingly when entering transactions on behalf of the LLC during his tenure as manager. ((2024) 101 Cal.App.5th 556.) But, after a year, Sam and Kwan, the defendant, were no longer operating on good terms, so Kwan sold a parking lot Sam had purchased as manager and personally guaranteed the loan, without Sam’s knowledge. (Ibid.) Kwan was not the LLC’s designated manager when selling the lot, and did not disclose this to the buyer, and despite Sam’s name appearing on the parking lot’s deed as manager, the buyer did not inquire about the discrepancies between Sam and Kwan’s identities. (Ibid.) Ultimately, because Kwan was not the LLC’s manager when he sold the parking lot to a third party, the court held the parking lot’s purchaser failed to uphold their duty as a buyer to make a reasonable inquiry regarding the identity of the LLC’s manager. (Ibid.) As a result, the buyer was not a “bona fide purchaser” because factual disputes existed on summary judgment regarding the identity of the LLC’s manager that they failed to inquire about to the extent that any reasonable and prudent buyer would have. (Ibid.)

So, while members have authority to make changes in an LLC’s management structure, they must be executed properly to avoid mishandling LLC business and potentially incurring additional liability like in Sam v. Kwan. 

What is an Example? 

For example, “Shawn” and “Julie” purchased six rental properties in California that they deeded to their business “Realty Adventures, LLC.” Three of the properties are extremely profitable Airbnbs while the other three are long term rentals. Shawn notices the Airbnbs produce impressive short term profits and pushes Julie to turn their remaining three rentals into Airbnbs too. Julie, however, is much more concerned with establishing the long-term rentals as stable income sources. Shawn ignores Julie’s desires, refuses to even consider the possibility of long-term rental success, and rents the long-term rentals out as Airbnbs anyways.  

Upon discovering Shawn’s actions, Julie files for partition citing Shawn’s aggressive and selfish tactics as justification for enacting the operating agreements right to partition the LLC. The court rules in Julie’s favor and awards Julie the long-term rental properties, while Shawn keeps the three original Airbnbs. Now, Julie can establish her long-term rentals’ success and Shawn can continue chasing short term profits through renting his Airbnb units. 

Conclusion

The Underwood Law Firm has a team of experienced lawyers who can help guide you through complicated legal matters relating to LLCs and Partitions, and help you pursue solutions to protect your legal rights to the fullest extent of the law.  Contact us to learn more.