The Rights of LLC Members, Managers, Directors and Officers to Receive Reimbursement and Advances for Attorney's Fees and Indemnification for Liability
When can a member, manager, director, or officer of a Tennessee limited liability company (“LLC”) expect the LLC to pay attorney’s fees when that individual 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 for attorney’s fees and indemnification for liability. If the LLC has an operating agreement that provides terms and conditions for indemnification and the advancement or reimbursement of attorney’s fees, then those terms will supplant the provisions of the Act. The LLC’s operating agreement might provide terms that cover some situations, but not others, in which event the terms of the Act might still apply.
While LLC members have the absolute right to provide, in an operating agreement, terms and conditions related to the payment of attorney’s fees and indemnification for liability that differ from the Act, the Act provides that an operating agreement can never waive certain provisions.
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 establishing that the responsible person breached a duty of loyalty to the LLC or its members;
A judgment for acts or omissions not in good faith, or that involve intentional misconduct or a knowing violation of the law; or
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. It does not include an officer. (Officers’ rights are discussed separately below.)
The non-waivability of T.C.A. §48-249-115(i)(1)(A)(B) and (C) prevents, for example, a majority member who has been found liable in a derivative action from using LLC assets to pay the judgment against him or her. This is an important protection for minority members.
T.C.A. §48-249-115 is a fairly complex statute, the applicability and scope of which cannot be fully analyzed in a single blog post. What follows is a broad overview of the framework.
SECTION (b): “AUTHORITY TO INDEMNIFY”
This section provides a Tennessee LLC with the right, but not the obligation, to indemnify a responsible person against liability incurred. The right exists only where the person has met certain standards of conduct.
“Liability incurred” includes attorney’s fees, since “liability” is defined to include “reasonable expenses with respect to a proceeding.” However, the LLC may not provide indemnity where the responsible person was held liable to the LLC in a derivative action or for receiving an improper benefit in an action other than a derivative action.
If the LLC has an operating agreement, it may set different terms for indemnification.
SECTION (c): “MANDATORY INDEMNIFICATION”
This section requires an LLC to indemnify a responsible person who has been “wholly successful” in defending an action. The obligation is limited to indemnification for “reasonable expenses” incurred in the defense.
Of course, such a person, having been successful, would not need indemnification for liability on a judgment.
SECTION (d): “ADVANCES FOR EXPENSES”
This section allows an LLC to advance reasonable expenses — most often attorney’s fees — before the lawsuit or arbitration proceeding is resolved. Advances are permitted only if certain conditions are met and if the board of directors, managers, or members determine that those conditions have been satisfied.
SECTION (e): “COURT ORDERED INDEMNIFICATION”
This section gives courts authority to order an LLC to indemnify a responsible person in two situations.
First, if the LLC fails to provide indemnification when required under section (c), the court may order it.
Second, the court has broad discretion to order indemnification where fairness dictates, even if the responsible person’s conduct did not meet the standard under section (b), and even if the person was held liable. In such cases, however, the court may only order indemnification for attorney’s fees and expenses — not for the judgment itself.
SECTION (g): “INDEMNIFICATION OF OFFICERS, EMPLOYEES AND AGENTS”
This section allows an officer to apply for mandatory indemnification under section (c) and for court-ordered indemnification under section (e). It also provides that an LLC may indemnify and advance expenses to an officer to the same extent that it may do so for a responsible person.
The statute applies only to Tennessee LLCs formed after January 1, 2006.
Lastly, any officer, manager, director, or member of an LLC who is named as a defendant in an LLC lawsuit or arbitration proceeding should, at the outset, determine whether the LLC has coverage under an officers’ and directors’ insurance policy.