The Kansas LLC Act requires an LLC to indemnify its members or managers, in some cases, for their attorneys’ fees to the extent they are successful in litigation. The statute was recently interpreted to require an LLC to indemnify a member for his attorneys’ fees in a lawsuit where the member successfully sued to establish his membership in the LLC and to recover on fiduciary duty claims against two other members. Davis v. Winning Streak Sports, LLC, No. 107,613, 2013 WL 1010622 (Kan. Ct. App. Mar. 15, 2013).
Background. Christopher Davis sued Winning Streak Sports, LLC (WSS), U.S. Hardwood Distributors, Inc. (Hardwood), and Lauren Larson. (Hardwood and Larson were members of WSS.) Davis sought a declaratory judgment that he owned a 49% membership interest in WSS, and claimed damages from Hardwood and Larson for breaches of their fiduciary duties as members of WSS.
Davis was partially successful. The trial court ruled that he was a member of WSS, but only a 0.96% member, and awarded him damages of $600,000 for breaches of fiduciary duties by Hardwood and Larson. The court also awarded WSS $74,788 on its counterclaim against Davis for breach of contract. Both sides appealed, and in 2010 the Court of Appeals affirmed the trial court’s rulings. Winning Streak, Inc. v. Winning Streak Sports, LLC, No. 100,725, 2010 WL 348272 (Kan. Ct. App. 2010) (unpublished opinion), rev. denied, 222 P.3d 564 (Kan. 2010).
Claim for Attorneys’ Fees. Davis then brought suit to recover his attorneys’ fees incurred in the original action against WSS. Davis contended that he was entitled to indemnification for his attorneys’ fees under Section 17-7670(b) of the Kansas LLC Act. The trial court ruled on summary judgment that Davis was not a prevailing party and therefore was not entitled to recover his attorneys’ fees, and Davis appealed.
The Court of Appeals saw the interpretation of Section 17-7670(b) as central to its resolution of the appeal. This section has two components: paragraph (a) authorizes an LLC to indemnify any member, manager, or other person from any and all claims, and paragraph (b) mandates indemnification in limited circumstances:
(a) Subject to such standards and restrictions, if any, as are set forth in its operating agreement, a limited liability company may, and shall have the power to, indemnify and hold harmless any member or manager or other person from and against any and all claims and demands whatsoever.
(b) To the extent that a member, manager, officer, employee or agent has been successful on the merits or otherwise or the defenses of any action, suits or proceeding, or in defense of any issue or matter therein, such director, officer, employee or agent shall be indemnified against expenses actually and reasonably incurred by such person in connection therewith, including attorney fees.
Kan. Stat. Ann. § 17-7670.
The parties focused their arguments on whether Davis or WSS was the prevailing party, but the Court of Appeals saw those arguments as misplaced. “The statute in plain and simple language requires indemnity to the extent that a litigant prevails. There is no doubt that Davis prevailed, at least in part, in this litigation.” Davis, 2013 WL 1010622, at *5 (emphasis in original).
Because Davis prevailed in part, and because the statute is mandatory (“such director, officer, employee or agent shall be indemnified”), the court concluded that Davis was entitled to indemnification to the extent he was successful in the original litigation, and that the amount of the fees would have to be decided by the trial court. Id.
The court went on to consider additional arguments made by WSS that were not reached at trial.
No Operating Agreement. WSS had no operating agreement, and WSS claimed that therefore Davis could not seek relief under Section 17-7670(b). Paragraph (a) authorizes LLCs to indemnify managers and members, “[s]ubject to such standards and restrictions, if any, as are set forth in its operating agreement,” and WSS argued that an operating agreement is therefore required for both paragraphs. The court, however, ruled that the plain language of paragraph (b) controlled and that the lack of an operating agreement did not render Section 17-7670(b) inoperative. Id. at *8.
Unconstitutionally Vague. WSS argued that paragraph (b) is unconstitutionally vague, because it begins by referring to “a member, manager, officer, employee or agent,” and then refers to “such director, officer, employee or agent.” The first phrase refers to a member or manager, while the second phrase refers to “such director.” The court said this was an obvious clerical error in the drafting of the statute, and read the paragraph to include LLC members in the class of persons entitled to indemnity to the extent they are successful. Id. at *9.
Claims Personal to Davis. Lastly, WSS argued that Davis’s claims, whether or not successful, did not qualify for indemnification because they advanced only his personal, private interest. Note that paragraph (b) of Section 17-7670 is silent about the nature of the “action, suits or proceeding,” and in fact refers to “any action, suits or proceeding” (emphasis added).
The court apparently assumed that paragraph (b) requires a nexus between the lawsuit and the interests of the LLC, i.e., that there be some benefit to the LLC. But the court did not require that the lawsuit benefit only the LLC. “WSS does not provide any support for the notion that indemnity is not required when the underlying action benefits both the LLC and the individual plaintiff.” Id.
The court took note that (a) Davis contended he was a member of the LLC at the time of his suit, (b) some of Davis’s claims not only affected him personally but also dealt with the integrity of the LLC’s books and records, and (c) the issues Davis brought forth also benefited the LLC’s interest in properly identifying its members and their interest in the LLC, and in the accuracy of its books and records. “We cannot conclude, as WSS argues, that Davis’s suit advanced only his private interest.” Id. at *10.
The court therefore ruled that Davis was entitled to summary judgment on his indemnification claim for attorneys’ fees, and remanded the case to the trial court to determine the amount of attorneys’ fees that Davis should recover.
Comment. This case revolves around a poorly drafted paragraph of the Kansas LLC Act: Section 17-7670(b), quoted above. The Court of Appeals discussed the statute’s inconsistent reference to “such directors.” But beyond that, the scope of the statute’s indemnification requirement is breathtakingly wide. The statute requires an LLC to indemnify a member or manager to the extent it is successful in maintaining or defending “any action, suits or proceeding.” There is no explicit requirement that the member’s or manager’s suit or defense be in its capacity as a member or manager, or even that the suit have any connection to the LLC.
The court did not directly address the scope of paragraph (b), but it appeared to implicitly accept WSS’s premise that Davis would not have been entitled to indemnification for his attorneys’ fees if his suit had only addressed his personal interests.
So when does Section 17-7670(b) apply? Presumably a member that is successful in a suit for dissolution of the LLC, or in a suit for breach of fiduciary duty by a manager or other member, would be entitled to its attorneys’ fees under paragraph (b). Either of those claims arguably would, at least in many cases, benefit the LLC as well as the individual plaintiff.
This statute is an outlier in another respect. Many state LLC statutes authorize an LLC to provide in the LLC’s operating agreement for indemnification of managers and members, but few if any other LLC statutes require indemnification of members’ or managers’ attorneys’ fees. Both Washington and Delaware, for example, authorize but don’t require indemnification. RCW 25.15.040; Del. Code Ann. tit. 6, § 18-108.