Notes & Comment
Vol. 2005, No. 5
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Business Entities and Commercial Real Estate
Are LLC Managers Responsible For Their Tenants' Wrongdoing?
A California appeals court, in a case of first impression construing the state's limited liability company law, has held that a "manager" of a limited liability company (LLC) which leases commercial real estate can be held personally responsible for the illegal acts of its tenants. On the surface, the case perhaps makes sense. But dig deeper and the decision seems imprudent, was maybe designed to "teach a lesson", and perhaps was influenced by the seedy facts and characters involved ("bad facts make bad law"). What the decision means for managers of LLCs engaged in commercial real estate leasing in California is murky -- but potentially significant. People v. Pacific Landmark, Civ. No. B171419 (2d District) (May 31, 2005).
The Facts
Pacific Landmark, LLC (Pacific), acting through its manager, Ron Mavaddat, leased commercial office space that it owned in a strip mall in Los Angeles to two people known by local officials to be engaged in illicit activity, including massage parlors and prostitution. The tenants used the premises to operate these illegal businesses. The commercial lease included all the usual control features one expects in such documents, including use restrictions, covenants to comply with law, landlord inspection rights and control of signage.
There was considerable enforcement action by local authorities attempting to stop the unlawful behavior, including meetings with Pacific and its lawyers, but little was done by the landlord to stop the unlawful conduct. Eventually the city filed a nuisance abatement lawsuit against Pacific, its manager (Mavaddat) and the tenants. It won a restraining order (the tenants then vacated the premises), and subsequently obtained a preliminary injunction. The trial court enjoined the defendants, including Mavaddat personally, from maintaining or occupying the premises for purposes of prostitution or operating a massage parlor.
Pacific and Mavaddat appealed the preliminary injunction arguing, among other things, that Mavaddat, as manager of Pacific, was immune from liability and should not be subject to the preliminary injunction. The broader issue resolved by the Court is whether a manager of an LLC under California law is immune from personal liability for acts of the LLC that he or she manages. The court held that Mavaddat was not immune as a manager of the LLC and affirmed the entry of a preliminary injunction against him personally.
LLC Manager Liability
We previously have discussed the legal structure of LLCs under California law. Under the Beverly-Killea Limited Liability Company Act, an LLC manager (who is akin to the director of a corporation) is not personally liable for "any judgment of a court, or in any other manner, for any debt, obligation, or liability of the limited liability company, whether that liability or obligation arises in contract, tort, or otherwise, solely by reason of being a manager…" (Calif. Corporations Code §17158(a)). Mavaddat argued that this protected him from liability as manager of the LLC; that he was not subject to the preliminary injunction personally. The appeals court disagreed, concluding that, while there was no authority on the point in California, other states and other legal principles in California authorized them to affirm the preliminary injunction against Mavaddat personally.
They began with the injunction itself. Citing a California Penal Code section that authorized the issuance of permanent injunctions in public nuisance cases against the person maintaining the nuisance and the "owner, lessee, or agent of the building or place, in or upon which the nuisance exists…," the court held that an LLC manager was not immune from liability insofar as he or she is an "agent" of the LLC, and owes the same fiduciary duties to the LLC as a partner owes to a partnership. Borrowing principles of corporate law, the appeals court said that, because corporate officers and directors can be personally responsible for their own tortuous and unlawful conduct, LLC managers are not immune:
"[W]e hold that whereas managers of limited liability companies may not be held liable for the wrongful conduct of the companies merely because of the managers' status, they may nonetheless be held accountable under [California] Corporations Code section 17158, subdivision (a) for their personal participation in tortuous and criminal conduct, even when performing their duties as manager."
So What's the Problem?
Nobody should shed tears for commercial landlords who allow houses of prostitution to operate in suburban strip malls. But People v. Pacific Landmark was on appeal of a preliminary injunction in a public nuisance context. There had been no trial on the facts and no permanent injunction had been entered. That part of the court's decision affirming entry of the preliminary injunction was unpublished. Thus, this groundbreaking ruling regarding a manager's personal liability under California's limited liability company law was based on an unpublished finding about the case's most foundational element -- the propriety of the preliminary injunction in the first place.
Moreover, the Penal Code section the court cited as authority to extend the injunction to Mavaddat as a manager of Pacific applies to permanent injunctions, not preliminary injunctions. There was no bench trial finding that Mavaddat had, in fact, personally engaged in "tortuous or wrongful" conduct justifying an extension of "liability" to him personally. This was not a damages case, nor was it an appeal from a trial court judgment entered after a finding of facts regarding personal involvement by the LLC manager. In short, the court simply declared that Mavaddat had engaged in the type of "tortuous" or other wrongful conduct that justified imposing liability upon him as a manager of the LLC that owned the property. Never mind the inconvenience of a trial to establish his personal responsibility.
In other words, absent a final decision on the merits regarding Mavaddat's personal participation in continuing the public nuisance, what was the court's basis for affirming a preliminary injunction entered personally against him except his mere status a manager of the LLC? Ultimately, this decision probably construed the law properly, but the procedural status of the case did not permit that decision.
Conclusion
We certainly don't advocate for Mavaddat, and we sympathize with Los Angeles city officials trying to raise the quality of life for nearby residents and businesses by squelching a public nuisance. Our quarrel is with the results-oriented plunge into complicated issues of California business law that the three-judge appeals court took when they need not; when, instead, they could have affirmed the grant of preliminary injunction against the LLC which owned the property, and deferred the issue of manager liability until the facts had been more fully developed.
Now, individual managers of LLCs that own or operate commercial real estate in California can potentially be enjoined for actions of their tenants without a factual finding that they are personally responsible for the tenants' wrongdoing. Had the court been more thoughtful about the consequences of generically imposing personal liability on LLC managers without a proper factual finding below, we might not have the potentially significant decision we now face.
© Matthew Joseph 2005. Law Offices of Matthew Joseph, San Mateo, California, practices in the areas of intellectual property licensing, commercial real estate leasing, and corporate and business transactions. No legal advice is intended by the information provided herein and recipients should independently consult counsel before taking any action related to this subject matter.