In Burksfield II, the Washington State Court of Appeals discussed statutory and contractual indemnification in the context a derivative action. In this post, I briefly detail the facts and discuss the meat of the matter.
Burksfield v. LSL Properties, LLC – The Facts
Deborah Burksfield (“Burksfield”) and two of her brothers, Larry and Steve Sali (the “Salis”), were member-managers of LSL Properties, LLC (LSL), which owns gravel pits in Yakima County. The Salis collectively owned 82 percent of the membership interests, and Burksfield owned 17 percent. LSL leased gravel pits to companies wholly owned by the Salis. Deborah brought derivative claims on behalf of LSL, alleging the Salis favored their personal companies over LSL. See Burksfield v. LSL Properties, LLC, 2 Wash.App.2d 1061 (Wash. Ct. App. 2018).
In Burksfield I, Burksfield and LSL won a judgment for $535,000 and claimed statutory fees (permissive) under the LLC Act’s derivative action statute.
In Burksfield II, both sides sought an award of fees and costs under the LLC Act and the indemnification provision (Section 3.2) in LSL’s LLC Agreement. First, the Court ruled that there are different standards for an award of fees pursuant to the derivative action statute and LSL’s LLC Agreement. For a statutory claim, the claimant must be successful “in whole or in part.” However, with LSL’s LLC Agreement, the right to indemnification applied even where a party does not prevail.
The Court further stated “[a]s a result, while the member managers can vote on a request for indemnification under the provision [; however,] their vote is not the definitive answer on what the contract requires. A member or manager who is improperly denied indemnification under [S]ection 3.2 will be able to sue.” Burksfield claimed improper denial of indemnification under Section 3.2, raising the issue whether Burksfield is entitled to indemnification. See Id.
Comparing Corporate Indemnification to LLC Indemnification
In interpreting Section 3.2, the Court compared the Washington Business Corporation Act (RCW Title 23B), and the Washington LLC Act (RCW 25.15) regarding permissive versus mandatory indemnification. Under the Business Corporation Act, “permissive indemnification of directors can extend to expense and liability incurred unsuccessfully in proceedings—it can extend even to judgments entered against the director and the cost of an unsuccessful criminal defense, as long as the indemnified director’s actions resulting in the expense or liability meet a minimum standard of conduct.” See RCW 23B.08.510. “Unless the shareholders have committed in advance through the articles of incorporation or bylaws to indemnify directors, RCW 23B.08.550 dictates who will make the decision whether a director is indemnified in a particular case… If a director is statutorily ineligible but indemnification is approved, litigation might ensue. But if the director is statutorily eligible, whether to indemnify is a business decision.”
Furthermore, “[m]andatory indemnification also exists under the business corporation act, unless limited by a corporation’s articles of incorporation, and a party’s right to it can be enforced in court. See RCW 23B.08.520. It is not a business decision. But it is available only where the director is ‘wholly successful, on the merits or otherwise, in the defense of any proceeding’ to which he or she was a party because of being a director. RCW 23B.08.520.” See Id at *9.
The Washington State LLC Act provides for permissive indemnification for members or managers of an LLC. See RCW 25.15.041. The Washington State LLC Act does not provide for mandatory indemnification for members or managers of an LLC; however, an LLC Agreement may provide such mandatory indemnification. Specifically, in Burksfield, the Court “interpret[ed] [S]ection 3.2 as designed to address the situations where mandatory indemnification is appropriate, similar to the business corporation act indemnification regime.” Id.
Careful drafting of an indemnification provision and—more broadly—an LLC Agreement, is a must. In addition, should the indemnification provision include the right to advancement and under what circumstances? Without thoughtful drafting, unknowingly, you might open the door to mandatory indemnification. For all questions regarding indemnification, give me a call at (425) 776-4100 or shoot me an email at firstname.lastname@example.org.