On February 3, 2021, the Iowa Court of Appeals issued an opinion in the case of Erwin v. Erwin, No. 19-1978 (Iowa Ct. App. Feb. 3, 2021). that involved a dispute between a father and son regarding the operation of their member/managed LLC. In 2012, the father and his spouse transferred title of farm ground owned by them into a LLC for estate planning purposes. The property was subject to a mortgage, however, the deed did not state that the transfer was subject to a mortgage. The father subsequently made a gift to his son of one-half of the membership units, consisting of Class B non-voting units. The father and his spouse retained the remaining units consisting of Class A voting units and Class B non-voting units. The father was named as the manager of the LLC in the operating agreement. The mortgage which predated the creation of the LLC remained in the father’s name. The son farmed the land owned by the LLC under a crop sharing arrangement. The son received 70 percent of the income and the LLC received 30 percent of the income. The son was responsible for the majority of the expenses. The lease also provided for the rental to the son of a pasture and hay ground. The father used the LLC’s farm income to pay the mortgage.
Upon the creation of the LLC, the father used his personal bank account to deposit income and make payments on behalf of the LLC. The farmer’s tax preparer recommended that the father separate the business and personal accounts. The son requested access to the financial records of the LLC which was denied by the father. The son then proceeded to file a lawsuit. Following the filing of the lawsuit, the father terminated the LLC’s farm lease with the son and proceeded to enroll the real estate in the Conservation Reserve Program. Such was done four months before the farm lease with the son expired. The father did not have his son sign a consent to enroll the farm ground. The father used a Power of Attorney previously executed by the son in 2002 to authorize the enrollment.
The District Court found that the father did not breach fiduciary duties or the operating agreement by using LLC funds to pay personal debts related to the real estate; that the son was entitled to damages for annual distributions not paid to him; and the father should not be removed as manager; and that neither party was awarded attorney fees.
The Court of Appeals in examining the fiduciary duties of the LLC, found that the father’s asset reinvestment and debt repayment did not hurt the LLC and that such actions were done in good faith and in the best interest of the company, concluding that such duties of loyalty and care were not breached. In regard to the claim for the breach of the operating agreement, by filing inaccurate tax returns and not providing requested financial information, the Court acknowledged the father’s omissions and concluded that they were in good faith in that the father was acting to preserve the Company’s assets for his son. The Court of Appeals agreed with the District Court in not removing the father as the manager of the LLC. The Court found that the reporting requirements and compliance hearing ordered by the District Court was within the District Court’s discretion.
Finally, in regard to damages, the Court of Appeals affirmed the District Court’s reward of $47,866.00 to the son for annual distributions not paid to him; refused to award additional damages from lost distributions; and reversed the lower Court’s ruling and awarded $2,985.76 in favor of the son who was unable to use the farm ground for four months due to the father’s wrongful use of the power of attorney.
The case is an example of the need for attorneys and tax professionals to advise clients as to the set up and operation of a new entity. Many of the problems that led to the litigation could have been avoided if the manager of the LLC had operated the LLC properly.