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Modification of Fiduciary Duties in Limited Liability Companies

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Modification of Fiduciary Duties in Limited Liability Companies Specific, Explicit, Unambiguous By James D. Johnson and Spencer W. Tanner Modification of Fiduciary Duties in Limited Liability Companies COMMERCIAL LITIGATION Many commercial disputes duties from those within the business. Typ- they also can be implied by law. However, a ically, the structuring of the organization, dispute between or among members and/or involving limited liability compa- done through an LLC’s articles of organiza- managers of an LLC does not always follow tion and operating agreement, is of utmost a typical path. By agreement, parties can nies (LLCs) arise from allega- importance in establishing the relation- alter certain duties to expand, restrict, or ships among the parties within the entity eliminate fiduciary duties owing to either tions of breach of fiduciary and to the entity. Generally, fiduciary duties the LLC or the other members and man- arise from those relationships, although agers, so that the business fits expecta- ■ James D. Johnson is a member of Jackson Kelly’s Evansville, Indiana, office. Mr. Johnson advises clients in business matters, including commercial law, civil litigation, appellate law, and matters of trade secrets and intel- lectual property. Mr. Johnson is an associate member of the American Board of Trial Advocates (ABOTA) and has handled over 50 appeals and multiple oral arguments before state and federal courts. He has been named to The Best Lawyers in America for Appellate Practice since 2007. Spencer W. Tanner is an associate in the business law industry group, focusing primarily on bankruptcy and commercial litigation. He also practices out of the firm’s office in Evansville, Indiana. 32 ■ In-House Defense Quarterly ■ Summer 2018 tions and needs. Any modification must benefit the fiduciary without the other offi- depend on the type of entity under which be performed in accordance with the LLC’s cers’, directors’, or members’ approval. the fiduciary is acting. state authorizing statute, which may limit The fiduciary duty of care requires that which duties can be modified. Finally, in directors, officers, or managers act with General Partnerships elimination or “exculpation” of fiduciary the care of an ordinarily prudent per- Under common law, a partnership can duties, some states mandate that provi- son in a like position and under simi- be created simply by two or more people sions be made in the LLC’s written operat- lar circumstances. In other words, act as carrying on business for profit. Thus, the ing agreement and that the provisions be an ordinarily prudent director, officer, formation requirements for creating a part- set forth “clearly” and “unambiguously” nership are minimal. However, a business to be upheld and not be rendered void by ■ organized as a general partnership subjects courts as a matter of public policy. all partners to joint and several liability for In the corporate context, debts and obligations of the partnership, The Traditional Fiduciary Duties while having the benefit of pass-through Accountability and liability are vital issues directors and officers enjoy the taxation. For fiduciary duties, generally, to consider when determining what kind partners must always place the interest of business entity would best suit a partic- benefit of a presumption called of the partnership above their own per- ular business model or venture. If an offi- sonal or business interests. To elaborate, cer, director, partner, or member makes a “the business judgment rule” “[u]nder common law, general partners poor business decision or wants to pursue owe each other and the partnership fidu- other opportunities outside of the business if it is alleged that they have ciary duties until final termination of the entity, what liability can he or she face from partnership… This fiduciary relationship others in the business, or from the business violated their duty of care. between partners requires each partner to itself? Which duties are owed to the busi- exercise good faith and fair dealing in part- ness by the officers, directors, or members? ■ nership transactions and toward co-part- Most importantly, how are officers, direc- ners.” In re Rueth Dev. Co., 976 N.E.2d 42, tors, partners, or members able to protect or manager would act in those circum- 53 (Ind. Ct. App. 2012) (citation omitted). themselves from liability? stances. In the corporate context, direc- In addition, partners have the obligation to Fiduciary duties in the closely held busi- tors and officers enjoy the benefit of a fully disclose to other partners any infor- ness context are duties owed to a busi- presumption called “the business judg- mation relating to the partnership that ness entity and to its shareholders or other ment rule” if it is alleged that they have could affect a partner’s material interest. members by those in positions of power or violated their duty of care. The business Partnership agreements can be structured trust within the entity. Most people prob- judgment rule, provided by either a state to modify, and in some states eliminate, ably believe that fiduciary duties are an corporation law statute or by common law, fiduciary duties, but all changes must be inherent responsibility assumed by the creates a presumption that a director or reasonable and be made in good faith. leaders of the business entity, but that is not officer acted in good faith, on an informed strictly the case. Fiduciary duties can either basis, and in the honest belief that the Domestic Corporations be imposed by statute or created by the decision was in the best interest of the A domestic corporation can be an attractive circumstances underlying a relationship company, and the burden of proving oth- business model for those who want to limit as judged through common law jurispru- erwise belongs to the complainant. Thus, their liability and maintain the corporation dence. The most common fiduciary duties the presumption is a powerful shield and as a separate business entity. Corporations, in the business context fall into three cate- defense against accusations of care viola- however, are inherently creatures of state gories: the duty of loyalty, the duty of care, tions. The presumption is so strong that statutes, with many formalities that must and the duty to act in good faith. fiduciaries are rarely found prima facie be met to successfully incorporate. In addi- The fiduciary duty of loyalty requires liable for a breach of their duty of care. tion, corporations are subject to dual taxa- that fiduciaries be loyal to the business Finally, a fiduciary must act with good tion. The corporation is taxed on its profits, entity or persons with whom they have a faith, not in a fraudulent way, with honesty and if profits are distributed as dividends, fiduciary relationship. Breaching the duty of purpose, and in the best interest and wel- then the profit is taxed again. Corporations of loyalty usually occurs when a fiduciary fare of the corporation. The duty of good are wholly owned by shareholders, but they fails to act for the benefit of the entity and faith is often thought of as another compo- are operated by a separate management that instead acts for his or her own benefit by nent in, or a subset of, the duty of loyalty. is accountable to the corporation and stock- usurping opportunities that could have holders. Unless the corporation is closely benefitted the corporation, using the cor- Creation of Fiduciary Duties in held, stockholders do not generally owe poration’s information against it or for the Closely Held Business Organizations any duties to each other. Under the Model fiduciary’s benefit, or otherwise engaging Which fiduciary duties are imposed and Business Corporations Act (MBCA), even in transactions using the corporation that which fiduciary duties can be modified can though the duties of loyalty and care are In-House Defense Quarterly ■ Summer 2018 ■ 33 imposed, directors can be exculpated for limitation of personal liability for business and not necessarily the members. ULLCA some breaches of the duty of care, but not debts, but also the ability to modify the §404(b). A “manager” is a person or persons breaches of the duty of loyalty, in the cor- form of the business including modifying chosen by the members to run the LLC. Id. poration’s articles of incorporation. MBCA fiduciary duties. In 1996, the Uniform Law Generally, for fiduciary duties under the §2.02(b)(4). In addition, under the MBCA, Commission enacted the Uniform Limited ULLCA, managers and members can mod- directors are not liable to the corporation or Liability Company Act (ULLCA) to take ify the statutorily imposed fiduciary duties to shareholders for any decision unless the into consideration the then-relatively new of loyalty and care owing to the LLC and conduct was an action not taken in “good form of unincorporated business organi- to the other members but only in a limited faith,” or was a decision “which the direc- fashion. The ULLCA (and the case law inter- tor did not reasonably believe to be in the ■ preting it) does not permit complete elimi- best interests of the corporation,” or was a nation or waiver of fiduciary duties. decision “as to which the director was not In 1996, the Uniform Law The “second generation” 2006 Revised informed to an extent the director reason- Uniform Limited Liability Company Act ably believed appropriate in the circum- Commission enacted the (RULLCA) took into account nearly a COMMERCIAL LITIGATION stances.” MBCA §8.31. decade of developments in the field and Closely held corporations have been held Uniform Limited Liability created a comprehensive, fully integrated to higher fiduciary duty standards. Fidu- LLC statute. One significant change in the ciary standards in closely held corpora- Company Act (ULLCA) to RULLCA concerns the extent to which the tions are similar to the fiduciary standards operating agreement can define, alter, or of partnerships because shareholders, offi- take into consideration eliminate aspects of fiduciary duties and cers, and directors are often all the same liabilities of members and managers of an people when the corporation is closely held, the then-relatively new LLC.
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