In this two-part series, we will examine the fiduciary duties of members and managers of limited liability companies. This first part is a primer on the concept of fiduciary duties, and the form of business entity known as a “limited liability company.”
Part One: Introduction to the concept of “fiduciary duties” and the Limited Liability Company
A. FIDUCIARY DUTIES
A “fiduciary” relationship is basically a trust relationship. If someone owes you a “fiduciary duty,” it means that you are entitled to trust that that person will act carefully and in your best interest. Correspondingly, there are two basic types of fiduciary duties, the duty of care and the duty of loyalty.
The duty of care requires its holder to make decisions in good faith and in a reasonably prudent matter. It requires the holder to be present, informed, and engaged in the business or relationship in which they owe a fiduciary duty. At all times, they should make sure they are living up to a high standard. For example, if the president of a company (who, as an office of the company, owes the company a fiduciary duty) is making a decision about some legal issue the company is involved with, acting reasonably and prudently might dictate that she consult an attorney experienced in the types of legal issues faced by the company, and further, it might be a breach of the president’s fiduciary duty to proceed without consulting such an attorney.
The duty of loyalty requires its holder to act at all times in the best interests of the one to whom the holder owes the duty. It requires the holder to avoid possible conflicts of interest, and to report all potential and actual conflicts of interests, as well as any other material information they encounter in their capacity as the holder of a duty of loyalty. They also cannot take opportunities they learn about in their fiduciary capacity for their own gain. For example, the aforementioned president might run a chain of marijuana retail stores, and at her job, she might hear about a marijuana retail store for sale at a great price. In that instance, her fiduciary duty of loyalty would not allow her to buy the store for herself; instead, she would be obligated to tell the company about the deal and allow it to pass on it before she got involved. Failing to do so would be a “usurpation of a corporate opportunity.”
B. THE LIMITED LIABILITY COMPANY
The two most basic forms of business organizations are the general partnership and the corporation. In a partnership, traditionally, the partnership itself was not a separate entity from the partners, and the partners have equal right to control the business of the partnership, they owe each other fiduciary duties, and are each personally and jointly and severally liable for the debts and obligations of the partnership. By contrast, a corporation has a separate legal existence from its constituents; it is owned by shareholders who usually do not owe each other fiduciary duties, and who elect a board of directors for corporate governance, who designate officers to run the day-to-day business of the corporation, and none of these constituents normally face any personal liability for engaging in the business of the corporation.
The limited liability company is a comparatively recent development in the world of business organizations. The first state to enact a law authorizing limited liability companies was Wyoming, in 1977, and by 1996 all fifty states had laws permitting the formation of LLC’s. LLC’s have characteristics of both partnerships and corporations – like partnerships, they may be taxed as pass-through entities; and like corporations, they limit the liability of their owners. However, LLC’s are flexible enough that their organizers may make their management structures closely resemble either a partnership or a corporation, with very different effects on the ability of the owners to control the business of the LLC, as well as their fiduciary relationships with the LLC and each other.
There are two broad categories of LLC management structures: 1) member-managed and 2) manager-managed. A member-managed LLC is more like a partnership in that each of the members (and only the members) has the right to manage and control the business of the LLC and to bind the LLC to agreements with third parties. The members of a member-managed LLC owe each other fiduciary duties, and also owe fiduciary duties to the LLC itself. In this way, a member-managed LLC more closely resembles a partnership.
By contrast, in a manager-managed LLC, the members, who are more like shareholders in a corporation, select “managers” (who can also be members), who then either run the business just like the officers of a corporation, or act more like a board of directors that appoints officers to actually run the business. The fiduciary duties owed by members of a manager-managed LLC to each other and the LLC can be extremely limited, depending upon the choices made by the members in the organization of the LLC. Obviously, a manager-managed LLC looks more like a classic corporation than a partnership.
One of the benefits of utilizing the limited liability company form for your business is the flexibility it provides. Although state law contains default provisions for the corporate governance of LLC’s (for example, in Oregon they are located in ORS Chapter 63), the organizers of an LLC can modify these default provisions with an incredible degree of flexibility, providing the business owners with a customized corporate governance scheme tailored to the company’s individual business circumstances.
In the forthcoming Part Two of this article, we will discuss nuances of the fiduciary duties of members and managers of limited liability companies.
You can contact Andrew DeWeese at email@example.com or (503) 488-5424.