Llc Fiduciary Law

For a limited liability company ( LLC ) to succeed, its managers should know from the start that they will be subject to fiduciary duties of care and loyalty in performing their management responsibilities. While LLC members must be fair to their managers, they also must be able to remedy manager breaches of these duties and get full compensation from them for injuries caused by these breaches.

Many multimember LLCs are formed without the help of lawyers with LLC fiduciary expertise. At the same time, the fiduciary provisions of many LLC laws principally protect the interests of LLC promoters and managers who can afford them. Operating agreements should include provisions that change the generic results under applicable laws.

The most influential and widely used LLC act is Delaware. Almost ten percent of all U.S. LLCs are formed under Delaware law. Many of the more important fiduciary rules of Delaware law and cases primarily address the fiduciary needs of members represented by sophisticated counsel. The Delaware law, like many others, does not meet many basic fiduciary needs of members.

Delaware Law

Delaware law has no provisions specifically creating fiduciary duties of care or loyalty for members or managers. It has provisions that address fiduciary and related issues. They are:

Members have with a broad right to indemnify managers and others for fiduciary and other claims.

Members have a right to get six types of LLC documents and information for a "proper purpose" on written demand.

Members can provide for manager removals in the operating agreement.

Gives members broad flexibility to impose penalties and other consequences on managers for breaches of fiduciary and other duties.

Gives managers full protection if, in their management conduct, they rely on reports and competent experts.

Allow derivative actions to challenge manager misconduct.

States the policy of Delaware law is to give maximum effect to freedom of contract enforceability of LLC agreements.

Allow members to expand, restrict or eliminate manager fiduciary and other duties except for those under the implied covenant of good faith and fair dealing ("Implied Covenant").

Protects managers from personal liability for conduct arising from good faith reliance on the agreement.

Allows members to clear managers from personal liability for breaches of fiduciary duties except for the Implied Covenant.

The net result is that managers and members involved in Delaware LLC management have a duty of avoiding gross negligence. The cases define gross negligence as an entire neglect of the duty of care.

This standard of care is intended to protect directors of large Delaware corporations from the risk of personal liability for breaches of the duty of care and encourage them to be directors. However, this standard makes it extremely difficult for members of Delaware LLCs to prove their managers have breached a duty of care. Members who want to protect their LLCs from negligent managers should write an ordinary prudence standard into their operating agreements.

The problem is not limited to Delaware. At least 18 state laws provide for a "gross negligence" standard of care. This standard makes it very difficult for members to prove manager negligence. 20 laws are silent on whether managers have a duty of loyalty. Six have derivative provisions that create serious barriers to member fiduciary claims against managers. Only 13 expressly impose the Implied Covenant on managers. Only one imposes on managers the burden of disproving adequately pleaded allegations that they have breached their duty of loyalty.

The bottom line is that people forming LLCs have to read and understand the operating agreements they are signing and make sure they are comfortable understanding the levels of duty of managers and members. They cannot simply assume that the law will take care of those issues.