Fiduciary Duties

December 4, 2012

Fiduciary Duties Change In New Jersey LLC Law

Law Specifies Fiduciary Duties for Members and Managers of New Jersey LLCs

A Series on New Jersey’s Adoption of the Revised Uniform Limited Liability Company Act

The fiduciary duties imposed on a member or manager of a New Jersey LLC are at present elusively and poorly defined in the statute. While the current act contains several provisions limiting the personal liability of members, nowhere does it clearly define the duties that are inherent in the relationship of the members. Attempts to impose the fiduciary obligations that have traditionally been thought to be a fundamental aspect of the relationship of partners in a partnership, or the officers and directors in a corporation, have met with uneven results.

As we noted in our recent blog post (Fiduciary Duties Murky Under Delaware Law), reviewing a decision from the Delaware Supreme Court, the issue is still undecided in the most influential jurisdiction in the country on issues of business governance, and there is little guidance in the form of controlling authority in New Jersey.

Uncertain ResponsibilitIes of LLC Members

That uncertainty should change significantly when the revisions to New Jersey’s limited liability company law take effect in March 2013 for newly formed companies, and in March 2014 for existing LLCs. In adopting the RULLC, the legislature put in place a new set of standards for the conduct of members and managers of LLCs organized under New Jersey law. While some of the changes reflect much of the judge-made law applying equitable principles to the conduct of small business owners, there are some significant differences in the way those duties will now work, and anyone involved with a New Jersey limited liability company needs to have a firm grasp of the structure.

This definition of fiduciary duties is significant because courts are often hesitant to create new rules of law by analogizing to the law of corporations or partnerships. A particularly contentious issue in New Jersey, for example, was whether a minority member of an LLC who was treated unfairly could bring an action for oppression and obtain the remedies available under corporate law. These efforts have uniformly had anything but uniform results — in New Jersey and other states with similar limited liability company statutes.

The RULLC is more comprehensive that the present New Jersey Liability Company Act. Under the current act, there is no explicit definition of the duties. The current law simply provides that to the extent that “at law or in equity” a member or manager has any duties, including fiduciary duties, those duties can be varied by the operating agreement and that the member or manager can rely on the operating agreement (N.J.S.A. 42:2B-66). The current act also provides that where the statute is silent, the “rules of law and equity” govern (N.J.S.A. 42:2B-67) Many commentators see this as the express understanding that fiduciary duties are created by the equitable principles that are widely accepted as governing the relationships between members of business enterprises. Others think not.

November 26, 2012

Fiduciary Duties of Limited Liability Principals Undecided

by Jay R. McDaniel

Court Rejects as Unnecessary Statutory Interpretation Finding Fiduciary Duties in LLC Act

One of the burning issues in limited liability company law is the existence and scope of
the fiduciary duties that are the core of the business relationship between the owners and managers of the business. Our discussion of a recent decision from Delaware is intended to emphasize the unsettled nature of the question in much of the country and to provide a good starting point for an ongoing discussion of just how deep are the changes in the recently enacted changes to New Jersey’s limited liability company statute.

The decision, Gatz Properties, LLC v. Auriga Capital Corp., C.A. No. 4390 (Nov. 7, 2012), is significant to the members and managers of New Jersey LLCs not just because of the influence of the Delaware courts, but because the New Jersey statute – for a short while longer – contains an identical provision. We don’t discuss the case at length here because our point is somewhat different – the the different way fiduciary duties are addressed by the Revised Uniform Limited Liability Company Act adopted in September. There are some excellent discussions of the case and its impact can be found on the blogs of Francis Pileggi’s blog (post here), Stoel Rives LLP (post here) and Peter Mahler (post here.)

There are those that argue that an LLC is at its core is a creature of contract, and that the relationship between the members or managers carries with it no inherent fiduciary obligations. Thus, the argument goes, the members and managers owe each other no greater obligations that they do in any other contractual relationship and the only fiduciary duties that exist are those that are created by the LLC’s operating agreement.

Others, meanwhile, argue that a limited liability is a business enterprise and that the fiduciary relationships that one finds in other forms of business organization, such as corporations or partnerships, should apply. In many states, including New Jersey, it is an open issue. So when a Delaware Chancery Court judge went out of its way to find that the Delaware limited liability company statute itself creates fiduciary duties akin to those widely accepted in the context of corporate governance, people paid attention. Delaware is still considered the fatherland of corporate governance and its decisions, even those of trial judges, carry a great deal of influence.

Any certainty, however, disappeared with the holding of the Delaware Supreme Court that the finding of the trial court concerning any fiduciary duties under the statute was dicta not necessary to the final outcome of the case, and expressly stating that the question of the fiduciary duties of limited liability company managers is still an open issue under Delaware law.

October 8, 2012

Protecting Profit Margins from Employee Saboteurs

by Jay R. McDaniel

Employee Held Liable for Actively Competing With Current Employer

The success of businesses in specialized fields often depends on the employees’ ability to deliver consistent-quality service and implement specialized techniques and processes. Business owners in these fields know that the costs of investment in employee training and development can be very high. What is a business owner to do when employees take this costly knowledge and expertise to a new company and begin competing against the former employer? Fortunately, New Jersey offers relief from such acts, as discussed in the recent Appellate Division case of Baseline Services, Inc. v. Kutz, et al., A-5214-09T3.

Baseline provides metrology services involving repair, maintenance, and calibration of laboratory equipment to its clients. The corporation had a substantial annual contract – in the amount of $269,000 – with Global Pharmaceutical Sourcing Group (GPSG), which is a division of Johnson & Johnson, Inc. The contract was primarily serviced from 2002 to 2006 by two Baseline employees – Kutz and Nicoludis.

January 3, 2012

Fiduciary Duties Change With Time

by Jay R. McDaniel

Partnership Failed to Keep Inactive Partner Informed

The fiduciary duties owed among partners can change with time and circumstances, and the disclosures that were appropriate when all of the partners worked together in the business may become inadequate when one of the partners has ceased to take an active role.

This is the lesson of Munoz v. Perla, Docket No. A-5922-08T3 (App. Div. Dec. 20, 2011) in which the Appellate Division affirmed a trial court decision holding that the members of a partnership had failed to make adequate disclosure of the terms of the leases held by the engineering firm, of which the parties had all once been partners.

Although the case involved the now-repealed Uniform Partnership Act, and thus not all of the holdings may be applicable to partnerships formed under later law, the decision is instructive as to how the fiduciary relationships between partners my evolve as time passes and circumstances change. (For another reason decision involving fiduciary duties among partners, see our blog post here.)

December 27, 2011

Limited Liability Co Founders May Have Disclosure Duties

by Jay R. McDaniel

Promoters of LLC Subject to Breach of Fiduciary Duty Claims

Limited liability companies are clearly the vehicle of choice for new, closely held businesses. That means that more often than not the principals have some existing relationship before they take up their new business together. Can that prior relationship create fiduciary duties even before the company has begun operations?

A decision out of the New York Court of Appeals indicates that there may be fiduciary duties in such a relationship, in particular duties of full disclosure and fair dealing. Moreover it appears that these duties may exist before the limited liability company is formed or membership interests are acquired. In Roni LLC v. Arfa, 2011 N.Y. Slip Op. 09163 (Dec. 20, 2011), The court held that the existence, or not, of a fiduciary relationship depends up the relationship of the parties and whether it meets the traditional criteria necessary to create fiduciary obligations.

Real Estate Investments by LLC

This case involved the conduct of promoters, the individuals who organize a new business and seek out other participants or investors. The defendant promoters organized seven limited liability companies under New York law for the purpose of buying and renovating buildings in the Bronx and Harlem for resale. The plaintiffs were a number of Israeli investors who acquired interests in the LLCs.

October 19, 2011

Failure to Disclose Transfer of Partnership Not Wrongful

by Jay R. McDaniel

Partnership Interest Secretly Transferred to Family Member

Does a partner have an obligation — separate and apart from the terms of a partnership agreement — to disclose the fact that one of the partners has transferred their interest to another member of the partnership?

The question seems to answer itself. Of course it is. After all, is there anything more material to the business of a partnership than the identities of the partners? But in a case earlier this year involving a secret transfer from a mother to one of her sons, the New Jersey Appellate Division’s came to the contrary conclusion. The narrow reading given by the court to the Uniform Partnership Act and its failure to find that there was a duty to disclose the transfer is troubling.

Fiduciary Duties under the Uniform Partnership Act

The question that is lurking in this decision, Taylor v. Taylor, Docket No. A-4363-09T1 (N.J. App. Div. July 8, 2011), is whether the adoption of the UPA fundamentally altered the relationship between the partners of a partnership, and whether precedent going back to the early 20^th Century is still good law. The Taylor decision suggests it is not.

I do need to confess my personal bias. I think the current trend of allowing parties in a business relationship to contract away basic principles of honesty and loyalty, demonstrated by statutory and occasional court approval of agreements that eliminate fiduciary duties, is a bad idea. In my opinion, it’s like the Japanese gangster who willingly cuts off his own fingertip to atone for a mistake. The fact that the Yakuza participated in the wrong done to himself doesn’t make it right. On the other hand, I appear to be in the minority and the drafters of the Uniform Partnership Act, adopted in New Jersey in 2000, and a growing number of courts seem to think otherwise.

March 14, 2011

Fiduciary Duties in Unfair Competition Case

by Jay R. McDaniel

You just learned that an employee secretly formed and operated a competing business while employed by you. Is there a claim against the competing business or just the employee? Most likely there are viable claims against both. The fiduciary duties of the employee are likely to be imputed to the company he or she formed.

Breach of Fiduciary Duties

Similar facts were before the court recently in an unfair competition and breach of fiduciary duty case, Vibra-Tech Engineers, Inc. v. Kavalek, Civil Action No.: 08-cv-2646, in the United District Court for the District of New Jersey. (opinion here) A vice president and director of Vibra-Tech, along with his wife, formed two businesses. One of the businesses sold equipment to Vibra-Tech; the other competed directly for the same customers. Vibra-Tech, of course, had no idea that one of their executives was involved in the two businesses.

January 28, 2011

Partnership Agreement Disclosure to Labor Union Pending Trial Court Decision

by Jay R. McDaniel

In some circumstances, a business may be able to claim that its organizational documents are trade secrets. That seems to be the holding of a trial court decision insulating a partnership agreement from disclosure to a labor union.

The case is interesting because non-management owners do not generally have free access to all of the records of a business, but they do have a right of access to organizational documents. This case raises the prospect that a company that in turn enters into other ventures might classify those documents as proprietary or trade secrets and avoid disclosure to parties with an interest in their contents.

The dispute actually arose under New Jersey’s Open Public Meetings Act. The lawsuit, Communications Workers of America and New Jersey Education Association v. John McCormac and Blackstone Capital Partners et al., L-3217-05 (2008), involved a complaint brought by several state workers’ groups against defendant public officials and private equity funds seeking documents which might reveal the investment strategy defendant private equity firms were utilizing to invest state worker pensions.

December 20, 2010

Derivative Claim in Dispute Between Owners May Require Independent Counsel

by Jay R. McDaniel

A derivative claim is an action brought by an individual, but to enforce a right owned by the company. Any remedy or recovery belongs to the company.
An individual claim is brought to vindicate the rights of an individual owner. The recovery or remedy belongs to the individual owner.
Although the business is often considered a nominal party in derivative litigation — one without a significant stake in the outcome — it may be necessary to have a separate attorney represent the corporation or limited liability company to avoid conflicts of interest with the lawyers representing individual owners.

September 30, 2010

Owners of Parent Corporations Should Have Remedies Against Officers of Subsidiary Businesses

by Jay R. McDaniel

Businesses often create additional new businesses, whether as joint ventures or subsidiaries. The flexibility and favorable tax treatment given to the limited liability company have made it fairly common that an LLC has other business entities as its owners. For the individual owner, however, this situation can present problems. The requirement that the members act at the company level often means less individual control and less ability to address acts of wrongdoing in the subsidiary or joint venture.

The individual owner’s recourse is the double derivative action, a complicated device in which the individual owner. asserts the rights of the parent to assert a claim as an owner of the subsidiary. It’s confusing, but the principle is generally well accepted.

An Example

Law Specifies Fiduciary Duties for Members and Managers of New Jersey LLCs

A Series on New Jersey’s Adoption of the Revised Uniform Limited Liability Company Act

Uncertain ResponsibilitIes of LLC Members

Court Rejects as Unnecessary Statutory Interpretation Finding Fiduciary Duties in LLC Act

Employee Held Liable for Actively Competing With Current Employer

Partnership Failed to Keep Inactive Partner Informed

Promoters of LLC Subject to Breach of Fiduciary Duty Claims

Real Estate Investments by LLC

Partnership Interest Secretly Transferred to Family Member

Fiduciary Duties under the Uniform Partnership Act

Breach of Fiduciary Duties

A derivative claim is an action brought by an individual, but to enforce a right owned by the company. Any remedy or recovery belongs to the company.

An individual claim is brought to vindicate the rights of an individual owner. The recovery or remedy belongs to the individual owner.

An Example