Articles Tagged with fiduciary duties

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Law Specifies Fiduciary Duties for Members and Managers of New Jersey LLCsfd-proxy

 


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.

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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 company-stock-in-retirement-plans-cartoon
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.

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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 20th 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.

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Limited liability companies are creatures of contract, and the Operating Agreement is the Magna Carta of the business.  Because it is a contract, however, all of the members must consent to any changes to the Operating Agreement, which means that the holdout member has a veto.  In short, the minority rules on major changes.

The Minority Rule Problem

All of the members, save one, may agree that a change to an operating agreement is in the best interests of the business.  Yet that one holdout, for whatever reason, can veto the change because a contract cannot be changed unless all of the parties’ to the original agreement consent.

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