Chapter 4 - § 4.3 • DUTIES, RIGHTS, WAIVER, AND THE CONTRACTUAL OBLIGATION OF GOOD FAITH AND FAIR DEALING — LLCS
| Jurisdiction | Colorado |
§ 4.3.1—Statutory Duties Owed by Members and Managers
For an LLC, certain duties owed by the members and managers arise statutorily in §§ 7-80-404 through -408 of the LLC Act. Unlike in a partnership11 or corporation,12 however, the members may agree to modify or even eliminate any duties (whether statutory, from principles of agency, or otherwise) of the managers (or members in a member-managed LLC) in the operating agreement.13 The broad authority in the LLC Act to modify "duties, including, but not limited to, fiduciary duties"14 recognizes that members and managers have duties in addition to those in the LLC Act — certainly under agency law and potentially under common law.
The statutory duties apply to managers of a manager-managed LLC and to members of a member-managed LLC and (unless waived or modified) include:
• The duty to account to the LLC and hold as trustee for the LLC any property, profit, or benefit
◦ derived by such manager (or member in a member-managed LLC) in the conduct or winding up of the LLC's business; or• A prohibition against dealing with the LLC in the conduct or winding up of the LLC's business as or on behalf of a party having an adverse interest;16
◦ derived from a use by the manger (or member) of property of the LLC, including the appropriation of an LLC opportunity;15
• A prohibition against competition with the LLC in the conduct of its business before dissolution;17 and
• The duty of care in the conduct and winding up of the LLC's business, which duty is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law;18
By contrast, the contractual obligation of good faith and fair dealing applies to all members (whether or not the LLC is a member-managed LLC) and to managers of a manager-managed LLC.19
As discussed in § 4.3.3, "Waivers and Explanation in the Operating Agreement," subject to exceptions and limitations, an operating agreement may modify or eliminate each of the foregoing duties. As discussed in § 4.2, "Agency Law — A Common Source of Duties in LLCs and Partnerships," duties also arise under agency law for members and managers of LLCs. The drafter of an operating agreement who intends to modify the statutory duties in § 7-80-404 should also ensure that the language used will provide for corresponding modifications of the duties under agency law if that is intended.20
The LLC Act imposes duties under § 7-80-404 on members of a member-managed LLC and managers of a manager-managed LLC. These authors are unaware of any case imposing duties on members in a manager-managed LLC, but do not discount the possibility that a court might impose duties on members of a manager-managed LLC in a particular case — especially in the case of a manager-managed LLC where the members have chosen to appoint no managers.21 Alternatively, a court might interpret the contractual obligation of good faith and fair dealing as a duty. Admittedly, the difference between a "contractual obligation" and a "duty" is difficult to explain.
§ 4.3.2—Rights of Members and Managers
In contrast to duties set forth in the statute, the statute also provides certain rights, including the following rights, which must be exercised in accordance with the contractual obligation of good faith and fair dealing:
• Each member or manager may lend money to or transact other business with the LLC;22
• Each member and manager may expect reimbursement and indemnification for "liabilities incurred . . . in the ordinary course of the business of the [LLC] or for the preservation of its business or property" if the payments were made or liabilities incurred without violating the person's duties to the LLC;23
• Each member and each manager has certain inspection rights;24
• Each member has the right to a formal accounting of the LLC's "affairs whenever circumstances render it just and reasonable";25
• Each member of a member-managed LLC and each manager of a manager-managed LLC has the right to act as an agent of the LLC for purposes of apparently carrying on the business of the LLC in the ordinary course;26 and
• Each member of an LLC has the right to inspect and copy specified records.27 An operating agreement may limit (but not eliminate) this right.28 The LLC can require that the inspection of records be for a proper purpose — a "purpose reasonably related to the member's interest as a member of the [LLC]."29 The LLC Act also gives the managing body (managers, or members in an LLC without managers) the right to impose confidentiality restrictions as a condition of inspecting records "for such period of time as the members or managers deem reasonable."30 It is preferable for the operating agreement, which is the agreement of the members, to address these issues directly.31 The statutory inspection right is not self-executing; that is, a member must demand to inspect and copy records and must explain the purpose of the demand.32 As discussed in § 5.3.1, "Limited Liability Companies," the parties to an operating agreement may want to consider expanding the information rights, particularly in the case of the legal representative of a deceased or disabled member.33
The statutory provision allowing a member or manager to lend money to or transact other business with the LLC goes on to state that "as to each loan or transaction the rights and obligations of the member or manager may be exercised or performed in the same manner as those of a person who is not a member or manager, subject to other applicable law."34 Presumably, "other applicable law" includes provisions in the LLC Act such as § 7-80-404(1)(b), which states that one of the duties of a manager or of a member of a member-managed LLC is to:
Refrain from dealing with the limited liability company in the conduct or winding up of the limited liability company business as or on behalf of a party having an interest adverse to the limited liability company.
"Other applicable law" would also include the law of agency. See § 4.2, "Agency Law — A Common Source of Duties in LLCs and Partnerships."
Accordingly, a careful drafter of an operating agreement that, for example, allows a member or manager to loan money to the LLC, will also want to allow in the operating agreement that the lending member or manager may take a security interest in the LLC's assets and may employ normal commercially reasonable collection procedures — or whatever other collection procedures the members desire to allow.35
§ 4.3.3—Waivers and Explanation in the Operating Agreement
The LLC Act provides that the operating agreement "governs the rights, duties, limitations, qualifications, and relations among the managers, the members, the members' assignees and transferees, and the [LLC]. Such provisions shall control over any provision of this article to the contrary except as set forth in subsection (1.5), (2), or (3) of this section."36 Subject to § 7-80-108(2), the LLC Act permits restrictions and waivers of duties:
To the extent that a member or manager or other person that is a party to, or is otherwise bound by, the operating agreement has duties, including, but not limited to, fiduciary duties, to a limited liability company or to another member, manager, or other person that is a party to or is otherwise bound by an operating agreement, the duties of such member, manager, or other person may be restricted or eliminated by provisions in the operating agreement, as long as any such provision is not manifestly unreasonable.37
Consequently, the operating agreement may modify or eliminate any duty (whether created under the LLC Act, by the law of agency, or otherwise) that a member or manager has to the LLC or other members or to any other person who is a party to the operating agreement, provided such modification or elimination "is not manifestly unreasonable."38 However, an operating agreement may not eliminate the duty of all members of an LLC (whether or not member-managed) and managers of an LLC to "discharge the member's or manager's duties to the limited liability company and exercise any rights consistently with the contractual obligation of good faith and fair dealing."39 It is important to note that "good faith" as a duty is a subsidiary element to the duty of loyalty and therefore itself arguably rises to a fiduciary duty.40 The contractual obligation of good faith and fair dealing is, on the other hand, a rule of contract law and does not rise to the level of a fiduciary duty.41
Subject to the foregoing limitation, an operating agreement:
• May give the members of a member-managed LLC (or managers of a manager-managed LLC) the right to compete, thus waiving § 7-80-404(1)(c);
• May waive the duty of care of the members (in a member-managed LLC) and managers (in a manager-managed LLC) in the conduct and winding up of the LLC's business set forth in § 7-80-404(2); and
• May waive the obligation found in § 7-80-404(1)(b) to refrain from dealing with the LLC as, or on behalf of a, party having an adverse interest.
Any operating agreement that intends to modify or waive any duty imposed by the LLC Act should also modify or waive the corresponding duty under agency law. These authors are not suggesting that a waiver of a duty under agency law must be set forth separately. For example, if a provision of an operating agreement states that the manager's duty of care is limited to not engaging in intentionally reckless acts or knowing violations of law, subject to the waiver not being considered manifestly unreasonable, these authors believe that such provision should be an effective waiver of the duty of care under agency law as well as the duty of care under § 7-80-404(2). What the drafter should avoid is language such as "the manager's duty under § 7-80-404(2) is limited to. . . ." A court might hold that a...
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