What fiduciary duties should apply to the LLC manager after more than a decade of experimentation?

• Author: Miller, Sandra K.
• Position: Limited liability company

1. INTRODUCTION II. ACADEMIC AND THEORETICAL APPROACHES TO THE STUDY OF FIDUCIARY DUTIES A. The Corporate Context of the Fiduciary Duty Debate B. The Unincorporated Context of the Fiduciary Duty Debate C. A Closer Look at the Schools of Thought 1. The Contractarian School 2. Traditionalists 3. The Team Production Theory of the Corporation, Fiduciary Duties, and Social Norms 4. Game Theory Applied to Fiduciary Duties 5. The Empirical Study of Fiduciary Duties 6. The Structural Model for Fiduciary Duty Terms III. THE LLC STATUTES IV. THE CASES: NO SHORTAGE OF FIDUCIARY DUTY VIOLATIONS A. A Mandatory Core of Minimum Standards Emerges in Courts Outside of and Within Delaware B. Traditional Broad Formulations of Fiduciary Duty Outside of Delaware C. The Entire Fairness Test Within Delaware D. The Importance of a Duty of Candor E. Troubling Decisions Suggest the Importance of Turning to Contractually Oriented Limitations 1. The Need to Distinguish the Right to Compete from the Duty of Candor 2. Contractual Standards That Ensure the Enforcement of the Spirit of the Contract 3. Recognition That the Right to Privately Order LLC Relationships is Not a License to Exploit, Steal, Self-Deal, or Deceive 4. Good Faith as an Implied Covenant to Ensure the Enforcement of Reasonable Expectations V. THE LEGISLATIVE PROPOSALS: A BALANCED APPROACH TO FIDUCIARY DUTIES A. The Policy Debate Unfolds as the Uniform Limited Liability Company Act is Revised B. The Mandatory Core Approach Recommended C. Theoretical Justification for the Mandatory Core Theory: Promoting and Reflecting Positive Social Norms D. Litigation Over the Last Decade Illustrates the Necessity of Mandatory Minimum Standards E. The Implied Covenant of Good Faith May Not Effectively Substitute the Fiduciary Duty of Loyalty F. A Balanced Statutory Framework in Light of Imperfections and Inequalities in the Contracting Process, and Courts that May Lack Business Expertise G. An Express Statutory Duty of Loyalty and Standard of Care is Needed to Guide Courts H. Leaving Room for Contractual Modification Demanded by the Marketplace I. Permitting a Right to Compete Without Eliminating the Duty of Candor or Eliminating Other Fiduciary Duties VI. CONCLUSION APPENDIX A APPENDIX B APPENDIX C I. INTRODUCTION

   The American limited liability company (LLC) is like an incorporated partnership. (1) The LLC allows private business owners to form a company that provides protection from personal liability for business debts, without incurring a second level of corporate federal income tax on the business entity's earnings. (2) It provides freedom from cumbersome corporate processes by offering unparalleled flexibility in management structure. (3) Although unburdened by an entity level corporate tax, the LLC can have centralized management similar to that of a corporation or create any number of alternative modes of management. (4)

   Beginning with Wyoming in 1977, states across the country eagerly embraced the LLC concept. (5) Although in 1994 the National Conference of Commissioners on Uniform State Laws (NCCUSL) endorsed a uniform LLC statute called the Uniform Limited Liability Company Act (ULLCA), most states had just completed the process of adopting their own self-styled LLC statutes, (6) and few states wanted to quickly return to their legislative chambers to adopt a different LLC statute. Consequently, only a handful of states adopted ULLCA and the great majority of LLC statutes differ considerably from state to state. (7)

   The variation among LLC statutes is particularly striking with regard to the standard of care applicable to LLC managers, (8) the duty of loyalty owed to the LLC, (9) and the extent to which remedies are available to address wrongful treatment when one LLC member or manager has mistreated another. (10) Some states contain mandatory statutory standards, while others defer to the contractual provisions adopted by the LLC members. (11) The state of Delaware-long considered the most important jurisdiction in developing business entity laws in the United States (12)-has taken the lead in permitting not merely the modification of default fiduciary duties, but their elimination by contract. (13)

   This Article explores two of the most controversial issues that enlivened the NCCUSL Committee's discussions in revising the Uniform Limited Liability Company Act including: 1) whether fiduciary duties should be articulated in the LLC statute or left solely to judicial articulation; and 2) whether fiduciary duties should be subject to a partial or complete waiver in the LLC operating agreement. Fiduciary duties are generally regarded as consisting of the duty of loyalty and the standard of care in the conduct of management. (14) This Article focuses exclusively on the duty of loyalty, and a separate, related article addresses the questions concerning the standard of care. The present Article analyzes the LLC litigation that has occurred over the last ten years among LLC investors and managers. (15) Also, it considers the empirical data that has been gathered on the contractual practices of attorneys representing majority and minority LLC investors. (16)

   The above questions concerning duties and waivers are ripe for reconsideration now that the Uniform Limited Liability Company Act has been revised and states have had some time and experience working with their LLC statutes. Also, the American Bar Association is currently in the process of revising the ABA's Prototype Limited Liability Company Statute. (17) Legal scholars have disagreed on the extent to which mandatory statutory protections should be given to minority LLC participants. (18) They have further disagreed on whether the standard of care for managers should be based on the requirement to exercise due care, or a standard based on the duty to refrain from grossly negligent conduct, or on some other formulation. (19)

   The contractarian view of investors in unincorporated entities is that parties should be free to strike their own bargain free from external interference. (20) This position has gained significant popularity, particularly in Delaware. (21) The contractarian philosophy embraces the view that statutory business laws should be kept to a minimum, giving maximum freedom to business participants to contractually determine their legal rights and responsibilities. (22) Based on this philosophy, several LLC statutes, including that of Delaware, expressly defer to the parties' agreement. (23) The Delaware statute contains few default statutory rules for the operating agreement and fails to provide the statutory remedy of a dissolution or buy-out in the event that the controlling LLC owner engages in fraudulent, illegal, or oppressive conduct. (24) This contractarian approach presupposes that majority and minority participants will be represented by legal counsel and will be able to negotiate for suitable exit rights and/or remedies in the event of a dispute.

   The more traditional view is that mandatory protections are needed to govern managerial conduct and to stem the tide of opportunistic and/or abusive conduct. (25) The concept of mandatory fiduciary duties has its origins in the laws of trusts and of agency relationships. (26) They dictate that the fiduciary is required to act in the exclusive interest of the beneficiary or principal and must refrain from engaging in transactions from which he might gain for himself or harm the beneficiary. (27) Disgorgement of gains is the remedy for a breach of duty by a fiduciary. (28)

   This Article argues for mandatory minimum fiduciary duties grounded in statute--hereinafter referred to as the Mandatory Core Theory of Duties. This approach permits the LLC manager to contractually tailor his or her duties to the LLC but nevertheless includes a statutory articulation of mandatory minimum fiduciary duties and a standard of conduct that managers cannot completely waive. Under the Mandatory Core approach, the duty of loyalty is articulated in the statute, with the expectation that courts will elaborate upon duties as the context requires. The standard of care would be based upon the duty to exercise reasonable care, subject to the application of the business judgment rule, to be discussed in a separate article. The approach has a mandatory dimension because duties cannot be eliminated, but is contractarian in the sense that it welcomes parties to contractually define their duties within a mandatory framework.

   The Revised Uniform Limited Liability Company Act (hereinafter referred to as ULLCA II) offers a slightly less contractarian alternative to the Delaware paradigm. The Delaware LLC statute permits not only the modification of duties, but also the complete contractual elimination of fiduciary duties. (29) The final ULLCA II approach permits, "if not manifestly unreasonable," the operating agreement to eliminate the following duties: the duty to account; (30) to refrain from dealing with the LLC on behalf of a party with an adverse interest; and to refrain from competing with the LLC. (31) Earlier versions of ULLCA II prohibited the operating agreement from eliminating the duty of loyalty, but permitted the identification of specific categories of activities that do not violate the duty of loyalty. (32) This more moderate statutory position endorsed by earlier versions of ULLCA II is recommended here and reflects what I shall call the Mandatory Core approach. The Mandatory Core approach provides the best of both worlds by preserving the longstanding duty of loyalty and by permitting the operating agreement to alter and curtail particular aspects of duties. (33)

   From a theoretical standpoint, the Mandatory Core approach advanced by this Article recognizes that one of the central roles of business entity governance is to foster investor confidence. Our LLC statutes further the overall goal of promoting investor confidence by playing a prominent role in defining the...