Ethan Zook writes:
As was alluded to in a prior blog post, one of the major changes that has been enacted through Pennsylvania’s Act 170 is the ability, through the operating agreement, to contractually vary fiduciary duties of members and managers in Pennsylvania limited liability companies.
What Fiduciary Duties?
There are two major fiduciary duties to be aware of: the duty of care and the duty of loyalty. The fiduciary duty of loyalty is comprised of five subsections which can be summarized as follows:
- account to the company and hold as trustee for it any property, profit or benefit derived in the conduct or winding up of the company’s activities;
- do not use the company’s property for personal gain;
- do not appropriate a company opportunity for personal gain;
- refrain from engaging in self-dealing with the company; and
- refrain from competing with the company in the conduct of the company’s activities and affairs.
The duty of care is to refrain from engaging in gross negligence, recklessness, willful misconduct or knowing violation of law. Lastly, there is an obligation of good faith and fair dealing to be aware of, however, it is not a fiduciary duty. Rather, it is treated as a contractual obligation, and as will be discussed, can be contractually altered by the operating agreement.
A member of a member-managed limited liability company owes to the company and the other members the fiduciary duties of loyalty and care. Managers of manager-managed limited liability companies owe to the company and the members those same duties.
Contracting Around Fiduciary Duties
The Act gives tremendous deference to the operating agreement, the main governing document for Pennsylvania limited liability companies. If not manifestly unreasonable, the operating agreement may alter subsections 1), 2), and 4) of the duty of loyalty stated above. Subsections 3) and 5) can be eliminated altogether. Further, if not manifestly unreasonable, the operating agreement may also identify types of activities that do not violate the duty of loyalty, may freely alter the duty of care, and may prescribe the standards by with the performance of the contractual obligation of good faith and fair dealing is to be measured. Any other fiduciary duty can be altered or eliminated though the operating agreement, if not manifestly unreasonable.
In any dispute regarding the reasonableness of the terms of the operating agreement, courts will decide whether those terms are manifestly unreasonable as a matter of law. That determination will be made as of the time the challenged term became part of the operating agreement by considering circumstances existing only at such time. This does not shed much light on what will be considered manifestly unreasonable under the terms of the Act. Instead, for now, we are left with intuition in deciding what is manifestly unreasonable.
Despite the ambiguity surrounding “manifestly unreasonable”, the Act makes it clear what fiduciary duties can be altered and eliminated. With that, it has become more important than ever to review the operating agreements of investment, potential partner, and current parent and subsidiary companies to see how loyal that company has chosen to be to itself and its members.
Ethan Zook is an associate in the firm’s Corporate Department, resident in its Exton office.