The most common non-corporate operating entity in the state of Texas is limited liability companies. This series topic is designed to help these organizations understand their duties and responsibilities and is intended to be educational in nature and should not be construed as legal advice.
In Texas, a limited liability company (“LLC”) can be either member managed, or manager managed. The Texas Business Organizations Code (“BOC”) requires the LLC to state whom the governing person is, be it a member or manager.
No Statutory Duties in Texas LLC’s?
Texas prides itself on being different from most other states. Texas LLCs are one of the ways in which this state differs from other states in the duties of governing members. The BOC does not set out fiduciary duties by statute like most other states, but instead implies or suggests that these duties exist. In Texas, you will find that the Company/Operating Agreement is the primary document in which you will find any specific fiduciary duties of any manager or member of the LLC, as long as it complies with the BOC. If language regarding the fiduciary duties is absent in the Company/Operating Agreement, one can infer through statute the following: Duty of Care (BOC § 3.102 and 101.251) and Duty of Loyalty (BOC § 101.255).
Manager-managed vs. Member-managed LLC’s
When a company agreement is silent as to the fiduciary duties of the Managers in a manager managed LLC, they are viewed as similar to the Board of Directors in a corporate formation or a General Partner’s role in a partnership. Similarly, the member managed LLCs are often viewed as the board of directors in a closely held corporation because all of the shareholders are also members. There are some Texas courts who view any fiduciary duties of either type of managed LLCs under the Agency Principles as seen in the Restatement (Third) of Agency.
However, it is important to note that a single manager who is a majority member of the LLC does have a formal fiduciary duty to minority members in certain acts that would affect the membership of those minority shareholders. Likewise, if there is a two member LLC, if the membership is 50/50, then those members owe each other fiduciary duties.
The most important thing to remember is the Courts will almost always find that the person or entity in their role as a manager or member managing the LLC, has a fiduciary duty to the company of good faith and candor.
Agency
Under Agency law, managers or managing members of the LLC owe a duty of care when acting as an agent of the LLC. Principal-Agent relationships are a type of fiduciary relationship where fiduciary duties arise as a matter of law. An agent is a person who is authorized to transact business or manage an affair on behalf of another. For there to be an agency relationship to exist, certain elements must be present, and the critical element is the right to control the means and details of the process in which the agent is to accomplish their task.
Informal Fiduciary Relationships
Almost all informal fiduciary breaches alleged against the manager or member of an LLC are fact specific and remain a question of law. Courts look to determine whether there was a special relationship between the parties that are moral, social, domestic, or just “business”. The analysis extends to the length of the relationship, the type, whether the parties knew each other prior to the transaction at issue and whether one party relied upon the other for moral, financial, or personal guidance. The actual relationship is examined. A cordial business relationship is not evidence of a confidential relationship, and neither is a longstanding personal relationship without anything more, and therefore no fiduciary duties could be found in those types of relationships.
Types of Duties
The duties of loyalty and care are implied absent specific provisions in the Company/Operating Agreement. These duties are best summarized as putting the interests of the company in front of the manager or members own. Acting in such a manner as to benefit the manager or the member at the detriment of the company is a breach of these duties.
Surprisingly, the duty of good faith and fair dealing has not been imposed by Texas Courts in the context of LLC managers and members under all circumstances as a matter of law, and instead hold it as a question of fact.
Company/Operating Agreement
The LLC needs to have a company or operating agreement pursuant to the BOC. In this document, it may outline the fiduciary duties of the managers or members so that the liability of those managers or members can be restricted or exposed. The BOC provides that the company agreement may expand or restrict any duties of the managers or members and the associated liability.
Breaches of Loyalty: No Limitation of Liability
While a governing person’s liability for certain breaches of the duty of care may be limited or eliminated by the documents and the LLC formation forms, the liabilities for breaching the duty of loyalty cannot be limited or eliminated.
Renouncing specific business opportunities presented to the LLC or its managers or members need to be in writing in the statement of formation, or by action of the managers/members in order to assess if breach has occurred. Likewise, a governing person in an LLC may be found liable for breach of the duty of loyalty if they make, authorize, or perform a contract or transaction involving the LLC if that person is found to have a financial interest and failed to disclose that financial interest and/or failed to seek the approval of the managers/members of the LLC before committing those acts or transactions.
Breaches of Care: Limited Liability
The certificate of formation documents or the company agreement can minimize the liability of a governing person for breaches of their duty of care to the LLC, and possibly eliminate any liability. An act or omission that is not considered to be in good faith is one that evidences a breach of that governing person’s duty to the LLC, involves intentional misconduct against the LLC, and/or commission of a knowing violation of the law. Further, a transaction that a governing person makes that results in an improper benefit to such person as well as any acts or omissions that are specifically addressed by statute can result in liability for the breach of its duty of care.
Best Practices: Duties of Managers and Members of an LLC
Governing persons of an LLC may and most likely owe fiduciary duties to the LLC. As a best practice, these governing persons should do the following:
Observe all the formalities of the company agreement,
Carefully review the LLC’s financial reports and ask relevant questions,
Stay informed of the LLC’s business problems and policies,
Carefully review potential mergers or takeovers,
Create formal records, such as minutes, of business disputes, actions that may result in significant changes to the LLC, or other non-standard business,
Present business opportunities for the LLC’s consideration before taking action independently to preclude claims of usurpation,
Document counsel’s advice on performance in meeting or breaching any of these duties.
Other Liability Concerns
There are other ways in which the governing member may be found liable for its actions outside the breach of any fiduciary duties. These include:
Receipt of unlawful distribution,
Failure to make an agreed contribution to the LLC,
Fraud, whether constructive or common law fraud,
Liability under the Company Agreement,
Veil Piercing Liability.
The Law Office of J.R. Smith provides legal counseling to LLC’s. If you are not sure if your Company Agreement provides protection to governing members or managers, what the liability limitations are (if any), or if you do not have a company agreement, we can help. Our base company agreement is 57 pages long and extremely comprehensive to provide you with a clear and bright line document in which you can rely on to operate your LLC confidently. Contact the Law Office of J.R. Smith to schedule a free 30-minute consultation and see how we can help you and your LLC.
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