Every business owner knows that there are a great many duties and responsibilities that come with owning and operating a business successfully. Beyond just the business side of running a business, there are important legal duties owed to a business’ owners partners and associates a.k.a. fiduciary duties in an LLC. These duties are known as fiduciary duties and serve as a protection for the business relationship and guard against business partners acting out of self-interest. If you are a member of an LLC, you may want to consider the following information to ensure you are upholding your fiduciary duties.
What is a Fiduciary Duty?
Before determining what duties, you owe or are owed, you may be wondering what exactly are fiduciary duties? A fiduciary obligation occurs in law when a person or entity invests trust, confidence, and reliance in another to act on behalf of the client with discretion and knowledge. The Bouvier Law Dictionary explains that a fiduciary duty is “both general, in that the fiduciary must exercise good faith, placing the interests of the principal above the fiduciary’s interests, and specific, in that the fiduciary has a duty of loyalty to avoid conflicts of interest, to use the fiduciary’s best efforts, and to avoid misrepresentation.”
This relationship is a legal connection between two parties and requires that the individual knowingly accept this responsibility. A fiduciary bears a legal obligation to a principle, and extreme caution must be exercised to ensure there is no conflict of interest between the fiduciary and the principal. But what exactly are these duties, and how do they correspond to operating an LLC?
Fiduciary Duties in an LLC
This article focuses on the fiduciary duties associated with LLCs. An LLC is a hybrid entity with characteristics of both a corporation & a general partnership. As such, this business structure has a greater sense of freedom regarding governance. However, South Carolina established clear rules for operating an LLC in 1996 when the South Carolina Limited Liability Company Act was enacted. While determining the existence of a duty is solely the responsibility of the court, the LLC Act clearly states in Section 33-44-409 that “the only fiduciary duties a member owes to a member-managed company, and its other members are the duty of loyalty and the duty of care.”
Duty of Care
Under Section 33-44-409 of the South Carolina LLC Act, a duty of care requires a person to refrain from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law. However, if members of the LLC wish to impose a higher duty of care than just a gross negligence standard, then they can include that in their agreement.
Duty of Loyalty
Section 33-44-409 of the South Carolina LLC Act mentions the duty of loyalty. Members and Managers are both required to account to the company, hold as trustee of property or assets, refrain from conducting business with the competition that is averse to the mission of the LLC, and refrain from competing with the LLC before the dissolution of the company is final.
You may have heard mention of the duty of good faith, but the LLC Act is clear that this is not a duty per se but rather an obligation. This obligation of good faith is a general presumption that the parties to a contract would treat one another honestly, fairly, and in good faith. Each member of an LLC is obliged to act in good faith, and this obligation cannot be eliminated through any agreement.
Who Owes a Fiduciary Duty in an LLC?
Now that you better understand what a fiduciary duty is, you may wonder who owes this duty. A fiduciary is a person or organization who works on behalf of others, placing their clients’ interests ahead of their own. Therefore, any member or manager within an LLC would owe a fiduciary duty to the LLC and the company’s partners and associates.
What Happens if a Fiduciary Duty is Breached?
Once a fiduciary relationship has been established, a person can breach their fiduciary duty in a variety of different ways and can be held liable in court for their actions. The South Carolina case of Vortex Sports and Entertainment v. Ware provided clarification as to how a breach is committed by stating: The elements for a cause of action are (1) a breach of a fiduciary duty owed to the plaintiff; (2) the defendant’s knowing participation in the breach; and (3) damages.” Vortex Sports & Entm’t, Inc. v. Ware, 378 S.C. 197, 662 S.E.2d 444 (Ct. App. 2008). To simplify this, there must be a duty, a breach of that duty, damages, and causation.
A breach of fiduciary responsibility is a legal cause of action open to anybody who puts their faith in someone else to manage a situation or who is due a specific financial or another sort of duty, and that person fails to handle the matter appropriately. So in the context of an LLC, any member or manager could breach their fiduciary duty to the LLC and be held liable for their actions in the court of law so long as there is evidence to support your claim.
To help provide you with a better sense of how a fiduciary duty is breached in an LLC, here are a couple of examples from South Carolina cases:
In the 2005 South Carolina case of Jordan v. Holt, two colleagues, Dr. Holt and Dr. Jordan, decided to become investors in a racing-themed restaurant called the Winner’s Circle in Myrtle Beach. Jordan v. Holt, 362 S.C. 201, 608 S.E.2d 129 (2005). They formed an LLC, and the restaurant opened in 1995; however, within a year, dissension among the members of the LLC when it became clear that the business was “undercapitalized and constantly in need of additional operating capital.” Id. The Jordan family refused to provide the other members with financial information, used LLC monies to pay for personal debts, sold LLC property, and benefited from the profits without informing the other members. For these reasons, the court awarded punitive damages to the other LLC members due to the egregious behavior of the Jordans.
In the case of In re JK Harris & Company, LLC, debtors filed for bankruptcy with the federal court. In re JK Harris & Co., LLC, 512 B.R. 562 (Bankr. D.S.C. 2012). The amount owned exceeded the debtors’ assets, and during the period of insolvency, the defendant in this case, held the majority of the voting interest in JK Harris and Company, LLC and was the manager of the manager-managed LLC. The defendant knew the debtors were insolvent and still ordered that the debtors distribute over 3 million dollars in member distributions to him in addition to his salary. The trustee appointed to this case filed a complaint against the defendant and alleged breach of fiduciary duties under the South Carolina LLC Act. The court found that the defendant breached his duty of loyalty because he had a duty under Section 33-44-409(b)(1) to account to and hold for Debtors “any property, profit, or benefit derived by the members” of Debtors. The court also found that the defendant breached his duty of care by authorizing the Member Distributions. The defendant knew the debtors were insolvent, but still, he authorized and received member distributions, an action the court defined as grossly negligent and reckless.
If you have experienced a similar situation to the above cases or believe your business partner has breached their fiduciary duties or if there is a breach of contract dispute, then you may have a cause for action in court and could receive compensation for the breach.
Should you have any questions about fiduciary duties or breaches of this duty, please give Henderson & Henderson a call at 843-212-3188.
