Sandra Miller: Un-Sophisticated Parties Require Mandatory Duties at least in Publicly-Traded Entities if Not in all Entities (Contract Is King Micro-symposium)

 Guest post by Sandra Miller:

The ratio of LLC filings to corporate filings in Delaware from 2010 to 2014 was over 3 to 1.  Alternative business entities are no longer the province of a relatively small number of sophisticated investors.  Increasingly, corporations are becoming the “alternative” and LLCs and other unincorporated entities the norm.  Mom and Pop business as well as sophisticated real estate syndicators use alternative business entities.  Additionally, as discussed below, publicly-traded limited partnerships and LLCs are now being aggressively marketed. 

Accordingly, the assumptions that might once have justified greater reliance on private ordering in LLCs and alternative business entities should be revisited.  Not all investors are highly sophisticated parties and a relentlessly contractual approach to business entity governance is not appropriate for unsophisticated parties.   Nor is it appropriate for those without sophisticated legal counsel.  In backhanded fashion, this point was recognized by Larry E. Ribstein who advocated the removal of restrictions on waivers of fiduciary duties in limited partnerships when these entities were used by sophisticated firms that were unlikely to be publicly traded.   Ribstein expressly stated that limited partnership interests may be less vulnerable than corporate shareholders and are unlikely to be publicly traded.  (See Fiduciary Duties and Limited Partnerships)

Master limited partnerships (e.g. publicly-traded limited partnerships and publicly-traded LLCs) provide an important example of how capital from unsophisticated investors now flows readily into alternative investments.  According to the National Association of Publicly-Traded Partnerships (NAPTP) most MLP investors are individuals, the vast majority of whom are over age 50.  Many investors are individuals, estates, and retirement plans – unsophisticated economic players.  Thus, there are asymmetries in the marketplace that make it unlikely that the marketplace will efficiently discount the effects of waivers.  Given the investor profile, at a very minimum, the duty of loyalty should be non-waivable for publicly-traded entities.   (See Toward Consistent Fiduciary Duties)

            There are even strong arguments in favor of reinstating mandatory minimum fiduciary duties for all business entities, public or private.  Contractarians pre-suppose a level contractual playing field.  Yet, repeat players who structure similar transactions repeatedly are at a distinct advantage.  Moreover, there may not be equal legal representation of majority and minority investors.  (See A New Direction for LLC Research in a Contractarian Legal Environment) Moreover, it is total madness to think that a contractual approach to business entity governance reduces costs.  If anything, costs are increased by the lack of standard terms under a contractual regime. 

     In short, we have empirical data and years of experience with waivers that expose serious inefficiencies and injustices in a system that permits the waiver of all fiduciary duties.  It is time to reconsider the benefits of a mandatory duty of loyalty for all entities, public or private. 

-Sandra Miller