Sunday, December 1, 2019

Dissent Duly Noted: LLCs, Private Ordering, and Ample Notice

Over at Kentucky Business Entity Law Blog, Tom Rutledge recently posted Respectfully, I Dissent: Dean Fershee and Elimination of Fiduciary Duties, in response to my recent paper, An Overt Disclosure Requirement for Eliminating the Fiduciary Duty of Loyalty. Tom and I have crossed paths many times over the past few years, and I greatly value his insight, expertise, and opinion. On this one, though, we will have to agree to disagree, but I recommend checking out his writing.  You may well agree with him.  

I actually agree with Tom in most cases when he says, "I do not believe there is justification for protecting people from the consequences of the contracts into which they enter." Similarly, I generally agree with Tom "that entering into an operating agreement that may be amended without the approval of a particular member constitutes that member placing themselves almost entirely at the mercy of those with the capacity to amend the operating agreement . . . . "  Nonetheless, I maintain that there is a subtle but significant difference where, as in Delaware, such changes can be made to completely eliminate (not just reduce or modify) the fiduciary duty of loyalty. 

As applied, Tom may be right. Still, until Delaware's recent change, we had a long history, in every U.S. jurisdiction, prohibiting the elimination of the duty of loyalty. It is simply expected, that at some basic level, those in control of an entity owe the entity some level of a duty of loyalty. Because that is such a long-held rule and expectation, I remain convinced that the option to eliminate the duty requires some type of special notice to those entering an entity. Until now, even conceding that a lack of control could put an LLC member "almost entirely at the mercy of those with the capacity to amend the operating agreement," the amending member's power was still limited by the duty of loyalty.  

Ultimately, I tend to be a big fan of private ordering and freedom of contract, especially for LLCs. But, when we change fundamental rules, I also think we should more overtly acknowledge those changes, for at least some period of time, to let people catch up.

Contracts, Corporations, Delaware, Joshua P. Fershee, LLCs | Permalink


My view (and I think you know it--or could predict it)? Notice is certainly better than no notice in a fiduciary duty elimination state like Delaware. But I still maintain that the bedrock assumption of fiduciary relations in a business association should not be completely discarded. As I have observed in my work, operating/limited liability company agreements are not contracts--or at least not common law contracts, although they often are enforced in a manner consistent with the enforcement of common law contracts. Operating/limited liability company agreements are statutorily permitted or required agreements that include both contractual provisions and entity governance arrangements that are not in the nature of contracts--they are more acknowledgements of structural, management, and control matters. I may later develop all of this in a separate post, but for now, I will just state my general view here.

Posted by: joanheminway | Dec 1, 2019 11:39:31 PM

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