Presenting a live 90 ‐ minute webinar with interactive Q&A LLC Operating Agreements Crafting Provisions on Fiduciary Duties, Indemnification and Exculpation to Minimize Business Disputes WEDNES DAY, DECEMBER 15, 2010 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific T d Today’s faculty features: ’ f l f Richard R. S pore, III, Member, Bass Berry & Sims , Memphis, Tenn. Benyamin S . Ross, Attorney, Gibson Dunn & Crutcher , Los Angeles Edward M. McNally, Partner, Morris James , Wilmington, Del. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .
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COMMON LAW FIDUCIARY DUTIES OF LLC MEMBERS DUTIES OF LLC MEMBERS Richard Spore p Bass, Berry & Sims PLC (901) 543-5902 rspore@bassberry.com 4
INTRODUCTION TO FIDUCIARY DUTIES AMONG BUSINESS OWNERS AMONG BUSINESS OWNERS Fiduciary duties apply in situations in which the parties occupy positions of special trust, and the rule of “caveat iti f i l t t d th l f “ t emptor” is an inadequate standard of conduct. Fiduciary duty law among business owners first developed in the context of general partnerships. General partners have co-equal agency and management rights. management rights. General partners are jointly and severally liable for partnership obligations. 5
MEINHARD V. SALMON, 165 N.E. 545 (N.Y. 1928) (N Y 1928) “Joint adventurers, like co-partners, owe to one another, while the enterprise continues the duty of the finest loyalty while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm's length, are forbidden to those bound by fiduciary ties… Not honesty alone, but the punctilio of b fid i ti N t h t l b t th tili f an honor the most sensitive, is then the standard of behavior.” Note (i) the references to partners, and (ii) the extension of partnership principles to a different but analogous form of business entity. 6
EXTENSION OF OWNER FIDUCIARY DUTIES TO CLOSE CORPORATIONS TO CLOSE CORPORATIONS Courts have analogized close corporations to partnerships. Although corporations in theory follow a much different governance model than partnerships, in practice a close corporation may operate much like a general partnership. Courts have therefore looked at substance over form and asked why owners of close corporations should be treated any differently than general partners? See, for example, y y g p , p , Anderson v. Wilder, 2003 Tenn. App. LEXIS 819 (Tenn. Ct. App. Nov. 21, 2003). 7
EXTENSION OF FIDUCIARY DUTIES TO LIMITED LIABILITY COMPANIES LIABILITY COMPANIES LLCs emerged on the scene in the early to mid-1990’s and have developed into the entity of choice for most closely have developed into the entity of choice for most closely held enterprises. Many courts have followed their past practice of extending fiduciary duty concepts from general partners to other kinds of business owners by imposing common law fiduciary duties on LLC members. See, for example, Out of the Box Promotions LLC v. Koschitzki, 15 Misc. 3d 1134(A), 2007 WL 1374501 (N.Y. Sup.). However confusion persists in the area of fiduciary duties However, confusion persists in the area of fiduciary duties of LLC members and managers. 8
SOURCES OF CONFUSION LLCs are still relatively new, compared to partnerships and corporations and corporations. There is no “gold standard” uniform LLC act, and state LLC acts differ widely LLC acts differ widely. There are various governance models for LLCs, some more like general partnerships some more like limited more like general partnerships, some more like limited partnerships, and some more like corporations. 9
Non-business practitioners (including some judges) still do not understand LLCs not understand LLCs. See, for example, Pointer vs. See for example Pointer vs Castellani, 455 Mass. 537, 918 N.E. 2d 805 (2009): “It is uncontested that [Fletcher Granite Company, LLC] is a close corporation in that it has ‘(1) a small number of l ti i th t it h ‘(1) ll b f stockholders; (2) no ready market for the corporate stock; and (3) substantial majority stockholder participation in the management, direction and operations of the corporation.’” di i d i f h i ’” A failure to distinguish among different kinds of business entities is typical of fiduciary duty cases but adds to the confusion. 10
THE CONFUSION CONTINUES What exactly does an LLC member’s common law fiduciary duty encompass? duty encompass? A duty of loyalty? A duty of care? y A duty of good faith and fair dealing? See for example Section 404 of the Revised Uniform See, for example, Section 404 of the Revised Uniform Partnership Act which describes the duties owed by general partners in these terms. To whom are these duties owed? The LLC, the other members, or both? 11
THE CONFUSION CONTINUES… See, for example, VGS, Inc. v. Castiel, et al., 2000 WL 1277372 (Del Ch ) (duty of loyalty owed to LLC owners and 1277372 (Del. Ch.) (duty of loyalty owed to LLC owners and managers). See also, Anderson v. Wilder, cited above (LLC member owes a fiduciary duty to other members even th though Tennessee’s LLC Act states that the fiduciary duty h T ’ LLC A t t t th t th fid i d t runs in favor of the LLC). 12
A “TYPICAL” FIDUCIARY DUTY CASE FACT PATTERN PATTERN A, B and C each owns a 33 1/3% membership interest in an LLC LLC. The LLC s operating agreement requires unanimous The LLC’s operating agreement requires unanimous member approval of certain fundamental actions. If there is a deadlock on such an action (i.e., if only 2 of the 3 members approve it), the two members who approve the action can buy approve it), the two members who approve the action can buy out the third for a stipulated formula price. A and B secretly negotiate with a public company strategic buyer y g p p y g y to sell the LLC’s business at a big premium to the operating agreement’s formula price. Before signing a purchase contract or disclosing the existence of negotiations, A and B manufacture a deadlock with C and use that deadlock as the basis for buying him out at the agreed formula price in accordance with the LLC’s operating agreement. They subsequently sell the LLC’s assets at a big profit at a big profit. 13
Assume that the applicable state LLC statutes are silent on the topic of fiduciary duties (e.g., like Delaware). Have A and B violated the operating agreement or the state’s A and B violated the operating agreement or the state s LLC statutes? Have they harmed the LLC in any way? Have A and B acted in good faith as to C? A member may be found to have acted in bad faith when he has frustrated the reasonable expectations of another member. See, for example, Pointer v. of another member See for example Pointer v Castellani, cited above. In this example, could C reasonably expect to receive his proportionate share of the purchase price his proportionate share of the purchase price premium paid by the strategic buyer? 14
POSSIBLE SCOPE OF STATE LAW FIDUCIARY DUTIES FIDUCIARY DUTIES Statutory, common law and contractual. C Common law and contractual, but not statutory. l d t t l b t t t t t Statutory and contractual, but not common law. 15
Defining or Eliminating Fiduciary Duties in Limited Liability Companies
<Presentation Title/Client Name> Introduction Introduction – Statutory fiduciary duties – Statutory approaches to waiving or modifying fiduciary duties – Recent judicial interpretations – Practical considerations in drafting waivers of fiduciary duties Practical considerations in drafting waivers of fiduciary duties Presented by: 333 South Grand Avenue Ben Ross Los Angeles, California 90071 Associate i Tel: 213 229 7048 Los Angeles Office bross@gibsondunn.com 17
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