Full Disclosure: Best Policy for Transactions Between Members of a Texas Limited Liability Company
In today’s business world, the entity of choice is often a Texas Limited Liability Company (LLC). Savvy business leaders tend to favor LLCs for their simplicity and lack of regulation. But as the LLC’s popularity continues to grow in Texas, so does the body of case law and legal issues associated with the LLC. Importantly, the business client should understand the potential fiduciary duties owed to the LLC and its members, as well as how those duties might impact other transactions between the LLC’s members.
Neither the Texas Limited Liability Company Act (TLLCA) nor the subsequently-enacted limited liability provisions of the Texas Business Organizations Code (TBOC) directly impose fiduciary duties on an LLC’s managers or its members. However, numerous Texas cases have found the existence of fiduciary duties for managing members of an LLC. While there is no bright-line test, Texas Courts have found that managing members owe fiduciary duties to the LLC and the other members because of the amount of control and responsibility given to the managing members, most often through the LLC Company Agreement. Because a manager or a member acts as the LLC’s agent in many situations, some Texas courts have imposed fiduciary duties on members and member managers of an LLC based on analogies to agency law. See, e.g., ERTG Invs., LLC v. Hardee (In re Hardee), 2013 WL1084494 (Bankr. E.D. Tex. 2013). The fact that the TBOC allows LLC members to directly bring derivative proceedings also demonstrates that lawmakers intended to provide a mechanism to hold LLC management accountable for breaches of fiduciary duty. See Tᴇx. Bᴜs. Oʀɢs. Cᴏᴅᴇ §§101.451-101.463.
What Leads to a Breach of Fiduciary Duty Claim?
Some examples of situations that could lead to a claim for breach of fiduciary duty against a managing member include: (1) the managing member forgoes a business opportunity for the LLC, then enters into the same opportunity for their personal benefit, or for another Company they own or control; (2) the managing member purchases a property or product from one of the managing member’s other companies for an inflated price; or (3) the managing member sells a product to one of the managing member’s other companies for a reduced price.
Other, less obvious transactions may also lead to breach of fiduciary duty claims. In fact, any transaction between a managing member and another member of the LLC can potentially lead to a breach of fiduciary duty claim. As a recent unpublished opinion from the Dallas Court of Appeals warns, any situation in which the managing member could be viewed as using his personal situation to benefit him or herself will be examined. Cardwell v. Gurley, 2018 WL 3454800 (Tex.App.—Dallas 2018, pet. denied). Similarly, another court found that a managing member of an LLC owed a fiduciary duty to another member of the LLC in connection with the repurchase of the other member’s interests. That court reasoned that the managing member had powers and responsibilities akin to that of a general partner and ultimately held that a fiduciary relationship arises when the managing member has special knowledge and a personal interest in the outcome.
Thus, either: (1) a redemption agreement where a member’s interest is purchased back by the LLC, or (2) a direct purchase agreement where the managing member sells his interests in the LLC to another member, could open the door to potential claims for breach of the fiduciary duties of full disclosure and loyalty. While Texas courts have shown a reluctance to go further than the specific facts of the case before them, the trend in Texas case law is clear—the greater the personal stake the managing member has in the transaction or occurrence at issue, the more likely the court will find fiduciary duties exist and have been breached. A potential concern could also exist even when the managing member enters into a completely separate transaction with another member of the LLC. No Texas case has gone this far, but a creative lawyer may attempt to “push the envelope” here under the right fact pattern.
Ways to Minimize the Risks
Importantly, the TBOC also allows an LLC to draft its company agreement in a way that could “expand or restrict” any duties (including fiduciary duties) of a member, manager, officer, or other person. See Tᴇx. Bᴜs. Oʀɢs. Cᴏᴅᴇ §101.401. Although it is not clear whether this provision can be used to eliminate fiduciary duties completely, including exculpatory language in the company agreement when the LLC is initially formed could provide some protection.
Because of uncertainty as to how far such a contractual limitation could protect the managing members, the best practice for the managing member is to document his or her “full disclosure” of all facts related to any transaction with another member of the LLC. The managing member may need that proof later on if the other member suffers from “buyer’s remorse” and pursues a claim for breach of fiduciary duty.