A limited liability company is essentially a combination or mix of a corporation and a partnership. The LLC as an entity provides the flexibility of a partnership with the ability to govern and create ownership interests similar to a corporation. The legislature codified the framework for LLCs in Connecticut in Title 34, Chapter 613 of the General Statutes. The statutory frameworks permits the owners or members of LLCs to include specific governance provisions in a document called an “operating agreement.” The operating agreement may cover a variety of topics including:
- duties and rights of members and managers
- ownership and transfer of property
- admission and withdrawal of members
- lawsuits by and against the company
- merger, consolidation and conversion
If the members of an LLC fail to address any of these issues, the provisions for the general statutes apply as a default. With some exceptions, the statutory framework basically provides for simple majority control. The failure to address these issues typically results in significant control in the majority member. So, if a minority member wants some aspect of control on these topics, the member would be well advised to take care of it in the operating agreement or insist on protections as part of the admission process.
Notwithstanding the above, members holding a minority ownership interest in an LLC continue to have rights that may provide some protection depending on the circumstances and the operating agreement. In particular, a minority owner might be permitted to assert claims of breach of fiduciary duty or breach of statutory duty to address various inequities in management of an LLC. A minority interest holder might seek to apply these rights in various situations such as:
- freezing out of the minority owner from affairs of the business
- unfairly devaluing the member’s ownership interest
- operating the company in bad faith
- depriving the member of books and records of the LLC
- use of deception and fraud in a buy-out of a member
- unfair expulsion of a member
- inequitable assignment of membership interest or sale of business
- improper dissolution or valuing of membership interests
- self dealing with excessive guaranteed payments
The outcome of these claims might depend on whether the court acknowledges a fiduciary duty exists between members of an LLC or between a member-manager of an LLC and the other owners. The existence of a fiduciary duty is significant because it requires the utmost good faith and loyalty. It also shifts the burden of proof in a civil case requiring the member owing such a duty to prove good faith and fair dealing. As a result, the question in many disputes involving minority ownership of LLCs is whether a fiduciary duty exists.
In Connecticut, by case law, a court may deem a fiduciary duty to exist when there is “justifiable trust confided on one side and a resulting superiority and influence on the other.” The relationship is broadly defined to permit courts to consider new situations. It is generally a relationship “characterized by a unique degree of trust and confidence.” The superior position of one party typically will permit a great opportunity for abuse of confidence.
At the outset, a fiduciary duty is likely to be found to exist if the operating agreement includes such duties for members or managers. As such, an individual that is offered a minority stake in an LLC might want to insist that the operating agreement impose a fiduciary duty on the manager or controlling members. In addition to an operating agreement, a claim for breach of duty may be found in General Statutes Section 34-141. The statute states in relevant part:
A member or manager shall discharge his duties under section 34-140 and the operating agreement, in good faith, with the care an ordinary prudent person in a like position would exercise under similar circumstances, and in the manner he reasonably believes to be in the best interests of the limited liability company, and shall not be liable for any action taken as a member or manager, or any failure to take such action, if he performs such duties in compliance with the provisions of this section.
Further, there are a series of trial court cases in Connecticut where judges have recognized a fiduciary duty between managers and/or controlling members of an LLC and the other members. The reasoning is based, in part, on the law dealing with partnerships and the fiduciary duty owed to each partner. There is some dispute as to the existence and extent of this duty, but the Connecticut Supreme Court has chosen to keep an open definition of a fiduciary relationship. Nevertheless, until such duties are further codified or deemed to exist as a matter of law, a controlling member or manager might opt to have such duties disclaimed in an operating agreement.
A fiduciary duty may or may not be desirable depending on your ownership interest or your role in the LLC. The take away here is that an operating agreement is the best method to clearly define the duties of members and managers. The operating agreement can include specific provisions on the extent and nature of the duties of a manager or member of an LLC. In the absence of a specific provision in the operating agreement stating otherwise, members or managers may be deemed a fiduciary with respect to other members.