Do Members of LLCs Owe A Fiduciary Duty To Each Other in CT?

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.” Many times members use an attorney to draft the operating agreement. The operating agreement may cover a variety of topics including:

  • duties and rights of members and managers
  • finance
  • distributions
  • ownership and transfer of property
  • admission and withdrawal of members
  • lawsuits by and against the company
  • merger, consolidation and conversion
  • dissolution

If the members of an LLC fail to address any of these issues, the provisions for the Connecticut 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 by using an attorney to negotiate or draft provisions in the operating agreement with 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 in a lawsuit for  breach of fiduciary duty or breach of statutory duty to address various inequities and unfair 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 or distributions

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 might help the attorney because it 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 lawyers have argued this point and 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.  Although not required, a lawyer familiar with LLCs can assist in ensuring valuable rights are in an agreement or bringing a lawsuit when rights are violated.

Fraud Lawsuits In Connecticut – Is A Promise of Happiness Fraud or Puffery?

Debra Cassens Weiss yesterday posted on article on the ABA’s website about the psychic Sean Morton who is being sued for fraud for taking 6 million dollars from investors on the promise of piles of money and spiritual happiness.  The Securities and Exchange Commission is bringing the suit and the main theory is that Morton is a fraud.  No kidding. 

For this post, I review what constitutes fraud in Connecticut under the common law and grounds for Connecticut attorneys to bring a lawsuit for fraud.   In Connecticut, fraud is committed when:

  • a person makes a false representation as a statement of true fact
  • the person knows the statement is not true
  • the person makes the statement to induce another person to act upon the statement
  • the person who acts upon the statement sustains damages

When an attorney brings a lawsuit for fraud in Connecticut, an attorney must allege more than simple facts stating these elements.  Attorneys bringing a fraud case must make specific allegations describing the actual fraud.  In general the false statements must relate to an existing fact, past fact, or a promise to do something in the future with no intent to do so.  Although generally affirmative statements must be made to support fraud, there are circumstances where a failure to speak can be fraud if there is a duty to speak.

When you bring a lawsuit for fraud in Connecticut, there is also a higher standard of proof.  Ordinarily, in civil cases, an attorney must prove the fraud elements of the case by a preponderance of the evidence.  Many people describe this standard as greater than 50% or more likely than not likely.  In fraud cases, the plaintiff must prove the elements of fraud by clear and convincing evidence.  This standard is greater than a preponderance of the evidence.

If a plaintiff is successful in proving fraud, there are two categories of damages that generally apply.  First, a plaintiff may rescind or get out of the induced transaction (i.e. cancel the contract) and sue for restitution type damages.  This type of remedy seeks to put the plaintiff in the same position as if the fraud never occurred.  Alternatively, a plaintiff may affirm the transaction and seek compensatory damages.   This type of remedy may apply when a plaintiff wants to keep some consideration from a transaction but sue for fraud damages.

In addition to these two categories of damages, a successful lawsuit for fraud could also result in an award of punitive damages, which is generally the cost of suit less expenses or the attorneys fees incurred in the case. 

Here is a short list of some of the types of fraud lawsuits attorneys bring in Connecticut:

  • Contract fraud – you enter contract based on false statements
  • Consumer fraud – think about the recent Toyota lawsuits
  • Advertising fraud – you buy a product based on a false claim, bait and switch 
  • Investment fraud – think Bernie Madoff, Sean Morton, Ponzi schemes
  • Real estate or mortgage fraud – false appraisals, straw buyers

When you consider the allegations against the psychic Sean Morton, it is evident he would be subject to a fraud lawsuit in Connecticut.  There might be a legitimate defense, however, to the some of the claim.  In general, puffery, opinions, exaggerations, and comments made in jest are not fraud. 

So what do you think, is a promise of happiness and piles of money by a self proclaimed prophet fraud?