A “fiduciary” is someone who has an obligation to act in the best interests of another person or entity. These duties can be established either by law or by the nature of the relationship itself. They typically arise when one party must place their trust and reliance on another to exercise sound judgment. Fiduciary duties impose a responsibility on individuals (i.e., the fiduciaries) entrusted with critical decision-making for an organization to always act in the organization’s and its owners’ best interests.
What happens if a company’s manager or director prioritizes their personal interests over the well-being of the company and its owners? Their actions could lead to a claim of a breach of her fiduciary duties. A fiduciary benefiting personally from an action on behalf of the company does not necessarily, by itself, establish a breach. However, self-dealing, entering a transaction that has an adverse effect on the company, or taking a client or business opportunity that belongs to the company, often should be scrutinized and approved by disinterested managers.
Although fiduciary duties may seem absolute, California law allows them to be modified, or their monetary consequences limited, in some situations, but usually not waived outright. What is permitted depends on the legal structure of the company, the terms of its governing documents, and the laws of the state where it was organized.
The Different Types of Fiduciary Duties
A company’s manager or director owes fiduciary duties to the company and its shareholders or members. Some basic fiduciary duties include:
- Duty of Care – The duty of care requires fiduciaries to use their informed business judgment in overseeing the company and making decisions.
- Duty of Candor –Fiduciaries may be required to disclose material information in particular circumstances, such as when a director with a financial interest in a transaction seeks its approval by the board or shareholders.
- Duty of Loyalty – The duty of loyalty bars fiduciaries from exploiting their position for personal benefit. In a California LLC (or corporation), the statutory duty of loyalty includes accounting to the LLC for any benefit derived by fiduciaries from the business, refraining from dealing with the LLC on behalf of themselves or parties with adverse interests, and refraining from competing with the LLC. This prohibits fiduciaries from putting their personal interests ahead of the company.
Fiduciary Duties in California
The exact nature of fiduciary duties of directors or managers can vary by state. Certain states allow waivers or limitations of fiduciary duties by contract. Other states prohibit the waiver of any fiduciary duty. Companies, corporations, and their owners (whether shareholders or members), must be aware of such state-specific limitations and draft corporate documents to meet their needs.
Limited Liability Companies (LLCs)
In California, an LLC will either be structured as a member-managed LLC or a manager-managed LLC. In a manager-managed LLC, only managers owe fiduciary duties to the LLC and its members, unless an operating agreement provides otherwise. In a member-managed LLC, members owe duties of loyalty and care to the LLC and often each other, akin to a partnership This distinction makes it clear that fiduciary duties are generally only imposed on those in control of the LLC. According to the California Revised Uniform Limited Liability Company Act (RULLCA), an LLC’s operating agreement can modify (but not eliminate) fiduciary duties, but only in a written operating agreement with the informed consent of the members.
Corporations
California law expressly states that while directors of corporations can limit their personal monetary liability for breaches of duty to the corporation or its shareholders, the duties of loyalty and good faith may not be limited or waived. California Corporations Code section 204(a)(10) permits a corporation’s articles of incorporation to eliminate or limit the personal liability of directors for monetary damages, but not for acts or omissions involving intentional misconduct, a knowing and culpable violation of law, bad faith, an improper personal benefit, or reckless disregard of the director’s duty to the corporation or its shareholders.
Conclusion
Do your company’s corporate documents purport to waive certain fiduciary duties? Depending on the state and entity type, those waivers may not be enforceable. California distinguishes between modifying a duty, limiting monetary liability, and providing indemnification, and each has its own requirements. Your company’s bylaws, articles of incorporation, or operating agreements should always be drafted or negotiated with the assistance of seasoned legal counsel to avoid potential pitfalls.
Contributions to this blog by Grant Gallagher
