- Fiduciary duties: What duty do you owe?
- June 14, 2012
- Law Firm: Business Technology Law Group - Columbia Office
A fiduciary duty is an obligation to act in the best interest of, and for the benefit of, another. The duties owed by those standing in a fiduciary relationship with a business entity differ depending on the entity classification. Some duties are codified in the Maryland Corporations and Associations statute, whereas other duties are rooted in common law. The following is an introduction to the types of fiduciary duties owed by those standing in a fiduciary relationship with corporations, partnerships and limited liability companies.
Under Maryland law, officers and directors occupy a fiduciary relationship with the corporation. The duties are generally divided into the duty of care and the duty of loyalty.
The standard of care owed by a director to the corporation is codified in the Maryland Corporations and Associations Article § 2-405.1. The statute requires directors to perform their duties 1) in good faith, 2) in a manner reasonably believed by the director to be in the best interest of the corporation, and 3) with the care that an ordinarily prudent person in a similar situation would use under similar circumstances. The business judgment rule is a presumption of the above, that the directors of a corporation have acted in good faith and in the best interest of the corporation. Absent fraud or bad faith, a court will not interfere or second guess business decisions made by directors of a corporation, but a director may be liable for gross negligence in exercising his or her business judgment. Black v. Fox Hills North Community Ass’n, Inc., 90 Md.App. 79 (1992).
A breach of the duty of loyalty generally involves a conflict between an officer or director’s personal interest and the interest of the corporation. Under the Corporate Opportunity Doctrine, an officer or director breaches the duty of loyalty if that person pursues a business opportunity for his or her own benefit, without first giving the opportunity to the corporation, if it is reasonably foreseeable that the corporation would be interested in such an opportunity. Maryland courts have adopted the interest or expectancy test to determine whether the corporation could realistically expect to seize and develop an opportunity. Independent Distributors Inc. v. Katz, 99 Md. App 441 (1994). If the corporation waives its right to the business opportunity, an officer of director may pursue the opportunity for his own benefit. On the other hand, if an opportunity is improperly acquired, the officer or director may be liable to the corporation for the profits realized from the opportunity. The duty of loyalty may also be breached in an interested director transaction wherein a director may be faced with a conflict of interest with regard to a specific transaction. An example of such a conflict of interest includes a situation where a director is a director for both corporations of a proposed transaction. In interested director transactions, if the director fully discloses his or her interest in the transaction to the board of directors and the transaction is approved by the non-interested directors or non-interested stockholders, then the transaction is not void or voidable.
There is generally no fiduciary duty on the part of a stockholder to the corporation. The stockholders of a close corporation that have elected to have no board of directors have the same fiduciary duties of the directors of a corporation.
Partners stand in a fiduciary relationship to each other and to the partnership. The fiduciary duties owed by a partner are codified in the Uniform Partnership Act found in the Maryland Corporations and Association Article § 9A-404 and are limited to the duties of loyalty and care as set forth in the sub-sections.
A partner’s duty of loyalty is comprised of three subsections: 1) the duty to account, 2) the duty to refrain from dealing adversely with the partnership and 3) the duty to refrain from competing with the partnership. The duty to account requires the partner to account for all property, profit or benefit derived by him in the conduct and winding up of the partnership business, or that was derived from any use by him of the partnership property, including the appropriation of a partnership opportunity. A partner is however, able to appropriate for his own benefit any new business opportunity that comes to his attention after his disassociation from the partnership. MD Corp. & Ass’n, §9A-603. The duty to refrain from dealing adversely with the partnership applies strictly to the conduct of the business or in winding up the business. This duty also ends once the partner has dissociated from the partnership. The duty to refrain from competing with the partnership in the conduct of the partnership before dissolution and this duty therefore does not extend to winding up of partnership business.
A partner’s duty of care to the partnership and other partners consists of refraining from engaging in 1) grossly negligent or reckless conduct, 2) intentional misconduct, or 3) a knowing violation of the law.
The partnership agreement may not unreasonably reduce the duty of care or eliminate the duty of loyalty. MD Corp. & Ass’n, §9A-103. On top of the duty of loyalty and care, a partner is required to discharge his or her duties in good faith and fair dealing.
In a limited partnership, general partners owed the same fiduciary duties that partners owed in a regular partnership. Limited partners, on the other hand, are just passive investors and therefore do not owe any fiduciary duties.
Limited Liability Companies.
The Maryland Limited Liability Company Act does not address fiduciary duties of the LLC members. Even though the statute is silent, LLC members still owe common law fiduciary duties to the LLC and the other LLC members. A member of an LLC is considered to be an agent acting on behalf of its principal. Accordingly, the fiduciary duties owed by an agent to its principal apply to LLC members. Wasserman v. Kay, 197 Md. App. 586 (2011). The fiduciary duties under agency law can be generally defined as the duties of 1) care, 2) obedience, 3) information, and 4) loyalty.
The duty of care requires that an agent exercise reasonable care, competence, diligence and judgment in decision making as would be exercised by similar agents under similar circumstances. Restatement (Third) of Agency § 8.08. The duty of obedience requires that an agent act within the scope of authority of the agency relationship. This means that the agent is required to act reasonably and refrain from conduct likely to damage the principal’s enterprise, and to act within the express and implied terms of any contract between the agent and principal. Restatement (Third) of Agency §§ 8.07, 8.09 and 8.10. The duty of information requires that an agent use reasonable effort to disclose information to the principal that the principal would need or want to know. Restatement (Third) of Agency § 8.11. Finally, the duty of loyalty requires that the agent act only in the principal’s best interest. This includes refraining from acquiring a material benefit from a third party in connection with the actions taken on the principals’ behalf, not acting on behalf of an adverse party in a transaction connected with the agency, refraining from competing with the principal, not using the principal’s property for the agent’s own use and not disclosing confidential information of the principal. Restatement (Third) of Agency §§ 8.02-8.05.
In addition to holding that LLC members owed the LLC and other members common law duties, the case of Wasserman v. Kay also alluded to the possibility that fiduciary duties may be altered or created by way of the LLC’s operating agreement, based upon the wording of §4A-402(2) of the Maryland Limited Liabilities Act.