While many people start their business on their own, there comes a time when they choose to take on other members or partners in the business. Many times, it is a friend or a colleague who you've known and you think would be a good asset to the business. Other times, you've hired someone for their skillset and after putting in hard work, you want to reward them with an interest in the business as well. No matter what road you travel to get there, bringing someone into the business is an impactful step for your business.
In the world of LLC's (Limited Liability Companies), the owners of the business are called "Members" and they have specific legal responsibilities as members of the LLC. When joining an LLC as a member, one of the first steps is to review the operating agreement for the LLC. In that agreement, one of the key responsibilities that is not often highlighted when I review previously drafted agreements with my clients is the duty of loyalty that an LLC member owes to the LLC.
It's one of those things that many clients say "Of course, I'm loyal to the LLC," but they often have not explored what that duty of loyalty entails. At the outset, many members are not concerned because everyone is on good terms and the LLC is looking towards a prosperous future. However, when things sour, and members have disputes, the duty of loyalty can often be thrown around amongst the allegations between members of the LLC. The duty of loyalty is a concept that all LLC members need to understand.
What is the Duty of Loyalty?
In legal terms, the duty of loyalty is a fundamental fiduciary duty that LLC members owe to the company and its other members. There are three main guidelines that can help you navigate this duty:
Avoid Conflicts of Interest: LLC members must avoid situations where their personal interests conflict with the interests of the LLC. This includes refraining from competing with the company, taking advantage of business opportunities meant for the LLC, or diverting company assets for personal gain.
Act in the Best Interests of the LLC: Members are obligated to make decisions and take actions that are in the best interests of the LLC. This means making choices that benefit the company as a whole rather than pursuing personal interests.
Full Disclosure: Members must provide complete and accurate information to the LLC regarding any potential conflicts of interest. Transparency is key in fulfilling this duty.
These may seem like common sense, but that doesn't mean that you don't end up in a precarious situation with another LLC member. It's important to make sure you are following these guidelines as a member of your LLC.
Why is the Duty of Loyalty Important?
This duty wasn't just created to give you another rule to follow with your other LLC members. It's important for a few different reasons, including:
Protection of the LLC: By adhering to this duty, members help safeguard the LLC's assets, reputation, and overall well-being.
Trust and Confidence: Fulfilling the duty of loyalty fosters trust and confidence among members. They can be assured that others are acting in the best interests of the business.
Legal Consequences: Breaching the duty of loyalty can lead to legal consequences, including lawsuits and potential personal liability for damages.
As you can probably see, by protecting the LLC, you are building confidence amongst the members of the LLC, which can make the operations and business of the LLC much more profitable for all involved. It's especially important when you consider the possibility of lawsuits and personal liability for damages caused to the LLC.
How to Fulfill the Duty of Loyalty
If you're a member of an LLC, adhering to your duty of loyalty doesn't need to be a challenge. There are three common paths that I advise my clients to pay attention to in order to make sure they are fulfilling their duty of loyalty:
Stay Informed: Be aware of the LLC's operations, financial health, and potential conflicts of interest.
Seek Legal Counsel: When in doubt about a particular situation, consult with legal professionals to ensure compliance with the duty of loyalty.
Follow the Operating Agreement: Many LLCs have an operating agreement that outlines the duty of loyalty and related matters. Members should adhere to this document.
The duty of loyalty is a vital aspect of an LLC member's responsibilities. By upholding this duty, members contribute to the ethical and legal functioning of the company, ensuring its success and the protection of all involved parties.
Do I Need a Business Attorney?
If you or your business want to discuss your duties as members of an LLC or if you need help preparing or updating your LLC operating agreement, let's schedule a Legal Strategy Session online or by calling my Edina, Minnesota office at (612) 294-6982 or my New York City office at (646) 847-3560. My office will be happy to find a convenient time for us to have a phone call to review the best options and next steps for you and your business.