Tuesday, February 16, 2016

THE FLEXIBILITY OF A LIMITED LIABILITY COMPANY ("LLC") GIVING SPECIAL RIGHTS TO A PASSIVE INVESTORS

By Bill Siegel

It is not unusual for a passive investor to condition her investment on her ability to appoint a manager as her representative.  Prior to 2013, the corresponding fiduciary duties of a specially designated representative manager were enough to keep many such managers from representing a specific investor or a group of investors.  

Generally speaking, under the Delaware and Texas laws dealing with limited liability companies, if the Company or Operating Agreement does not address a manager’s fiduciary duties, then a manager of the LLC has the same kinds of fiduciary duties to the LLC and its members as a director of a for profit corporation has to the corporation and its stockholders.  In each case, those fiduciary duties primarily relate to the respective duties of due care and loyalty.  Thus, for example, a manager of an LLC or a director of a corporation could be held to have breached their fiduciary duties if they  shared confidential information with a particular group of members or shareholders to the detriment of others.  In other words, the manager and director must act in the best interests of all members or shareholders.  

To avoid this inflexible approach, Delaware and Texas law provides that in certain circumstances a manager of an LLC can be appointed to represent specific members.  Such an approach does not apply to corporations.  If specific members of an LLC require a designated manager to specifically protect their interests, then the LLC Company Agreement should include provisions that facilitate this desired arrangement.

The Company Agreement should provide (a) that the representative manager neither has nor is subject to the fiduciary duties imposed by law and (b) those fiduciary duties are replaced by the standard of conduct or the duties imposed only by the Company Agreement which would include specifically enumerated rights.  For example, such rights, if applicable, would include: (a) the right of the representative manager to: (i) provide confidential information of, or about, the LLC to the designating member(s); (ii) withhold information from the other managers of the LLC regardless of how the manager obtained such information; (iii) advocate the position or interest of the specific member(s) in any and all deliberations by the LLC’s board of managers; (iv) vote for or consent to a position or interest more favorable to the specific member(s); (v) abstain from voting or taking actions by the LLC’s board of managers, if the representative manager deems it necessary; (vi) resign from the LLC’s board of managers, if the representative manager deems it necessary; and (vii) provide that the designating manager will not be deemed to have any fiduciary duties or liability to the LLC generally or to any of its other members as a manager.

The provisions of the Company Agreement should clearly set forth the duties of the designated representative manager to avoid the imposition by law of fiduciary duties to the LLC and its other members. It should be noted that these provisions are not foolproof especially in circumstances where the duties of a manager to the LLC and its representative member(s) is clearly in conflict with and not in the best interests of the LLC.  However, the flexibility attendant to an LLC gives investors substantial rights that would not otherwise exist and thus potentially creates access to funds that would not otherwise exist in a corporate structure.


 

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