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Fiduciary duties are not just for corporations and partnerships anymore. If you have a Kentucky limited liability company, life just got more complicated

As the title of this article suggests, if you own or manage a Kentucky limited liability company (LLC), you may want to review your Operating Agreement. In a recent case, Patmon v. Hobbs, the Kentucky Court of Appeals held that, as a matter of first impression, members and managers of LLCs owe similar common law fiduciary duties as corporate officers and directors or partners in a partnership in the absence of contrary provisions in the Operating Agreement of the LLC. The Court of Appeals also extended, for the first time, the business opportunity doctrine to members and managers of Kentucky LLCs. While many other states have concluded that members and managers of an LLC owe a duty of loyalty to the company and its members, Kentucky courts had not, until Patmon, had occasion to address the same question. This major ruling should prompt every member or manager of a Kentucky LLC to re-examine his or her Operating Agreement and determine the extent, if at all, he or she has contractually limited these new obligations or want to limit such duties.

LLCs have become a popular business entity for companies and individuals seeking the benefits of limited liability made available through a corporation while enjoying the operational flexibility and potential tax benefits of a traditional partnership. Today, all 50 states have laws providing for the creation of LLCs. LLCs are typically either member managed or manager managed. A member managed LLC may be governed by a single class of members or multiple classes of members and closely approximates the organizational structure of a general partnership. A manager managed LLC generally consists of a two-tiered management structure, where managers typically hold powers similar to corporate officers and directors or a general partner in a limited partnership.

In Patmon, the managing member was found to have breached his common law duty of loyalty by diverting a business opportunity from the LLC, which he managed, to a second LLC which was directly under his control. The business opportunity doctrine provides that such a person may not appropriate for themselves any business opportunity that could benefit the entity, and applies regardless of whether the entity is harmed by the transaction. The threshold question to be answered is whether a business opportunity is of sufficient importance and so closely related to an existing or prospective activity of the entity to warrant judicial sanctions against such a person. An opportunity exists for the benefit of the entity if the entity is financially able to undertake the opportunity, the opportunity is within the entity’s line of business and the entity has an interest or expectancy in the opportunity. However, unless otherwise provided in the Operating Agreement, interested parties may still pursue such transactions if the business opportunity is disclosed to, and approved by, a disinterested majority of the managers or ratified by the members of the entity. When a person is found to have breached their fiduciary duty of loyalty and the business opportunity doctrine is applied by a court, an entity may be entitled to all gross profits earned by the fiduciary from the challenged transaction.

The recent holding in Patmon may create new problems for managers and members who engage in a number of business ventures. This risk of significant liability for managers and members will encourage heightened scrutiny of conflict of interest transactions involving Kentucky LLCs.

However, at least in the context of an LLC, the application of these fiduciary duties and the business opportunity doctrine may be avoided by limiting or removing such obligations under the Operating Agreement, if appropriate.

  • Partner

    Chris is a member of the Business Services Department and Chair of the Private Equity/Mergers & Acquisitions Practice Group.  He practices in the areas of mergers and acquisitions, health care, securities, private equity ...

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