Over the years I have practiced law, one of the most common complaints that I have encountered is when business partners encounter difficulty in their relationships. For example, one member may believe another has acted selfishly, diverted a valuable business opportunity or not disclosed significant expenditures. This article will focus on the duties and obligations that business partners in member-managed Kentucky Limited Liability Companies (“LLC”) have to each other and from where those obligations arise. It will help members of a member-managed LLC better understand the obligations each has to the other.
An LLC is a legal entity that among many other benefits protects its members from personal liability for the acts of the LLC. LLCs can be managed by a manager or by its members. When managed by its members, each member of the LLC has authority to bind the LLC. With the exception that it insulates its members from liability, it is similar to a partnership.
In Kentucky, a member in a member-managed LLC owes the duties required by the operating agreement and the LLC Act. Additionally, a member may still owe duties imposed by the common-law. An LLC operating agreement is an agreement among the LLC members about how an LLC will function. Generally, the members can govern themselves in any manner they wish. This includes limits on the duties that each may have to the other. But, when an operating agreement does not limit those duties, Kentucky law governs.
Kentucky Revised Statute 275.170(1) imposes on members a statutory duty of care. A member is liable to another member if his act or failure to act constitutes wanton or reckless misconduct. To limit liability to wanton or reckless misconduct is consistent with Kentucky’s business judgment rule that protects business decision makers from liability where they act in good faith, on an informed basis, and in a manner honestly believed to be in the best interest of the LLC. It is logical then that members in a member-managed LLC should always act in an honest and informed manner. To act otherwise may subject them to liability.
Members of a member-managed LLC also owe duties to the LLC. KRS 275.170(2) imposes on members a statutory duty of loyalty. This duty does not apply to the other members. Reported Kentucky cases suggest this duty applies to conduct such as diverting business from the LLC to oneself or another company that person owns or controls.
In addition to the statutory duties of care and loyalty, the common-law may also impose fiduciary duties on LLC members. The Kentucky courts have held that absent contrary provisions in an operating agreement, members owe each other a common-law fiduciary duty.
In conclusion, a member of a member-managed LLC owes the other members a duty of care. A member must act in good faith, on an informed basis and in the best interest of the LLC. As well, a member should be very familiar with the operating agreement that governs the LLC. While this seems like common sense, problems with these duties and obligations arise with great frequency.
Todd McMurtry is a trial attorney with Hemmer DeFrank Wessels PLLC. His practice focuses on helping individuals and businesses solve complex problems through negotiation, mediation, arbitration and trial. You can reach him at [email protected].