It is typical for an investor that becomes a member of a manager-managed limited liability company (the “LLC”) to desire and bargain for a right to designate one or more persons to be managers of the LLC. This is particularly the case when the member is a professional investor, like a private equity or venture capital firm. Such an investor often designates a manager to represent it on the LLC’s board of managers for two principal purposes:
- to provide financial and other business skills and direction to the LLC, with the expectation that the skills and direction so provided would also promote the investor’s own interest, and
- to ensure the investor’s receipt of information from and about the LLC, with the intent to protect the investor’s own interest.
The election or appointment of such a representative manager usually is a condition to the designating member’s investment in the LLC and is agreed to by the LLC’s other members.
Nevertheless, unless properly documented as part of the LLC’s operating or company agreement (the “LLC Agreement”), the designating member may not achieve, or achieve to the extent desired, the principal purposes of having a representative manager. The “default” fiduciary duties imposed by Delaware or Texas law on the representative manager, and the corresponding potential liability of that manager for any violation of those duties, may impede the ability of the representative manager to act as intended by the designating member. (The issues addressed in this paper may well arise under other states’ laws, but this paper addresses only Delaware and Texas law).
As the result of a 2013 amendment to the Delaware Limited Liability Company Act, if the LLC is a Delaware LLC and its LLC Agreement does not address a manager’s fiduciary duties to the LLC and its members, then a manager of the LLC has the same kinds of fiduciary duties to the LLC and its members generally as the director of a Delaware business corporation has to the corporation and its stockholders generally. Under recent Texas case law, it likewise appears that if the LLC is a Texas LLC and its LLC 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 generally as the director of a Texas for-profit corporation has to the corporation and its shareholders generally. In each case, those fiduciary duties consist principally of the duty of due care and the duty of loyalty.
In the corporation context, Delaware courts have recognized the divided loyalties of a representative director to the corporation and to the particular stockholder or group of stockholders, such as holders of preferred stock, that have elected that representative director. The courts have almost always resolved that tension by giving precedence to the director’s fiduciary duties over any obligation the director may have to any particular stockholder or group of stockholders, even when the director’s allegiance to a particular stockholder or group of stockholders is evident. The Delaware courts have upheld the general rule that a director’s primary concern must be to act in the best interests of the corporation and its stockholders as a whole. Accordingly, corporate directors have been held to breach their fiduciary duties by sharing a corporation’s material confidential information with the particular stockholder or stockholders they represent or by voting or otherwise acting as a director in a way that would benefit the particular stockholder or stockholders they represent instead of the corporation and its stockholders generally. If this corporate approach were applied to an LLC and its managers, a representative manager might in effect be precluded from representing the interests of the designating member as intended by the designating member and undertaken by the representative manager.
Each of the Delaware Limited Liability Company Act and the LLC provisions of the Texas Business Organizations Code permit the LLC’s members to agree to vary the duties of managers of the LLC, subject to certain restrictions. Consistent with the contractual basis or orientation of an LLC, each statute specifically allows the expansion, limitation, or elimination of a manager’s fiduciary duties in the LLC Agreement. Under each of Delaware and Texas law, the flexibility of an LLC clearly offers the possibility of addressing the conflict between fiduciary duties and obligations to a particular constituency that the corporate form does not offer, or at least does not as clearly offer. If a designating member desires to provide that, in the event of a conflict in loyalties or duties, the duties to the LLC and its members generally will not preclude the representative manager from preferring and advancing the interests of the designating member, then the LLC Agreement could include provisions that facilitate the desired arrangement.
Provisions in an LLC Agreement, of course, will normally be the result of negotiations between or among the LLC’s members. A designating member should anticipate that other members will desire some balance between a manager’s conduct for the benefit of the LLC and its members as a whole and the manager’s conduct for the sole or primary benefit of the designating member.
Nevertheless, it is worth asking: What provisions might be proposed to facilitate the desired arrangement to achieve, to the greatest extent, the principal purposes of the designating member and provide the greatest protection to the representative manager? It appears that those possible provisions include the following:
- Disclosure of the desired relationship between the designating member and the representative manager, and express consent to that relationship by all of the other LLC’s members.
The key to a court’s recognition of the arrangement as fair or proper, even though it involves a departure from standards otherwise imposed by law, is that the arrangement is an essential part of the contractual relationship of the LLC’s members, expressly consented to by them.
- An express statement that the provisions supersede, or take precedence over, any fiduciary duties or relationship imposed on the designated or representative manager by law.
Courts applying Delaware law have stated that, to be effective, any departure from the “default” fiduciary duties must be “clear” or “explicit” and “unambiguous.” The provisions in the LLC Agreement should include statements to the effect that (a) the representative manager does not have, or is not 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 LLC Agreement (to include the rights briefly described below). Also, the provisions in the LLC Agreement regarding the standard of care for, and the limitations on liability of, managers should correspond to or be consistent with the contractual duties that are imposed on the representative manager.
- The right of the designated or representative manager to:
- Provide confidential information of, or about, the LLC to the designating member.
Because obtaining information is often a key reason to have a representative manager, this will likely be important to the designating member. It will also be important to the LLC and the other members that the information not be disclosed or used by the designating member in a way that would harm the LLC or its business and affairs. Frequently, if the designating member is enabled freely to receive material confidential information from its representative manager, the negotiations focus on covenants regarding confidentiality and restrictions on use of information by the designating member.
- Withhold information of, or from, the designating member from the other managers of the LLC.
During the course of its investment in the LLC, the designating member may obtain from other sources information relevant to the LLC that the designating member would prefer not to share with the LLC or its other members. In the absence of a provision like this, if the information is shared with or becomes known to the representative manager, he or she might have an obligation to disclose it to the other members of the LLC’s board of managers.
- Advocate the position or interest of the designating member in any and all deliberations by the LLC’s board of managers.
This should not be controversial, and consent to this may well be implied or deemed given by virtue of the agreement to the arrangement. But there is no reason not to make this clear. The representative manager should be careful to indicate when he or she is advocating the designating member’s interests at board meetings or in other communications.
- Vote or express consent as a manager in favor of the position or interest of the designating member.
In most situations, the representative manager’s exercise of his or her voting or consent right will not involve any conflict between the designating member and the LLC and its members generally, because their interests will (more or less) be aligned. In a few situations, however, this right may be critical for the designating member, particularly if the designating member owns a separate class of LLC membership interest. Negotiation of this may depend on the standards for board authorization or approval that the LLC’s members include in the LLC Agreement, and may result in the identification of only certain matters regarding which this is acceptable.
- Abstain from voting or other actions to be taken by the LLC’s board of managers, if the representative manager deems it necessary.
Despite the other provisions of the LLC Agreement regarding the arrangement, the representative manager’s judgment may be that, in a particular situation or regarding a particular matter, he or she may be able to avoid a violation of duty, and corresponding liability, to the LLC and its members only by recusing himself or herself from the board’s decision-making process. If the representative manager’s vote or other action is not required to achieve the result desired by the designating member, then the designating member will not be affected by this. Otherwise, the designating member will have to acknowledge and accept that the representative manager should not be required to take or omit to take action that may create personal liability to the LLC and its members.
- Resign from the LLC’s board of managers, if the representative manager deems it necessary.
Although it may be an extreme circumstance, if the conflict between the obligations to the LLC and its members and the obligations to the designating member cannot otherwise be resolved, the representative manager should have the right to resign his or her position, without such resignation being deemed a violation of any fiduciary duty to the LLC or its members or of any obligation to the designating member.
- Provide that the designating member will not be deemed to have any fiduciary duties or liability to the LLC or any of its other members as a manager because of the arrangement.
Under Delaware and Texas law, an LLC member, with respect to its ownership in the LLC (like a corporate stockholder or shareholder with respect to its shares), may generally pursue its own interests as it sees fit. Because the representative manager may be deemed an agent of the designating member, however, it is possible that the arrangement would result in (a) the imposition on the designating member of fiduciary or other duties to the LLC and its other members, with corresponding liability for any violation, or (b) restrictions on the designating member’s right to deal with its LLC membership interest in its sole discretion. Such duties might be imposed by law or, at the insistence of the LLC’s other members, in the LLC Agreement. Although the designating member may be willing to accept some obligations it might not otherwise have (in the absence of the representative-manager arrangement), like the covenants regarding material confidential information of the LLC described above, the designating member should be careful to avoid the imposition of fiduciary duties to the LLC and its other members by law. The designating member should disclaim any such duties in the LLC Agreement. Any obligations that the designating member accepts should be specifically negotiated and clearly stated in the LLC Agreement. An approach that may somewhat mitigate this issue, at least to the extent arising because of the designating member’s desire for information from and about the LLC, is for the designating member to request and negotiate for a provision in the LLC Agreement that would entitle it, solely in its capacity as an LLC member, to specified information from the LLC.
Because fiduciary duties derive from case law rather than statutes, the propriety of a manager’s conduct will depend on the circumstances. Therefore, it may not be possible to predict the full effect of all or any of the possible provisions of the LLC Agreement before they are tested in litigation. Nevertheless, existing Delaware and Texas law suggests that those provisions would be helpful to a designating member and a representative manager of an LLC.