"Fiduciary duty" is a frequently used legal term that, in practice, can have a very fuzzy meaning. But it has definite legal implications for individuals in a variety of roles. When one owes a "fiduciary" duty to another, it means that he or she must act with extreme loyalty or a high standard of care towards the other. A common example is an attorney, who owes a fiduciary duty to his or her clients. Another example is a corporate director who owes a fiduciary duty to the corporation. The director must make decisions and take actions for the benefit of the corporation, even when they may be detrimental to the director personally. In practice this has been a difficult standard to apply. But the law can be very strict in this regard.
One of the significant differences under limited liability company (LLC) law is the ability to have an operating agreement that gives much more flexibility in setting the duties owed by managers or members to a limited liability company. An LLC will have members which own interests in the LLC. An LLC will also frequently have managers which, as would be expected, manage the day-to-day business of the LLC.
Delaware has gone as far as any state by permitting an LLC to eliminate any duties that a member or manager owes to an LLC or, for that matter, to each other. So, in Delaware, a member or manager could owe little obligations to an LLC, other than what Delaware calls "the implied contractual covenant of good faith and fair dealing." (Delaware Limited Liability Company Act 18-1101)
Illinois did not go quite this far. Illinois generally does not permit an operating agreement to eliminate or reduce a member's fiduciary duties. (Illinois Limited Liability Company Act 15-5). But, in a key exception, Illinois provides that a member owes no duties to a manager-managed LLC just by being a member unless the member exercises authority of a manager "pursuant to the operating agreement." (Illinois Limited Liability Company Act 15-3). Now, in response to a recent Illinois court case (Katris vs. Carroll 362 Ill. App. 3d 1140 (2005)), Illinois has made it more difficult for a member to avoid fiduciary duties to the LLC.
Although application of these concepts can be difficult, the Katris case illustrates that they have real consequences. Katris involved a manager-managed LLC formed to exploit a software program developed by Doherty. Doherty was a member of the LLC, but not a manager.
But he was far from passive, having the title "Director of Katris, a manager and member of the LLC, alleged that Doherty colluded with Carroll and Ernst in breaching Doherty's fiduciary duty to the LLC. Katris claimed that Doherty worked with Carroll to develop a competing program and that, since Doherty owed fiduciary duties to the LLC, Doherty should have offered this competing program to the LLC.
But the Illinois court dismissed the claim on summary judgment, without a trial. The court found that, under the language of the statute, Doherty owed no fiduciary duties unless he was acting as a manager "pursuant to the Operating Agreement." It found that Doherty was not a manager of the LLC under the Operating Agreement in spite of his title of "Director of Technology."
Some corporate practitioners felt that the court either discovered or created a loophole in the statute that intended that members would have fiduciary duties to the LLC. As a result, a law passed by the Illinois legislature (and likely to become law) has amended the LLC statute. (Illinois House Bill 1336) Under the amended statute, a member will still owe duties to the LLC if the member "exercises the managerial authority" under the LLC statute. The amendment specifically eliminated the requirement that the managerial authority be "pursuant to the operating agreement."
The amended statute may have solved one perceived problem by deleting the reference to the operating agreement. But by broadening the duties of members, it may have substituted a less-defined standard. It will be interesting to see how this is applied by Illinois courts. It will also be interesting to see if it encourages more LLCs operating in Illinois to be formed under Delaware law's more flexible provisions, rather than those of Illinois.