To protect a business and its co-owners’ interests from such situations, the law imposes on actively involved partners, managing members, officers and directors a variety of fiduciary duties.
In simple terms, a fiduciary manages another party's assets and has a legal and ethical obligation to put the other party's interests ahead of his or her own. A fiduciary duty is the highest standard of care to which an individual can be held. In a business setting, fiduciary duties help ensure that each owner is acting in a manner that is consistent with the entity’s business objectives and the interests of investors and the other owners.
The fiduciary duties in operating a company vary among the three most common forms of legal entities: corporation, partnership, and limited liability company (LLC).
Corporations
Under Arizona law (
A.R.S. § 520-426-3824), corporate directors and officers must discharge their duties in good faith, with the care that an “ordinarily prudent person” would exercise under similar circumstances, in the best interests of the corporation.
Directors and officers must act loyally and with due care toward the corporation and its shareholders. Directors and officers are not permitted to use any information, acquired while acting in their official capacity, in a way that is detrimental to the corporation. Additionally, the duty of care mandates that, prior to acting on behalf of the corporation, directors and officers apprise themselves of all necessary information to make an informed decision.
Partnerships
Arizona law (
A.R.S. § 520-426-3824) also imposes fiduciary duties on partners within a partnership. Partners owe each other, and the partnership, the duties of loyalty and due care. In fulfilling those duties, a partner is prohibited from competing with the partnership and must account to the partnership for any profits received or earned on behalf of the partnership.
Limited Liability Companies
An LLC is a hybrid entity that offers the limited liability of a corporation and the pass-through taxation benefits of a partnership. In contrast to the fiduciary duties imposed on corporations and partnerships, the duties owed by an LLC’s “members” or “managers” are not as clearly defined in statute. However, in June 2019, the Arizona Supreme Court ruled, in In re Sky Harbor Properties, LLC v. Patel Properties, LLC,
that fiduciary duties do exist in Arizona LLCs.
Also, under the 2018 Arizona Limited Liability Company Act (ALLCA), a member of a member-managed LLC owes the company and other members a duty of loyalty and should act in a manner consistent with a contractual obligation of good faith and fair dealing. Similarly, the manager of a manager-managed LLC owes the company and its members a duty of loyalty and must discharge his duties and obligations under the ALLCA with a contractual obligation of good faith and fair dealing.
Those duties are among the default provisions contained in the ALLCA. LLC members wishing to waive that default provision may do so through the wording of the LLC's operating agreement.
The ALLCA goes into effect September 1, 2020, for Arizona LLCs that were formed prior to September 1, 2019. It is already in effect for Arizona LLCs formed on or after September 1, 2019.
Conclusion
To achieve the protections and other benefits available to co-owners under their choice of legal entity, they should take at least three preparatory steps:
- understand which form of legal entity will best serve their personal and business objectives;
- gain a solid understanding of their fiduciary duties to each other and to the entity; and
- if they choose to operate as an LLC, seek professional guidance from their business attorney and tax professional in drafting the terms of a thorough, well-conceived operating agreement.
