The Duty Of Loyalty Under The New Jersey Revised Uniform Limited Liability Company Act

Gianfranco A. Pietrafesa, a partner in the firm's Corporate Practice Group, analyzes the duty of loyalty of managers and members of New Jersey limited liability companies. In an article in New Jersey Lawyer Magazine, he explains the duty of loyalty, to whom it applies, and how an LLC operating agreement may restrict or eliminate the duty.

On March 1, 2014, the New Jersey Limited Liability Company Act was repealed1 and replaced by the New Jersey Revised Uniform Limited Liability Company Act (NJRULLCA).2 On that date, NJRULLCA began to govern all limited liability companies (LLCs) in New Jersey.3

NJRULLCA has made significant changes in New Jersey's LLC law.4 Among them are specific statutory fiduciary duties for managers and members of LLCs.5 One such fiduciary duty is the duty of loyalty.

What is the Duty of Loyalty?

The statutory duty of loyalty is comprised of the following specific duties:

to account to the company and to hold as trustee for it any property, profit, or benefit derived by the member: in the conduct or winding up of the company's activities; from a use by the member of the company's property; or from the appropriation of a company opportunity; to refrain from dealing with the company in the conduct or winding up of the company's activities as or on behalf of a person having an interest adverse to the company [i.e., self-dealing]; and to refrain from competing with the company in the conduct of the company's activities before the dissolution of the company.6 Thus, a member or manager must account to the LLC for any profits derived from: 1) conducting the business of the LLC and dissolving the LLC, 2) using the LLC's property, and 3) appropriating business opportunities of the LLC. Also, a member or manager must refrain from engaging in self-dealing and competing with the LLC. The prohibitions against self-dealing and competing with the LLC may present problems for certain LLCs, but any problems can be addressed in an operating agreement.

To Whom Does the Duty Apply?

An LLC may be managed by its members or by one or more managers,7 and who manages the LLC determines who is bound by the duty of loyalty. Thus, the duty applies to the members of a member-managed LLC8 or to the managers (but not the members) of a manager-managed LLC.9 Note that in a member-managed LLC, a member has a duty to refrain from competing with the LLC before the dissolution of the LLC, whereas in a manager-managed LLC, a manager has a duty to refrain from competing with the LLC until the completion of the winding up of the LLC.10

Comparison to Prior New Jersey LLC Law

New Jersey's prior statute did not include a duty of loyalty.11 In fact, the term "fiduciary duty" was mentioned once, at the end of the statute.12 In addition, there is virtually no New Jersey case law discussing the duty of loyalty in the context of an LLC. The sparse case law that does exist is contradictory and, as a result, not helpful.13

Some have argued that, unless otherwise expressed in an operating agreement, managers and members did not have any fiduciary duties, including the duty of loyalty.14 Others assumed that managers and controlling members must have had fiduciary duties.15

Comparison to Other New Jersey Entity Laws

The duty of loyalty imposed by NJRULLCA is substantially similar to the duty of loyalty under New Jersey's general partnership and limited partnership statutes.16 This should come as no surprise since all three laws were drafted by the uniform law commissioners.17

However, the duty of loyalty for managers and members of an LLC is broader than the comparable duty for partners of a general partnership or general partners of a limited partnership. First, the general partnership statute states that "[t]he only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care set forth in [the statute]."18 By comparison, NJRULLCA does not include such a limiting term.19 Second, NJRULLCA implies that managers and members may be subject to other fiduciary duties,20 meaning fiduciary duties developed by the courts under the common law.21

By contrast, New Jersey's corporate statute does not include a duty of loyalty. Instead, the duty of loyalty of directors and officers to a corporation and its shareholders is determined by the courts under the common law. Although the duty of loyalty is determined on a case-by-case basis, and thus cannot be defined with precision, it includes a duty to act in the best interests of the corporation, without self-dealing and usurping corporate opportunities.22

Comparison to Delaware LLC Law

While NJRULLCA clearly specifies the duty of loyalty in New Jersey LLCs, the duty of loyalty for managers and members of Delaware LLCs is not so certain. In fact, the issue of fiduciary duties caused a significant disagreement between the Delaware Supreme Court and the chancery court (which decides disputes involving the internal affairs of LLCs, corporations and other business entities).

In Jan. 2012, the chancery court held that the manager of an LLC had default fiduciary duties to the LLC and its members, which confirmed the common understanding under prior case law that a manager had fiduciary duties unless contradicted by an operating agreement.23 In Nov. 2012, the Delaware Supreme Court disagreed and held that the chancery court's pronouncement about default fiduciary duties was "improvident and unnecessary" and "dictum without precedential value."24 A few weeks later, the chancery court again held that default fiduciary duties apply to managers of an LLC.25

The Delaware Legislature ended the controversy by amending its LLC statute.26 Thus, managers and controlling members of Delaware LLCs have a duty of loyalty to the LLC and its members. However, the nature and scope of the duty is still determined through case law.

Alter or Eliminate the Duty

The statutory duty of loyalty is a default provision that will apply if the LLC's operating agreement does not modify the duty. Fortunately, NJRULLCA provides an LLC with several methods to alter, or even eliminate, the duty. These methods are contained in Sections 11 and 39 of NJRULLCA.27 The provisions appear complex and even contradictory, and thus confusing, but as explained below, they do provide LLCs with great flexibility to deal with the duty of loyalty to suit the circumstances of each particular LLC.

Section 11 of NJRULLCA initially states that "[a]n operating agreement may not...(4) subject to subsections d. through g. of this section...