What is the duty of loyalty and why does it matter to multi-member LLC?
With the popularity of the LLC entity, it is not surprising that most co-owned small businesses are organized as multi-member LLC. Since most business partners begin as friends (or at least cordial acquaintances), they often gloss over the rules and LLC agreement provisions regarding their duty of loyalty. Unfortunately, relationships sometimes change and it is important to understand the duty of loyalty each owner has toward the business and the other owners.
What is the Duty of Loyalty?
Pennsylvania's Limited Liability law defines the duty of loyalty. To paraphrase the law, the duty of loyalty requires each owner to:
What does the Duty of Loyalty require of me?
In simple terms, the duty of loyalty requires each owner to act in the best interest of the company and to act fairly and honesty toward his/her fellow owners. Conflicts often arise when one owner perceives another owner is competing with the company, receiving unfair economic benefit (such as when the LLC hires family members or contracts with an owner's related businesses), or using business property for his/her personal use.
Now, these duties of loyalty can be contractually altered in your company's operating agreement. For example, it is not unusual for co-owners to consent to one or more owners engaging in a separate business that may compete with their jointly-owned business. The important point is that this is negotiated and memorialized in the LLC Operating Agreement so all parties are aware of their duties and of any potentially competitive activities of the other owners.
In Pennsylvania, the duty of loyalty is not something to gloss over. Though it is often relegated to the "boilerplate" section of your business operating agreement or nonprofit bylaws, it is very important and the consequences of violating the duty of loyalty can have serious consequences to the business and the owners / board of directors, including personal, financial liability for breaches of the duty.
Christine Jarzab Kuntz is an attorney specializing in the life cycle of businesses and nonprofit organizations. She is enthusiastic to share her knowledge, tools, and tips with the business and nonprofit community. She enjoys the excitement of tutoring start-ups, tackling the challenges of established businesses, and counseling her clients' transitions through all stages of the business life cycle.