A recent amendment to the New Hampshire Limited Liability Company Act, RSA Ch. 304-C (the “LLC Act”), that went into effect on August 9, 2016 increases the uncertainty surrounding the duties that an LLC and its members owe to a former LLC member under the statute. Unless the members of an LLC specifically overrule the new Section 99,IV of the LLC Act in their LLC agreement, the LLC and the members themselves may face breach of fiduciary duty claims and liability to former members.
An important theme that recurs throughout the LLC Act is freedom of contract: the members are generally free to order their obligations to each other as they consider most appropriate under the circumstances. In countless instances, the LLC Act provides rules that will apply to the members unless the members specify otherwise in the LLC agreement. As a result, it is important for the drafter of an LLC agreement to understand the rules that apply under the LLC Act unless another rule is specified in the LLC agreement. The new Section 99,IV provides former members with potentially draconian rights against the LLC and its members, unless the members are careful to negate those rights in the LLC agreement. Unfortunately, many businesspeople and business lawyers rarely understand and/or focus on the obligations that the LLC has to a departed member, which could pose a trap for many LLCs. The new rules apply to both existing and new LLCs formed after the August 9 effective date.
In the normal course of an LLC’s business, one or more members may end up “dissociating” from the LLC. The dissociating member may move on to another job or become disabled or pass away, or there may be a falling-out among the members, resulting in a member either receiving a payout or some other settlement from the LLC. These dissociation events are often negotiated, then the parties move on.
Section 99, IV of the LLC Act provides that:
“Unless the operating agreement provides otherwise, former members and transferees of the limited liability company interests of former members may claim in the superior court under the implied contractual covenant of good faith and fair dealing that they are entitled to fiduciary rights against the limited liability company and its members.”
What this means, in practice, is far from clear, if the parties have not specified the rights and obligations that apply to an event of dissociation. Unfortunately, this new provision mixes a number of different concepts: “implied contractual covenant of good faith and fair dealing” versus “fiduciary rights” and “claims” against “the limited liability company and its members.” Under general legal principles, an implied covenant of good faith and fair dealing is much less strict than a fiduciary duty, so the statute is based on a non-sequitur. The new section also endows former members and transferees of LLC interests with rights that perhaps they might have had while they were members but continue beyond when most businesspeople and business lawyers assume that those rights have terminated, i.e. after the actual dissociation and the end of such person’s status as a member.
Presumably, the drafters of this provision were worried about members being unfairly forced out of the LLC or payout amounts to dissociating members later being considered unfair. These issues are usually left to a negotiated agreement of the members when a dissociation is pending, when the issues are in the front of the parties’ minds. The new language appears to discourage dissociating members from negotiating a settlement at the time of their departure by leaving open the possibility of bringing a claim against the LLC and its members after the dissociation has become effective. Without language in the LLC agreement negating these rights, would a release given by a dissociating member at the time of his departure be effective to terminate his rights? Unless the release is drafted-into the LLC agreement, this language suggests that such a release might not be effective.
Also, it is unclear what “rights” a dissociated member should have under a fiduciary theory. Fiduciary theories typically involve fiduciary duties by a specified person in favor of another person. What a fiduciary right is, is not clear under traditional legal concepts. Also, what is the practical nature of that right? What type of conduct around a member’s dissociation was intended to trigger that right? The new language does not do anything more than hint at what such a right means.
The fact that the new “fiduciary right” of the dissociating member applies to the other LLC members in addition to the LLC itself, is also cause for concern. Most LLC members do not think that they are undertaking personal obligations to their fellow members when they enter into an LLC agreement, least of all in a dissociation scenario. Most LLC members choose to do business through an LLC because they are not prepared to run the risk of personal liability.
This new post-dissociation fiduciary right and its coverage are arguably unique to New Hampshire law. The author is not aware of any other states’ LLC laws which provide for a similar right. Although certain common law and securities law principles provide remedies to a dissociated member who believes that the terms of his departure from an LLC were unfair, the rubric adopted by the new statute is significantly different from those principles.
In order to avoid uncertain and potentially serious results, LLC members should carefully avoid the application of the new Section 99,IV by specifying a clear set of rules which govern in a dissociation scenario and will displace these confusing and contradictory rules.
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This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice.
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