Over 70% of all businesses in the United States are sole proprietorships. A sole proprietorship is an unincorporated business that is owned and operated by a single individual. As a sole proprietor, you are entitled to 100% of the profits. However, you are also 100% personally responsible for all debts, losses, and liabilities.
Many people choose to protect themselves from liability by forming limited liability corporations with other members. This generally limits liability to the LLC and not each individual member. However, certain legal duties may require members to disclose pertinent information related to the best interest of the LLC. These duties are known as fiduciary duties.
In Texas, there are two types of fiduciary duties. One is formal, the other informal. A formal fiduciary duty arises under relationships such as attorney-client, partnerships, and trustee relationships. Informal fiduciary relationships develop when the parties have dealt with each other over long periods of time, and a party expects the other to act in its best interests. In Texas, the law sometimes recognizes informal fiduciary duties between shareholders in a limited liability company. Texas courts look to the level of trust and confidence between members to determine if an informal fiduciary relationship exists.
The San Antonio Court of Appeals addressed this issue last summer. In that case, three life-long friends decided to enter the restaurant business. They formed a three-member LLC. A non-managing member invested much more money in the LLC than did the other two managing members. Eventually, the non-managing member learned of double dealing, and outright theft, by the two managing members. The non-managing member filed suit and alleged, among other things, fraud by nondisclosure. However, as a general proposition, fraud by nondisclosure requires a duty to disclose information. This is where the San Antonio Court of Appeals began its fiduciary duty analysis.
The court stated that while Texas law has not yet recognized formal fiduciary duties between majority and minority shareholders in closely held corporations, the nature of relationships between shareholders in LLCs sometimes give rise to informal fiduciary duties. For example, the court in this case found that the two managing members had a relationship of trust and confidence with the non-managing member. All three members had been friends since they were in school. As adults, they vacationed together. They used the same attorney to develop the company agreement. The non-managing member invested $80,000.00 in the LLC, substantially more than the managing members. The non-managing member gave the two managing members complete management control. And finally, the company agreement did not expressly disavow the formation of fiduciary duties. Thus, the court of appeals upheld the trial court’s verdict of $120,000.00 in damages for fraud by nondisclosure.
The limited liability corporation has exploded in popularity. It has many positive aspects for the average businessperson. However, it is important to be aware of any legal obligations you have to other members so that you can protect yourself.