Partnership / Member / Corporate Disputes / Partnership Fraud

The law in Texas was once that business owners owed each other true fiduciary duties, but by statute and cases those duties are now largely described in categories that are similar to fiduciary duties. The Texas Business and Organizations Code describes the law governing Texas business entities, and the rules and law for each entity are similar but have some differences. But irrespective of the law, when entities are formed, the formation documents can, by agreement of the people forming the business, create true fiduciary duties. So the first step in analyzing whether or not a business owner has breached their duties to the other business owners is to look at any governing documents, such as the articles, bylaws, LLC agreement, partnership agreement, etc.

Concerning corporations, the cases generally recognize that corporate directors owe the corporation a duty of obedience, a duty of care, and a duty of loyalty. See Ritchie v. Rupe, 443 S.W.3d 856, 868 (Tex. 2014). The duty of loyalty that officers and directors owe to the corporation specifically prohibits them from misapplying corporate assets for their personal gain or wrongfully diverting corporate opportunities for themselves. See Ritchie v. Rupe, 443 S.W.3d 856, 887 (Tex. 2014). Generally, the duty of obedience requires that the director act on authority from the corporation, but corporate powers are generally quite broad. Concerning the duty of care, this is not exactly as clear under the law as it needs to be, but generally corporate directors cannot commit fraud or illegal acts that harm the corporation. As to the duty of loyalty, common examples of breaches of that duty are self-dealing or where a director usurps a corporate opportunity. Essentially, when the director is taking actions that benefit himself or herself at the expense of the corporation, they can be liable for breaching the duty of care. One phrase that is mentioned quite a bit in this area is the “Business Judgment Rule,” which can protect directors when they act in good faith exercising business judgment. Directors, like all, are imperfect, and the law attempts to strike a balance between good faith judgmental errors and bad faith fraudulent or self-dealing actions. Another area where litigation can arise in the corporate area is where a corporation denies access to the corporation’s books and records. The Texas Legislature has expressly protected a corporate shareholder’s right to examine corporate records, provided penalties for a violation of those rights, and has identified applicable defenses in an action to enforce those rights. See Tex. Bus. Orgs. Code § 21.218, for instance.

For LLC’s, or Limited Liability Companies, although the statute does not define or expressly impose fiduciary duties on managers or members of an LLC, it is generally understood that a manager or managing member of an LLC owes a duty of care to the LLC. Generally this duty is imposed by agency principles – meaning that the manager or managing member is an agent of the LLC and has duties as an agent to the LLC. And like the corporate context, it is generally understood that a manager or managing member of an LLC would have a duty of obedience, a duty of loyalty, and a duty of care.

For partnerships, general partners owe to the partnership and the other partners a duty of loyalty and a duty of care. Tex. Bus. Org. Code § 152.204(a). A partner’s duty of care to the partnership and the other partners is “to act in the conduct and winding up of the partnership business with the care an ordinarily prudent person would exercise in similar circumstances.” Tex. Bus. Org. Code § 152.206. This is more than a mere error of judgment – acting in good faith, on an informed basis, and in a manner the partner reasonably believes to be in the best interest of the partnership is often good measure and helps provide a presumption that the partner is adhering to his or her duty of care. But the specific facts of any situation often shed light on whether liability would exist or not. A partner’s duty of loyalty includes (1) accounting to and holding for the partnership property, profit, or benefit derived by the partner; (A) in the conduct and winding up of the partnership business; or (b) from use by the partner of partnership property; (2) refraining from dealing with the partnership on behalf of a person who has an interest adverse to the partnership; and (3) refraining from competing or dealing with the partnership in a manner adverse to the partnership. Tex. Bus. Org. Code § 152.205. Limited partners owe less duties, as a general rule, than general partners, in usual contexts. When limited partners have other fiduciary relationships and/or begin acting outside their status as a limited partner, liability can sometimes arise.

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