Colorado offers a lifestyle that is attractive to many new businesses, and in recent years, we have seen an influx of residents and start-ups seeking to take advantage of all this state has to offer. But business people—and particularly friends entering into business on a handshake or “back-of-the-napkin” deal—should take care to draft business agreements up front in order to avoid the lawsuits that may ensue when disputes arise down the line. One particular area of concern that often times leads to the break-up of a business is a breach of fiduciary duty. But what is a fiduciary duty and how do you know if you are violating it? This series will first address the basics of fiduciary duties, the sources from which those duties come, and the enforcement of those duties. Then, each subsequent Part will address what those duties entail in relation to a partnership, limited liability company, and corporation.
What is a Fiduciary?
A fiduciary is a person having a duty, created by his or her undertaking, to act primarily for the benefit of another in matters connected with the undertaking. Tepley v. Pub. Employees Ret. Ass’n, 955 P.2d 573, 577 (Colo. App. 1997). In other words, a fiduciary is a person who acts on behalf of and for the benefit of another person and in whom that other person places trust. It may be a stockbroker, a real estate agent, a trustee, or a lawyer. Within the context of this series, a fiduciary is a key participant in a business entity, such as a partner, member, or director. In most cases, a fiduciary’s obligations include a duty of loyalty and a duty to exercise reasonable care and skill (see Tepley, supra); however, the specific fiduciary duties involved may be prescribed by statute or a written agreement.
What Fiduciary Duties are Owed?
In the context of a business, individuals may owe fiduciary duties to others, which begs the question—from where do fiduciary duties stem and to whom are they owed? In Colorado, the type of business entity oftentimes determines the fiduciary duties involved.
• Partnerships: The business of a partnership, including a limited liability partnership (LLP) or limited liability limited partnership (LLLP), is controlled by statute (C.R.S. §§ 7-60-101, et seq., 7-64-101, et seq.), and the duties of partners to the partnership and each other are set out in the statute as well. C.R.S. §§ 7-60-121, 7-64-404. The basic concepts laid out in the statute are partners’ duties of good faith and fair dealing, a duty of loyalty to the partnership to put its interests first, and a duty not to compete. These duties extend to the “formation, conduct, or liquidation of the partnership.” These duties will be discussed in greater detail in Part II of this series. While it is advisable to draft and sign a partnership agreement, that partnership agreement may not reduce or eliminate any of these duties, except that it can further describe acts and conduct that do or do not violate these duties. C.R.S. § 7-64-103.
• Limited Liability Companies (LLC): The business of an LLC is also controlled by statute (C.R.S. § 7-80-101, et seq.), and certain duties of members and managers are spelled out in the statutory language. See, for example, C.R.S. § 7-80-404. Similar to a partnership, the basic concepts laid out in the statute are members’ and managers’ duties of good faith and fair dealing, a duty of loyalty to the company to put its interests first, and a duty not to compete. These duties will be discussed in greater detail in Part III of this series. However, an LLC’s Operating Agreement may alter, limit, or address additional duties of the members and managers, so “long as any such provision is not manifestly unreasonable.” C.R.S. § 7-80-108.
• Corporation: The business of a corporation, once again, is controlled by statute (C.R.S. §§ 7-90-101, et seq., 7-101-101, et seq.), and certain duties of directors and officers are spelled out in the statutory language. See, for example, C.R.S. § 7-108-401. Directors and officers owe a duty of good faith and fair dealing, a duty of loyalty to act in the best interests of the corporation, and a duty of care to other directors and officers, to shareholders, and to the company. Intentional misconduct, a knowing violation of law, or “any transaction from which the director directly or indirectly derived an improper personal benefit” potentially subject a director or officer to liability as well. C.R.S. § 7-108-402. These duties will be discussed in greater detail in Part IV of this series. A corporation may and should draft bylaws that further address management of the business and regulation of the affairs of the corporation; however, those bylaws must be consistent with the law and with the articles of incorporation. C.R.S. § 7-102-106. If the bylaws are inconsistent with the articles of incorporation, the articles of incorporation control, and the inconsistent provisions of the bylaws are void.
How are Fiduciary Duties Enforced?
In the event an individual breaches or is thought to have breached a fiduciary duty, those entities or individuals to whom the duties are owed may have a claim in law to recover damages or stop the individual from taking certain action. However, Colorado statutes and law further clarify whether the legal claim belongs to the entity or whether an individual partner, member, or shareholder is entitled to sue directly on his or her own behalf. In many circumstances, the claim belongs to the company, and an individual must file a “derivative action” in the name of the company for the sought-after relief. Derivative actions carry with them their own set of rules, and those involved in a business are cautioned to consult with a lawyer to determine the available remedies and pre-requisites to filing suit.