Eliminating Fiduciary Duties in a Closely Held Business

Longstanding Massachusetts law holds that officers, directors, partners, and even equity holders in closely held corporations owe their respective entities and related equity holders a fiduciary duty to act with the utmost good faith and loyalty and “the punctilio of an honor ….” While that might sound eminently reasonable, if one has a fiduciary duty, she can risk personal liability by engaging in a variety of conduct that might seem to make sound business sense and/or appear to be completely benign.

For instance, if an officer of one company causes it to enter into a contract with another, and the officer has an equity interest in the second entity, he is exposed to a claim for self-dealing – even if it appears that the transaction will benefit both businesses. Likewise, a partner who invests in a business similar to her partnership could be sued for a “diverting a business opportunity” if she did not offer her partners an opportunity to participate equally in the investment.

Plainly, therefore, imposing fiduciary duties can have a chilling effect on conduct and transactions that might be good for business or, at least, would not be unfair. Fortunately, however, cases like the recently decided Butts v. Freedman confirm that there are ways to eliminate fiduciary duties that otherwise might impede people from taking various beneficial actions.

In Butts, Mark Butts and Arnold Freedman were equal, 50% equity holders in Boston Equity Advisors, LLC. After working together for more than 12 years, Freedman left BEA and joined a competing business. In response, Butts and BEA sued Freedman for, among other things, breach of fiduciary duty. Freedman defended, in part, by arguing that, based on the language of BEA’s operating agreement, any fiduciary duties he might have had were waived. Indeed, Superior Court noted that fiduciary obligations can be eliminated if an operating agreement “clearly and expressly indicates a departure from those obligations ….” Unfortunately for Freedman, however, the only language in the operating agreement to which he could point indicating that fiduciary duties were waived was the statement that BEA:

[I]s not intended to be a general partnership, limited partnership or joint venture, and no Member shall be considered to be a partner or joint venture of any other Member for any purposes other than foreign, domestic, federal and provincial local income tax purposes, and this Agreement shall not be construed to suggest otherwise.

Not surprisingly, the Court found this provision to fall far short of being “a clear and unequivocal elimination of one member’s fiduciary responsibility to another.” Accordingly, summary judgment was denied.

For in-house counsel, there are several takeaways from Butts. First, be sure that anyone who might have a fiduciary duty is aware of it and also is aware of the broad scope of such duty. Second, explain to the fiduciaries that there is a way to eliminate those duties if they want to do so. And, third, if you are drafting something to eliminate fiduciary duties, be sure that it clearly and expressly says so.

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