In this week's Freedom Friday blog and email newsletter, I want to dive a little deeper on a topic I discussed a few weeks ago, and that is why a partnership agreement is a bad idea. One of the reasons why partnerships are a bad idea, in general, as compared with limited liability companies (LLCs), is that general partnerships impose a fiduciary duty on the partners, both to each other, and to the partnership entity. This is also true in a corporation, when one becomes a director or an officer, and not just a mere shareholder. So, in today's Freedom Friday blog and email newsletter, I'm answering the question, “What is a fiduciary duty?”
Let's start with the concept of “fiduciary” to begin with. A “fiduciary duty” exists as a matter of a fiduciary relationship. Fiduciary relationships exist outside the context of general partnerships and corporations. Some examples that you might be more familiar with include the accountant to his client, a financial advisor to his client, a lawyer to his client, and the list goes on. In short, a fiduciary relationship often exists when there is an issue of trust, especially when one party is trusting the other (who is the fiduciary in the relationship) with their money.
A similar relationship exists when business partners get together in a general partnership, or when a corporation elects directors and officers. General partners owe a fiduciary duty to each other, and to the partnership entity. Likewise, officers and directors owe a fiduciary duty to the corporation, and to the shareholders who elected them. So, that's how a fiduciary duty is created. But the next question is what is a fiduciary duty that might be owed in these business relationships. Generally, there are two parts to a fiduciary duty: a duty of loyalty, and a duty of care. The duty of loyalty requires the partner or the corporate officer or director to act in the best interests of the partnership or the corporation, and not in their own best interests. The duty of care requires the partner or corporate officer or director to make sure they do their due diligence before making decisions, and not act in a hasty manner. In other words, if you're a partner in a general partnership, or a corporate officer or director, it's a big deal, and you can expose yourself to legal liability if you mess up.
However, there is a way to avoid a fiduciary duty, and that is to form a limited liability company (LLC) instead of a general partnership, or a corporation. In addition, the concepts of fiduciary duties do not belong in an LLC operating agreement. Unfortunately, I've seen too many LLC operating agreements in which the co-members who own the LLC create a fiduciary duty to each other, and that should be avoided, as well. Unless your operating agreement says otherwise, there is no automatic fiduciary duty in an LLC, and that is why an LLC is better than a general partnership or a corporation, because in an LLC, you can avoid the liability of a fiduciary duty.
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