New Jersey has followed the national trend in creating the “limited liability company,” (known as “LLC”), as an allowable form of business entity under New Jersey business law. The LLC combines the best elements of both a corporation and a partnership.
The Limited Liability Company
A (Limited liability company combines the best qualities of both corporations and partnerships (or sole proprietorships). Like corporations, but unlike partnerships and sole proprietorships, owners (known as “members” in an LLC) are shielded from personal liability for most corporate debts. However, like partnerships and sole proprietorships (but unlike many corporations, especially larger corporations), LLCs are “flow through” entities. This means that the business itself pays no income taxes. The profits “flow through” to the owners, who are then taxed on the profits as their income. This avoids the “double taxation” of corporations, where the company pays taxes on the profits before they are distributed to the owners, and then the owners pay income tax on the remaining after tax profits when they receive them. So essentially members in an LLC only pay tax once, while shareholders in a corporation pay tax twice, which can result in significantly higher after tax earnings for the owners on the same business revenue.
Limited liability companies were originally allowed over twenty years ago by the New Jersey Uniform Limited Liability Company Act. Then in 2012 the New Jersey Legislature adopted the Revised Uniform Limited Company Act, known as the Revised LLC Act, and the original Act was slowly phased out.
Fiduciary Duties in a Limited Liability Company
Like both shareholders in corporations, partners in a partnership, members in an LLC owe fiduciary duties both to the company itself and to their fellow owners. A fiduciary is one who is in a position of trust toward others, and therefore is held to a higher standard of care. A fiduciary duty is the duty owed by a fiduciary, and it is a higher duty and standard of care than that owed by those who are not fiduciaries.
The fiduciary duties owed by members in an LLC are the duty of care and the duty of loyalty. These duties are defined by statute and case law, but they may be amended by agreement of the members in the LLC’s operating agreement.
The Fiduciary Duty of Care
Interestingly, under New Jersey business law, the duty of care for members in an LLC is lesser than that for shareholders in a New Jersey corporation. Under the Revised LLC Act, unless amended by the LLC operating agreement members are liable for a lack of sufficient care only when their actions constitute “grossly negligent or reckless conduct, intentional misconduct, or willful violation of the law.” This is a low standard of care. So while a member might be liable in some way under general negligence principles, she would not be liable for breach of her fiduciary duties for merely being negligent or careless.
The Fiduciary Duty of Loyalty
The Revised LLC Act generally does not define the duty of loyalty, but largely defers to judicial interpretation of the duty of loyalty, with the caveat that the members may revise this duty in the LLC’s operating agreement.
Under the duty of loyalty, a member or manager must account to the company for her actions. She must hold as a trustee any property or profit gained in her actions as a member or her use of company assets for the company and its members. She also cannot compete against the company. However, these are specific prohibitions. Generally speaking, she cannot do anything to harm the company or its members, or act against their interests.
Often times many of the most bitter legal disputes are those between owners of small and medium size businesses. Owners often spend most of their time working with their co-owners on their businesses. When disputes arise, they can be worse than the breakup of marriages. That is why they are often called “business divorces.” This is no less so in disputes between the members of LLCs.
Our attorneys have decades of experience in business litigation, arbitration and mediation. We try to resolve disputes amicably when they occur, and more importantly to draft operating agreements so that disputes do not occur in the first place. When disputes do arise, however, we fight aggressively for our clients’ rights.
If you have any issues regarding LLC formation, the rights and responsibilities of the owners of an LLC, or disputes among LLC members, call us at (973) 890-0004, or email us. We can help.