As I’ve written in my past two columns, the virtually total freedom of contract that the New Hampshire LLC Act provides to LLC members in drafting their operating agreements and the fact that the Act provides members in these agreements with the right to validly eliminate the fiduciary and other duties of one or more of members or managers can readily lead to abuse. However, in my experience, there are six principal situations in which the members’ use of these provisions may be fair and reasonable. In last Sunday’s column, I provided hypothetical examples of the first two of these situations. Hypothetical examples of the third through the sixth situations are below.
3. Along with some friends, Ann Able forms AA, LLC, and she and her friends pool significant capital in AA to invest in New Hampshire real property they could not invest in as individuals. However, the default rules of the New Hampshire LLC Act provide that the members and managers of New Hampshire LLCs must be loyal to their LLCs and that they must comply with seven separate subsidiary duties of loyalty. The most important of these subsidiary duties are those barring competition against the LLC and requiring members who discover business opportunities that the LLC is capable of exploiting to offer them first to the LLC before exploiting them themselves. All of AA’s members agree in their operating agreement that each of them shall be exempt from these two subsidiary duties of loyalty.
4. Fifteen years ago, Tom Brown began a solo New Hampshire law practice, conducted through a single-member LLC called TB, LLC, as a specialist in bankruptcy law. His practice was very successful, and he eventually hired two younger lawyers as employees. These lawyers have performed excellently for TB, and Tom decides, both as a reward to them and to preserve their loyalty, to admit them as minority members of his LLC. However, he is aware of how quickly even the best of business relationships can turn bad, so he provides in TB’s operating agreement as a multi-member LLC that while his two employees, as members, will have duties of care and loyalty toward TB and him, he will have no such duties to TB or the two of them.
5. Elizabeth Evans and three friends form a New Hampshire LLC, called EE, LLC, to provide financial consulting services. They agree that they should all be subject to duties of care and loyalty. However, Section 109 of the New Hampshire LLC Act, entitled “business judgment rule” provides, in effect, that members seeking to prove claims that that members or managers have breached their duty of care must bear a heavy burden of proof. EE’s members agree to override Section 109 in their operating agreement.
6. Nancy Norris forms a multi-member LLC, NN, LLC, of which she is the majority owner.
In order to obtain the various special benefits available from the Small Business Administration and other federal and state authorities, the operating agreement must provide her with virtually complete domination of NN. On the basis of Sections 2 and 107 and other New Hampshire LLC Act provisions, NN’s operating agreement so provides.
As noted, all of the above hypotheticals are based on my own experience (but, needless to say, with names and other facts changed to protect client confidentiality). There may well be at least a few other situations in which the application of Sections 2 and 107 will be appropriate and in which LLC lawyers should recommend the implementation of these sections in their clients’ operating agreements. If you know of any such situations, please let me know. I’ll make note of them, with attribution, in future columns.