As I wrote in last week’s column, by far the most important section of the New Hampshire LLC Act aside from its asset protection provisions is Section 2. This section provides as follows:
It is the policy of this act to give the maximum effect to the principal of freedom of contract and the enforceability of operating agreements.
As I also wrote last week, the second most important New Hampshire LLC Act provisions besides its asset protection provisions is arguably Section 107, which provides that the operating agreement of a New Hampshire LLC can provide for the complete elimination of otherwise applicable duties owed by one or more members and managers of an LLC to the LLC and to the other members. These include, above all, the duties of care and loyalty.
When coupled with Section 2, Section 107 opens the door to possibly grave inequities in operating agreements, and the above “enforceability” language in Section 2 can make it impossible for New Hampshire courts to remedy these inequities in the absence of compelling proof of fraud, coercion, or other serious member or manager misconduct.
Why, then, in 2013, did the committee of New Hampshire lawyers – of which I was the chair – include Sections 2 and 107 in the New Hampshire LLC Act? And was our doing so a major mistake?
There is no written legislative history or other evidence as to the reasons why we included these provisions in the New Hampshire LLC Act. But my own sense is that we did so because, at least in the back of our minds, we knew there could be at least a few commonly occurring situations in which the implementation of the sections would be reasonable and fair. In my experience as an LLC lawyer, there are six such situations. I’ll provide hypothetical examples of the first two of these situations below and examples of the final four in my next column (with names and facts concerning my LLC clients changed to protect confidentiality).
1. Mary Jones is the only member and is the manager of MJ, LLC, a single-member LLC.
To provide for continuity of management, her operating agreement provides that if, because of illness or otherwise, she is unable to manage her LLC, her brother Joe will be authorized to manage it. Joe agrees to take this responsibility. The operating agreement provides for no compensation to Joe. However, in recognition of his generosity in being willing to serve as MJ’s assistant manager, MJ’s operating agreement provides that he will have no fiduciary or other duties to MJ.
2. John Smith is an experienced and successful manager in the field of widget manufacturing. Mary Jones forms WM, LLC, to manufacture widgets. She offers John a free membership in WM and a generous share of its profits if he agrees to be WM’s manager. John is willing to accept Mary’s offer, but he is determined to avoid even the slightest risk of being sued by Mary or any other member for alleged mismanagement.
At his insistence, WM’s operating agreement so provides.
Next week: Four more situations in which the extreme freedom of contract of the New Hampshire LLC Act and the elimination of fiduciary duties from multi-member LLC operating agreements may be fair and reasonable.
(John Cunningham is a Concord, NH lawyer of counsel to McLane Middleton, P.A. His practice is focused on LLC formations, general business and tax law, advising clients under IRC section 199A, and estate planning. His telephone number is (603) 856-7172, his e-mail address is lawjmc@comcast.net, and the link to his website is www.llc199A.com.)