The Pennsylvania legislature recently enacted sweeping changes to the law on partnerships and limited liability corporations including fiduciary duty. Known as Act 170, it applies to entities formed on or after February 21, 2017 or to entities which elect to be covered. This article focuses on the Act’s changes to the duties of loyalty and care which members owe to each other and to the company. A significant change under the Act is that for the first time, the Act prohibits entities from contractually limiting their fiduciary duty such that an act between members is reduced to a mere arm’s length transaction and/or a transaction ends up being “manifestly unreasonable.” 15 Pa.C.S.A. § 8815. Between those two goalposts, however, the Act allows companies substantial flexibility to contractually limit their members’ duties to each other and the company.
At the outset, the Act provides that members owe to the company and each other the duties of loyalty, care, good faith and fair dealing. 15 Pa.C.S.A. § 8849.1. The Act explicitly permits companies to limit these duties in the operating agreement as long as the limitations do not completely eviscerate those duties so that the end result is manifestly unreasonable. If a company’s operating agreement does not identify any duties, then the Act provides these duties by default. Members are therefore recommended to contractually limit their obligations to each other to avoid having the broad duties set forth in the Act apply.
The comments to Section 8815 provide an example of how an operating agreement should properly guide a manager who is given sole discretion to make decisions for the company. If the decision would benefit one group of members over another, the manager complies with the Act if she makes the decision with an honest subjective belief that the decision serves the company’s best interests and reasonably believes that the decision does not breach any member’s rights under the operating agreement. Thus, the Act strives to balance the interests of freedom of contract against the problems that arise when members wield power over other members.
For example, a company may provide in its operating agreement that each partner is presumed to act in good faith and that any transactions which are approved by a special committee will not constitute a breach of fiduciary duty. The company may decide to sell off some interests to the detriment of some of its members. To protect itself, the company obtains an opinion from an outside firm which concludes that the sale was fair. Notwithstanding the contractual safe harbors, the injured members may bring a cause of action if the opinion did not consider all of the material facts. Under the Act, the court will decide whether the transaction was manifestly unreasonable. The court is not permitted to re-write the parties’ agreement but instead must determine what the parties’ reasonable expectations were at the time of their agreement. In this example, if the parties could not have reasonably anticipated that the company would rely on a flawed opinion, then the injured members will have stated a claim.
Act 170 provides companies the freedom to contractually limit their members’ duties as long as they act to ensure that their transactions are not manifestly unreasonable. Companies are recommended to review the Act with their counsel to determine whether to amend the duties and standards set forth in their operating agreement and / or to elect to come with the Act’s purview.