Partners have a fiduciary relationship with each other. accordingly, a partner

Does your business partner owe you anything? We’re not talking about money, although that may be an ultimate outcome, we’re talking about how they treat you. Do they owe you any duty to be fair or to bring business opportunities to your company? Whether you are a shareholder in a small, closely held corporation or a member in a limited liability company, the answer to this question is yes, with some exceptions.

Every small business owner, again, whether be it a corporation or limited liability company, has a fiduciary relationship with the other business owners. What is a fiduciary relationship? A person who is a fiduciary is someone charged with a legal and/or ethical relationship of trust with one or more other persons. A fiduciary duty, in turn, is the highest standard of care that can be imposed on someone. A fiduciary is required to be loyal to the beneficiaries of that duty and there must be no conflict of interest between the fiduciary and beneficiaries. The fiduciary cannot profit personally from his position as a fiduciary.

Since each shareholder or limited liability company member owes each other a fiduciary duty the responsibility is reciprocal. Therefore, as a small business owner, you owe a fiduciary duty to your other partners whether you own 60% of the company or 5% of the company and they also owe you a reciprocal fiduciary duty.

The fiduciary duty has several components. One such component is a duty of care. Those in charge of running a business are required to understand the business and to exercise ordinary care in its operation. There is s Business Judgment rule which operates to give wide protection to the decisions made when running a business as long as they are made in good faith. Engaging in grossly negligent or reckless conduct, intentional misconduct or a knowing violation of law will constitute a breach of the duty of care.

Another component of the fiduciary duty is the duty of loyalty. This is the most fundamental aspect of the fiduciary duty and under the duty of loyalty the other business owners cannot solicit the company’s customers or otherwise compete with the company for their own benefit. How many times have you heard the story of your friend whose business partner went out and started a competing business, stealing many of the customers of your friend’s business? It happens frequently and, while New Jersey favors open competition, even that has limits. All may be fair in love and war, but not in business. If your partner has used business assets, either information, personnel or resources to engage in a competitive business, they have breached that duty of loyalty.

In many instances you may already be engaged in one business and have an idea to enter into a new line of business and want to bring in a partner. This can create issues later if the two businesses are similar or share one or more lines of business, but you can protect yourself with proper planning in the beginning. Business owners can make an agreement among themselves that allows for competition with the business by one or more owners, even if that other business would be a direct competitor, however, that agreement needs to be in writing and as specific as possible about what competition is permitted and what is not.

Accordingly, when starting a new business with others or bringing in new owners to your existing business, you need to carefully examine all possible scenarios and proper up front planning can avoid substantial legal woes later.

A partnership involves people carrying on a common business for profit. Partners in a partnership are fiduciaries to each other. This relationship means that they owe each other, and the business, certain basic duties.

Partners stand in a fiduciary relation to one another in all matters pertaining to the partnership. The partnership relation is one of trust, loyalty and confidence. It imposes upon the partners the highest standards of good faith, the duty to act for the common benefit of all partners in all transactions relating to the business and the duty to refrain from taking any advantage of one another by the slightest misrepresentation, concealment, threat or adverse pressure of any kind.

Full Disclosure

Partners are required to disclose fully all information relating to the business. This fiduciary relationship partners bear to each other means that if a partner gets any benefits from the partnership, he or she must share them with the other partners according to the terms of their partnership agreement.

Such disclosure may include contributions made, contracts entered, the valuation of a partner’s interest or the availability of a business opportunity in which the partnership may be interested. Full disclosure is particularly important when the business may be sold to one of the partners or to an outsider.

In the context of the sale of the business, this means that no partner can seek to benefit him or herself by the sale, to the detriment of the other partners. If that occurs, the other partners can sue to obtain their fair share of the benefits, whatever those might be.

Continuous Obligation

The obligation of utmost good faith begins with the preliminary negotiations in forming the partnership and continues throughout the life of the partnership, extending to the dissolution and complete settlement of the partnership affairs. Even when relations between partners have become strained, the partners must continue to exercise the highest standard of good faith in all transactions relating to the partnership business.

Breach of Fiduciary Duty

A breach of fiduciary duty occurs when a partner profits or acquires another type of benefit as a result of one of three things:

• Having a conflict of interest
• Having a conflict of duty
• Taking advantage of being a fiduciary
• Conflict of Interest

As a fiduciary, a partner cannot put his or her interests before those of the business. Furthermore, a fiduciary cannot perform actions that are not in the best interests of the business.

Conflict of Duty

As a fiduciary, a partner cannot have conflicting fiduciary duties. For instance, a real estate agent cannot represent a buyer of a house if the agent’s company represents the party selling the house because each party’s best interests cannot be represented.

Taking Advantage of Being a Fiduciary

As a fiduciary, a partner cannot profit as a result of taking advantage of their position. Opportunities for fiduciaries may arise because of their position, and they must make known to all partners any profit they receive as a result of being in the position they are in. The fiduciary can keep the profit only if the other partners give their consent.

Duty Owed Not Limitless

The extent of the fiduciary duty owed between partners is not limitless. The duty varies depending on the circumstances. For example, if a physician is both a partner in a health service partnership and also an independent contractor employed by the partnership, termination of the physician’s contract by the partner-hospital, with the consent of two other partners, as per the terms of the contract, would not be a breach of the hospital’s fiduciary duty to the physician.

Presumption of Fraud or Undue Influence

Where a confidential relationship exists between parties, as in a partnership, a presumption of fraud or undue influence arises where one of the parties has obtained an individual advantage or benefit by virtue of his or her fiduciary status. Such partner then has the burden of rebutting or countering that presumption by showing that he or she has not violated any fiduciary obligations. An offending partner is entirely responsible for any losses suffered by the partnership which were caused by the bad faith of that partner.

General Partners Accountable to Limited Partners

General partners have sole control of the business of the partnership, and are the only ones who can act on its behalf. Thus, they are accountable to the limited partners as fiduciaries. For example, a general partner would breach his or her fiduciary duties by failing to notify the limited partners of the sale of a partnership asset. As a general rule a general partner may not take for himself or herself a business opportunity which should be shared with the partnership. However, a general partner’s obligation to the partnership and the limited partners is not exclusive, and the general partner has the right to participate in similar business ventures to the extent that there is no conflict of interest.

Partnership Funds Must be Used for Partnership Purposes

General partners may not exceed the authority granted to them in the partnership agreement to use partnership funds for anything other than partnership purposes. Creditors who make loans to a general partner with knowledge that the loan will render the partnership insolvent or will breach the partnership agreement may not rely on the apparent authority of the general partner in pursuing any related claims against the partnership.

In a business partnership, under the California Partnership Act, there are two specified fiduciary duties – a duty of loyalty and a duty of care.

Duty of Loyalty:

Duty to Account

A partner may not appropriate benefits from the partnership without the other partners’ consent and may not usurp a partnership opportunity.

If you need any further clarification regarding Fiduciary Duties of Business Partners, please contact us at (310) 477-7767 or fill out the form here.

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