Partners in partnerships, LLCs, and other business ventures owe each other the utmost duties of loyalty and care. These duties are called “fiduciary duties.” In partnerships, which are generally governed by the Revise Uniform Partnership Act (1997), fiduciary duties of care and loyalty are owed to other partners, as well as a general duty of good faith and fair dealing, and duties with respect to information. See R.U.P.A. § 404. If you are in business with another person, and you share profits and losses, you owe that person fiduciary duties of care and loyalty. No matter what. These duties exist even in the very earliest stages of entrepreneurship, and these are two duties you do not want to mess with.
A Partner’s Fiduciary Duty of Care
A partner’s fiduciary duty of care is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law. Under RUPA, the standard is generally gross negligence. Partners are not necessarily liable for ordinary mistakes in judgment. A partnership agreement may change the duty of care, but may not unreasonably reduce it. A breach of fiduciary duty can give rise to not only actual damages, but also punitive damages. This is the essence of a fiduciary duty, and the reason partners should always observe fiduciary duties to other partners.
A Partner’s Fiduciary Duty of Loyalty
Partners also owe each other a fiduciary duty of loyalty. The touchstone of this rule was stated in Cardozo’s opinion in Meinhard v. Salmon:
“[j]oint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty… Something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.” Meinhard v. Salmon, 164 N.E. 545, 546. (N.Y. 1928).
In other words, a partner may not profit at the expense of another partner, either directly or indirectly. According to this duty of loyalty, without the consent of the partnership, a partner cannot:
- Compete with the partnership; R.U.P.A. § 404(b)(3));
- Take business opportunities from which the partnership might have benefitted or that the partnership might have needed;
- Use partnership property for personal gain. R.U.P.A. § 401(b)(1) requires the partner to disgorge any gain obtained without the consent of the partners; R.U.P.A. § 401(g), (b)(1)
- Engage in a conflict-of-interest transaction. R.U.P.A. § 404(b)(2).
In contrast to corporate fiduciary duties, which run from the management to the shareholders, in partnerships the fiduciary duties run to all partners, including passive investors.
A Partner’s Duty of Good Faith and Fair Dealing
Partners also owe each other a duty of good faith and fair dealing. R.U.P.A. § 404(d). This is not a fiduciary duty, but is important nonetheless. The duty of good faith and fair dealing includes both procedural and substantive fairness.
A Partner’s Duty to Disclose Information to Other Partners
Finally, partners have a duty to disclose material information to other partners, even without asking. All partners have full access to books and records at all times. Information that a partner needs to exercise his rights and duties under the partnership must be disclosed to other partners without asking. R.U.P.A. § 403. All partners should rigidly observe these duties. Breaches can lead to penalties for actual damages, and punitive damages.
Most partners may not realize these duties are owed to one another, but breaking them can lead to huge penalties. Just remember the Golden Rule and you should be fine. More information is available in Argyle Publishing’s Attorney’s Handbook on Small Business Organizations.