When it comes to an entity, the people in charge (officers) owe a duty of loyalty to the company and its owners. Today, we will define the Duty of Loyalty that officers owe to an entity.
The duty of loyalty requires an officer to act in good faith in carrying out the duties of the officer. That means, officers cannot allow personal interests to prevail over interests of the LLC and the LLC’s members.
An example would be if there was a proposal that the LLC run by an officer enter into a transaction which benefits the officer, but would not necessarily be in the best interest of the LLC. These situations when the officer’s interests conflict with the LLC or its members can lead to violations of the duty of loyalty. Transactions where an individual stands to benefit from a transaction with an entity are called “self-dealing” transactions. Though they are not prohibited, the best way to avoid any issues of violating the duty of loyalty is that the officer who stands to benefit from the transaction should:
- fully disclosethe personal benefit that will be gained from the transaction;
- obtain approval from disinterested officers and members of the company;
- make sure that the transaction, even though it benefits the officer, is fair to the LLC and its members.
Another issue that comes up in discussions of the duty of loyalty is whether an officer can engage in competition with the entity. This often comes up when an officer, who is skilled in the industry of the entity which he manages is approached with an opportunity to consult or invest or otherwise pursue a venture which could be in competition with the entity in which he is an officer. This is called the business opportunity doctrine. The duty of loyalty does not require the officer to forego the business opportunity, but the opportunity should be presented to the entity in some way or there must be some other evidence that the opportunity would not have been a viable option for the entity.
Of course, in the instance of a business opportunity, there could be other contractual duties imposed on the officer which would make the officer unable to partake in the business opportunity.
For officers of any entity, the duty of loyalty must be followed. The officer is to look out for the best interests of the entity first. Any personal benefit derived should also benefit the entity or should be approved by others in the entity who do not stand to benefit from the transaction.