Monday, March 10, 2014

What Exactly Do You Mean by "Fiduciary"?

Because it is not uncommon for design-build teams to be either single purpose LLCs or joint ventures, issues arise with respect to the enhanced duties implied under the law for these entities.  When design-build teams create these relationships, the obligations are different than those of parties to the garden variety or “arm’s length” contract.  When parties are members of an LLC or joint venture, they have a higher duty toward the other joint venturers or LLC members, known as a “fiduciary” duty.  When discussing this issue in the DBIA Contracts and Risk course, my usual line is that fulfilling a fiduciary obligation includes a requirement to put the interest of their partners over their own interests.  However, when asked for specific fact situations, I am often hard pressed to describe the type of obligations included in the fiduciary duty.  In a new case, the Federal District Court in Seattle provides some insight into how fiduciaries in an LLC created for a design-build project can get into trouble. 

In Kumar v. Entezar, 2014 WL 352960 (W. D. WA 2014), the parties created a single purpose LLC to acquire property and design and construct single family homes.  Entezar owned one of the LLC members and was appointed as the manager of the single purpose entity.  Kumar owned the other member of the single purpose entity.  Kumar brought a claim of breach of fiduciary duty against Entezar.  Although the procedural posture of the case had not sufficiently progressed to allow the court to make a holding with respect to the facts in the case, the court did note some potential actions that may give rise to a breach of fiduciary duty claim.  These actions include a conflict of interest through contracting with a related company and obtaining an unauthorized profit through the related company, hiring a manager for the LLC without obtaining the consent of the other LLC member and finalizing a design-build contract without obtaining the consent of the other LLC member.  The court noted that the parties’ fiduciary obligations to each other did not prohibit contracting with related entities; however, any contract with a related entity had to meet a commercially reasonable standard and the potential conflict of interest and profit pursuant to that contract would have to be disclosed to the other LLC member.  If, by contrast, the parties had entered into an arm’s length contract (such as a prime/subcontractor or subconsultant agreement), rather than an LLC with the additional fiduciary obligations, there would be no obligation to make such disclosures. 
The bottom line is that parties with fiduciary obligations need to be cautious about any actions taken during the course of the management of the project because their duties go beyond what is specifically defined in the LLC documents or the joint venture agreement.  One party cannot profit at the expense of the LLC without the other party knowing about the additional compensation and consenting to the transaction.  In these cases, over disclosure is the best course of action.

The DBIA has two upcoming conferences:  The Water/Wastewater Conference is scheduled for March 17-19, and the Transportation Conference is scheduled for March 19-21, both at the San Jose, CA Convention Center.  These conferences are always well produced and are specifically tailored to individuals in these market sectors.  More information can be found at:  http://www.dbia.org/Conferences/Pages/default.aspx 

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