Over the last decade or so, the National Conference of Commissioners on Uniform State Laws (NCCUSL) has promulgated a series of uniform laws dealing with unincorporated business entitites. The Uniform Partnership Act (1997) (RUPA), the Uniform Limited Partnership Act (2001) (ULPA (2001)), and the Uniform Limited Liability Company Act (1996) (ULLCA) are recent and important iterations of these uniform laws. One or more of these Acts have been adopted in many states and are certain to garner additional adoptions in the coming years.
Each of the Acts contains provisions that prescribe the fiduciary duties of the entity's managers. The managers' duties are articulated in the familiar terms of duties of care and duties of loyalty and are largely default rules that are subject to opt out rights by the parties. The fiduciary duty provisions are essentially identical in all three of the Acts.
The fiduciary duties in these Acts are to a significant degree unsatisfactory. In various and important ways, they promote outcomes that are unfair and inefficient.
The duties of care and loyalty in RUPA, ULPA (2001) and ULLCA are excessively pro-management. They seem designed to promote managers' pecuniary interests in achieving an inefficient and unfair bargain with the entity's investors regarding the nature of managers' fiduciary duties. The statutory standards themselves are overly lax and limited. The standards offer inadequate protection for the legitimate interests and expectations of investors regarding the standards of care and loyalty that they are due from their managers. The opt out provisions in the Acts offer managers the opportunity to exacerbate this bad situation by further exploiting informational asymmetries and thus capturing for themselves additional pecuniary gains by constructing an even more inefficient and unfair bargain with their investors.
The fundamental problem with the Acts' fiduciary duty standards is that they abandon widely-accepted and morally and economically pleasing principles. These abandoned principles are founded on consent and provide, for example, that in the absence of third-party effects, parties-in this case managers and investors-should be permitted to fashion their own arrangements with one another and that the rules of society should promote outcomes consistent with this idea.
Measured against the principles of actual or inferred consent, the fiduciary standards in the acts fail to pass muster. It is difficult to imagine that most investors, if fully informed, would consent to default standards of care and loyalty as law and limited as those contained in the Acts. It is even more difficult to imagine that investors, if fully informed, would consent to even lower standards that are permissible under the opt out provisions of the Acts. I short, the fiduciary standards contained in the Acts promote outcomes in which parties, who are less than fully informed, are saddled with terms that are not fully priced.
Public choice theory (also called interest group theory) offers an economic explanation for the extent to which interested groups are able to influence the outcome of legislative action. The theory posits that a smaller, cohesive interest group will have more influence on the outcome of legislation than a competing larger, diffuse group, even though the larger group as a whole may value the legislation more than the small group as a whole.
At first blush this theory seems problematic at best, since a group that stands to gain the most in total seemingly could expend the most resources to obtain their preferred legislative rule. Public choice theory, however, explains this counterintuitive outcome by reference to the problems and expense of collective action. It simply costs more to form and manage a large group than it does a small group. Free rider problems also increase with the size of the group. Members of large groups become more likely to hang back, hoping others in the group will commit sufficient resources to obtain the preferred outcome, enabling the non-participants to free ride on the contributions and work of the participating members of the group.
These collective action problems can explain why it is nearly impossible for investors in unincorporated businesses to obtain, for example, their preferred standard of care for managers in the uniform acts. The investors' group would consist of all investors in all unincorporated businesses, which is obviously a huge group. Concerted action by this group with regard to rules promulgated by NCCUSL or adopted by state legislatures involves overwhelming transaction costs and free rider problems.
Whatever may be the reason, the fiduciary duties in the uniform acts for unincorporated business entities are substantially flawed by a pro-management bias. This article, therefore, makes the case for rethinking these important duties and offers a number of first principles as bases from which to revise the fiduciary duties respecting partnerships, limited partnerships, and limited liability companies. The principles I offer are simple and generally uncontroversial. The principles illuminate the failure of the present fiduciary standards in RUPA, ULPA (2001) and ULLCA and offer guidance toward better fiduciary duty rules that promote fair and efficient outcomes.
In Part I of this article, I articulate my first principles, which should be the bases for fair and efficient fiduciary duty rules. In Part II, I use those principles to demonstrate the failings of the fiduciary standards presently found in the uniform acts and to support the revisions that I offer for those fiduciary standards.