Fiduciary Duties in a Closely Held Company: What the Owners Owe Each Other
The owners of a closely held company are not free to treat the business purely as their own. The people who manage or control the company, and in some circumstances controlling owners, may owe legal duties to the company and to the other owners. Those duties constrain how the business can be run, what the controlling owners can do with company assets and opportunities, and how the majority can treat the minority. When owners fall out, these duties are often the framework a court uses to decide whether someone crossed a line.
The precise contours of these duties depend on the type of entity and the state whose law governs it. A corporation and a limited liability company are treated differently, and the rules vary from state to state. This post describes the general framework rather than the law of any particular jurisdiction. It uses “shareholder” for the owners of a corporation, though some states and much of corporate practice use “stockholder,” and the terminology for the owners and managers of an LLC varies as well. For any specific company, the governing statute and the entity’s own documents control, and those should be confirmed rather than assumed from a general description.
With that framing, here is what the owners of a closely held company generally owe each other, how the duties differ between a corporation and an LLC, and how far the owners can change the default rules by agreement.
The Core Duties: Care and Loyalty
Fiduciary duties in a business generally fall into two categories. The duty of care requires the people running the company to act with the diligence and attention a reasonably prudent person would use in similar circumstances. It is a duty to be informed, to pay attention, and to make decisions on a reasonable basis, rather than carelessly or recklessly. The precise standard varies by entity and jurisdiction. Corporate statutes often frame the duty in terms of reasonable prudence, while some LLC statutes impose a narrower default standard. In practice, the duty of care sets a floor for the conduct of those managing the business, and honest decisions made on a reasonable basis are generally protected even if they turn out badly.
The duty of loyalty is typically the most consequential of the two in owner disputes, and it is the one at the center of most of them. It requires those who control the company to put the interests of the company and its owners ahead of their own personal interest. The duty of loyalty is what prohibits self-dealing without proper approval, taking for oneself an opportunity that belongs to the company, competing with the company, and using company assets or information for personal gain. When one owner accuses another of enriching themselves at the company’s expense, the duty of loyalty is usually the legal principle in play.
A recurring loyalty issue in closely held companies is the related-party transaction: the company buys from, sells to, leases from, or contracts with an entity that a controlling owner also owns. These transactions are not automatically improper, but they carry a loyalty concern because the controlling owner sits on both sides. Common protections include approval by disinterested decision-makers and ensuring that the terms are fair to the company, so that the transaction can withstand a later challenge that the controlling owner used the company to benefit themselves.
Who Owes the Duties, and to Whom
In a corporation, the directors and officers owe fiduciary duties to the corporation and its shareholders. They are the people entrusted with running the company, and the duties attach to that role. A passive shareholder who holds stock but does not manage the business generally does not owe fiduciary duties simply by virtue of owning shares.
There is an important exception. A controlling shareholder, one who has sufficient voting or other control to direct the company’s affairs, can owe fiduciary duties to the minority shareholders in many circumstances, particularly when the controller uses its control in a way that affects the minority. This is the principle that protects minority owners in a closely held corporation from being squeezed out or having value diverted away from them by the majority. The controlling shareholder cannot use its control purely for its own benefit at the minority’s expense.
In an LLC, the analysis depends heavily on how the company is managed. In a manager-managed LLC, the managers typically owe fiduciary duties similar in concept to those of corporate directors and officers, while members who are not managers may owe few or no duties in their capacity as members. In a member-managed LLC, the members are running the business, so the duties generally attach to them in that role. The management structure the LLC adopts therefore shapes who owes duties to whom, which is one reason the choice between member-managed and manager-managed is more than an administrative detail.
Because the details vary by state and by the specific management structure, the practical point is to identify, for a given company, who actually owes duties. That turns on the entity type, the governing statute, and how the company is managed, and it is worth confirming rather than assuming, because the answer determines who can be held accountable if the business is run for one owner’s benefit at the expense of the others.
How Far the Owners Can Change the Default Rules
This is where the corporation and the LLC diverge most sharply, and it is one of the most consequential differences between the two forms.
Corporate fiduciary duties are generally not something the owners can freely contract away. Corporate law tends to treat the core duties, particularly the duty of loyalty, as a fixed feature of the form. There are mechanisms in many states to limit certain liability, such as provisions that reduce exposure for some breaches of the duty of care, but the ability to eliminate the duty of loyalty outright is generally limited. A shareholder in a corporation can usually count on the core fiduciary framework being present whether or not the governing documents say anything about it.
The LLC is different, and this is one of the defining features of the form. LLC statutes in many states allow the operating agreement to modify, and in some states substantially eliminate, the default fiduciary duties, within limits the statute sets. This flexibility is a feature of the LLC, chosen deliberately to let sophisticated parties define their own relationship. It also means the default duties an LLC member might expect can be reduced or reshaped by the operating agreement, sometimes significantly. An LLC member who assumes the same protections a corporate shareholder has may be mistaken, because the operating agreement may have altered them.
Even where the statute allows broad modification, some limits generally remain. A statute that permits broad modification of fiduciary duties commonly still preserves an implied covenant of good faith and fair dealing that cannot be waived. That covenant is not the same as a full fiduciary duty, and it is generally narrower, but it means an LLC member is not left entirely without protection even under an operating agreement that reduces the express duties. The precise limits on what can be waived, and what the implied covenant requires, depend on the governing statute.
The practical consequence is that in an LLC, the operating agreement has to be read to understand what duties actually apply. The default rules are a starting point, and the operating agreement may have moved them. This connects directly to the broader point about closely held companies: the governing documents are where the owners’ relationship is actually defined, and in an LLC that includes the fiduciary duties themselves, not just the deadlock, transfer, and buy-sell terms that owners more often focus on.
Why This Matters Before a Dispute
Fiduciary duties usually become a live issue only when owners are already in conflict. By then, the question is whether conduct that has already happened breached a duty, and the answer depends on rules that were set long before, when the entity was formed and its documents drafted. Understanding the duties in advance lets the owners operate within them and structure the documents deliberately, rather than discovering the framework only when someone invokes it.
For the owner who controls or helps run the company, the duties are a standard of conduct to be aware of and to observe: keep the company’s interests ahead of personal ones, handle related-party transactions with proper approval or on fair terms, and avoid taking company opportunities or assets for personal benefit. Observing the duties is not only a legal obligation but a practical way to avoid the disputes that arise when a minority owner believes the controller is enriching itself at the company’s expense.
For the minority owner, the duties are a source of protection, but a source that varies with the entity and the documents. A minority shareholder in a corporation generally has the protection of the controlling shareholder’s duties as a baseline. A minority member in an LLC has to read the operating agreement to know what protection actually remains, because the duties may have been modified. The minority owner’s real position depends on knowing which duties apply, and that is a question to answer at the outset, not after a dispute has begun.
The Takeaway
The owners who control a closely held company generally owe duties of care and loyalty to the company and, in the case of a controlling owner, often to the minority. Those duties constrain self-dealing, the taking of company opportunities, and the use of control to benefit the majority at the minority’s expense, and they operate whether or not the owners have thought about them.
How those duties apply depends on the entity type, the governing state’s law, and, for an LLC, how the company is managed and what the operating agreement says. A corporation carries a relatively fixed fiduciary framework. An LLC allows the operating agreement to reshape the default duties, which makes reading that agreement essential to knowing what the owners actually owe each other. In both cases, the time to understand the duties, and to draft the documents with them in mind, is at formation, rather than after a dispute has made every rule a matter of contention.
This post is general information only and does not constitute legal advice. The application of fiduciary duties depends on the specific entity, its governing state law, and its documents. For questions about a particular company, contact Cruxterra Law Group.
