The degree to which business participants ought to be free to limit or eliminate fiduciary duties and associated liabilities remains a hotly contested matter in many jurisdictions. In a new chapter forthcoming in Edward Elgar’s Research Handbook on Fiduciary Law, I explore the extent of contractual freedom to opt out of the fiduciary governance paradigm in U.S. and U.K. business entities, including the U.S. corporation, general partnership, limited partnership, limited liability partnership, and limited liability company, and the U.K. limited company, general partnership, limited partnership, and limited liability partnership. I then consider potential explanations for observed divergences between two countries with very similar legal systems and business cultures.
Discernible trends and commonalities certainly emerge from this analysis. Notably, corporate law readily permits reducing liability exposure for breaches of duty in each jurisdiction, yet provides only limited capacity to carve back the substance of the duties themselves. Meanwhile, unincorporated entities in each jurisdiction offer substantially greater latitude to limit the duties themselves, in some cases resulting in purely contractual business relationships.
However, substantial differences are also apparent. U.S. corporate law permits greater insulation from liability exposure. Unlike U.K. companies, U.S. corporations can eliminate directors’ monetary liability for duty of care breaches. Meanwhile, U.S. law permits clearer and more extensive latitude for unincorporated entities to eliminate the duties of loyalty and care outright – particularly in Delaware, the most prominent U.S. jurisdiction for the organization of business entities. Under U.K. law, on the other hand, general partnership and limited partnership statutes permit certain statutory duties (including duties to account for profits arising from use of partnership assets or competing businesses) to be limited or eliminated, yet broader non-statutory duties of loyalty and care remain.
One cannot comprehensively declare that U.S. law deviates further from the fiduciary governance paradigm than U.K. law does, however, because among more recent hybrid entities – designed to combine corporate and partnership attributes – the balance arguably reverses. While default duties of loyalty and care can be eliminated in Delaware unincorporated entities, the U.K. limited liability partnership has gone further by providing an entity form in which no such general default duties apply at all. This striking and unexpected divergence stands in tension with received wisdom regarding the relative embrace of contractarian ideas in each country, and the chapter offers reflections on why the observed trends, commonalities, and divergences may have arisen – including in the dynamic context of hybrid entities.
The most consequential U.S. development in the law of business organizations over recent decades has been the rise of the limited liability company (LLC) – a hybrid entity combining corporate-style limited liability with partnership-style pass-through taxation and contractual flexibility. The limited liability partnership (LLP), meanwhile, represents another U.S. hybrid entity, grafting limited liability onto the general partnership to insulate partners from vicarious liability – a protection aimed principally at professional firms.
Subsequently the United Kingdom developed its own form of LLP, and the impetus resembled that of its U.S. namesake – insulating professionals from vicarious liability. The resulting legal form differs starkly, however, because the U.K. LLP is in fact an incorporated entity drawing from both partnership law and company law in a manner more closely resembling the U.S. LLC. Indeed, midstream in its development, it was determined that the U.K. LLP ought to be made available to any form of business. The U.K. LLP offers limited liability like a company yet is taxed like a partnership, and offers substantial contractual freedom to structure the business as the participants consider desirable.
Notwithstanding the partnership moniker, the Limited Liability Partnerships Act 2000 expressly provides that partnership law does not apply by default to an LLP, although regulations enacted by the secretary of state may draw from partnership law as a gap-filler. While the LLP Act does not speak directly to duties among the members and the LLP, duties to account for benefits derived without consent from transactions involving the LLP or from competing businesses have been applied by regulation. These mirror statutory partnership duties, yet the LLP Act does not at the same time preserve broader non-statutory duties as the Partnership Act 1890 (applicable to general partnerships) does.
Due to the LLP’s complex and accretive development, uncertainty long persisted regarding to whom duties of loyalty and care might be owed and how much contractual freedom there might be – particularly given the lack of any express authorization to eliminate such duties or an express pro-contract policy statement of the sort found in Delaware’s unincorporated entity statutes. In 2011, however, the High Court of Justice, Chancery Division, addressed this issue, concluding that no such default duties apply in a U.K. LLP. In F&C Alternative Investments (Holdings) Ltd. v. Barthelemy ( EWHC 1731 (Ch)), Mr. Justice Sales emphasized that, notwithstanding the name, the U.K. LLP is in fact an incorporated entity; that partnership law has no default application; and that the rights and duties among members are expressly to be governed by their agreement, concluding on this basis that the relationship among LLP members is not fiduciary by default. This holding makes clear that the U.K. LLP offers a degree of contractual freedom rivaling the U.S. LLC, and perhaps even exceeding it. While Delaware LLCs expressly permit elimination of such duties among members, it is equally clear that they apply with full force by default. In U.K. LLPs, however, the default is reversed – no such duties apply at all, unless the members affirmatively agree to them.
What sense can be made of the observed divergences? As to the greater flexibility of U.S. corporate law, one potentially relevant variable is the manner in which each system conceptualizes corporate power. U.K. company law is considerably more shareholder-centric in nature, styling the board’s power as a literal delegation from shareholders. Likewise, U.K. shareholders possess extraordinary governance powers relative to their U.S. counterparts. Stronger fiduciary duties, promoting single-minded focus on the shareholders’ interests, would seem consistent with this more shareholder-centric governance structure.
Another potentially relevant variable relates to prevailing perceptions regarding the litigation environment. While the degree of divergence in liability exposure facing U.S. and U.K. directors is often exaggerated, U.S. exculpation statutes clearly trace their origins to the Delaware Supreme Court’s unfortunate 1985 decision in Smith v. Van Gorkom (488 A.2d 858), widely interpreted as undermining the business judgment rule and blamed for an insurance crisis, reportedly rendering it difficult to attract outside directors. As it happened, these events coincided with the rise of contractarianism as a U.S. intellectual movement, prompting law and economics scholars to argue that the new flexibility regarding care liability ought to be extended to loyalty in a manner that, if successful, would have approximated full-blown fiduciary duty waivers in the corporate context. The foregoing events not only help to explain the apparent anomaly of greater contractual freedom regarding fiduciary duties arising in U.S. corporate law (even though the U.K. company is a more overtly contractual entity), but also help to explain the push toward greater contractual freedom in U.S. unincorporated entities, which picked up pace over the same period and largely reflected the influence of the same scholars and jurists.
Nevertheless, it remains unclear why the U.K. LLP would advance considerably further down the contractarian road than any other type of entity in either jurisdiction, providing a business arrangement in which no default fiduciary duties apply at all. In light of the idiosyncrasies leading to the Limited Liability Partnerships Act 2000, the complexities of its implementation, the legal uncertainties resulting from the interplay of numerous statutes and regulations, and the passage of a decade before non-application of default fiduciary duties would be judicially clarified, it seems implausible that the U.K. LLP’s architects consciously aimed to out-Delaware Delaware. Yet this recent addition to the menu of U.K. business entities does nevertheless give rise to a sort of natural experiment that may reveal much about the future role of the fiduciary governance paradigm in unincorporated businesses.
This post comes to us from Christopher M. Bruner, J. Alton Hosch Professor of Law at the University of Georgia School of Law. It is based on his forthcoming chapter, “Opting Out of Fiduciary Duties and Liabilities in U.S. and U.K. Business Entities,” available here.