Conflict between business partners is common, especially in long-standing ventures. While many partners try to anticipate and resolve potential issues early on, not all conflicts can be foreseen. Sometimes, a partner’s actions may come as a surprise – or even feel like a betrayal.

So, what boundaries exist around a partner’s behavior? When does a partner cross the line and breach their duty to the business or to each other? In this column, we’ll explore a framework for understanding the duties business partners owe to one another and to the enterprise itself.

State and statutory law

The rules that govern the actions and duties of business owners typically come from two main sources. First, there are the written agreements between the parties. Second, when those agreements are silent on an issue, the governing state’s laws apply. Unfortunately, the latter is often relied upon, as many partners fail to anticipate and address potential conflicts in advance. State law can be further divided into statutory law (enacted by the Legislature) and case law (developed through judicial decisions).

The analysis becomes more complex when considering the specific legal designations of both the business entity and its owners. While this column has so far referred generally to “business partners,” the precise legal roles and structures matter greatly when determining rights and obligations.

Precise roles

For instance, is the entity a corporation, a limited liability company or a partnership? And what is the role of the individual in question – are they a shareholder, officer, director, member, managing member, limited partner or general partner?

Once the specifics are identified, the next step is to determine whether the partner’s conduct is permissible.

To illustrate a scenario with minimal obligations, consider owning publicly traded stock. For example, I might own a share of Nike, a C corporation. If I haven’t signed a shareholder agreement, I have no management responsibilities and very limited rights. The company operates independently of my actions. So, if I were to start a shoe company that directly competes with Nike, my actions would likely be permissible.

If instead, I am a director or officer of Nike, my obligations change. Under Washington law, both a director and an officer have a duty to act in good faith and to exercise care of an ordinarily prudent person in the discharge of their duties (RCW 23B.08.300 and 23B.08.420).

These duties require directors and officers to act honestly, avoid conflicts of interest and make informed decisions in the best interest of the company. An officer or a director that fails in those duties might face personal liability for their actions.

Consider instead the role of a limited partner in a limited partnership.

Again, in the absence of a written agreement, state law controls.

For example, in Washington a limited partner expressly has no fiduciary duty under RCW 25.10.341. A fiduciary is required to act in the best interests of another and is the highest duty under the law.

However, under that same section, he or she does have the duty to both the other partners and the partnership to discharge duties “with the obligation of good faith and fair dealing.”   Interestingly, self-dealing is not expressly prohibited, meaning a limited partner could potentially engage in transactions that benefit themselves, as long as they act in good faith and deal fairly with the partnership.

Consider a limited liability company (LLC). There, the member does have a fiduciary duty to both the LLC and to other members, but that duty is limited in its scope and application under RCW 25.15.038. The exact parsing of the statute is outside the scope of this column, but a close reading of any applicable statute is necessary to determine the application of the facts to the question of whether the partner may permissibly engage in the questioned conduct. For example, the member does have a duty under the LLC statute to refrain from competing with the LLC.

Once the partner’s specific role and the applicable state law are identified, the conduct in question can be analyzed. A more precise example question might be: “Can a member of a member-managed Washington LLC open a second company that directly competes with the first?” As noted above, RCW 25.15.038 prohibits such competition.

Requiring interpretation

In many cases, however, the answer isn’t clearly spelled out in the statute. For example, whether a member violated their duty of care may require interpretation. In those situations, courts turn to case law to evaluate similar scenarios and apply established legal principles.

This discussion highlights the importance of proactive planning. Business owners don’t have to rely solely on default statutory or case law rules. Instead, they can – and should – clearly define their rights and obligations through governing documents such as bylaws, shareholder agreements or operating agreements.

Even if these weren’t established at the outset, it’s not too late. These documents can be created or amended at any time to reflect the owners’ intentions and prevent future disputes.

Beau Ruff, a licensed attorney and certified financial planner, is the director of planning at Cornerstone Wealth Strategies, a full-service independent investment management and financial planning firm in Kennewick.