Self-Dealing by a Partner or Manager: What Counts and What You Can Do

What self-dealing actually is

The test is structural, not moral. A transaction is self-dealing when the person deciding for the company is also on the other side of it, directly or through someone close to him. The common forms in Dallas closely held companies:

• The company rents space, equipment or vehicles from an entity the managing partner owns.
• The company buys services from a vendor owned by the manager's spouse, sibling or friend, often at above-market rates.
• The manager sets his own salary, bonus or 'management fee' without a vote.
• The company lends money to the manager, or he lends to it at a high rate.
• The manager buys company assets, or sells his own assets to the company, at a price he chose.
• The manager takes a business opportunity the company could have pursued, then sells to the company as a supplier.

None of these is forbidden as such. Many small companies rent from an owner's building and nobody objects. The law asks how the deal was made and whether it was fair, and it puts the burden of answering on the person who benefited.

Is it self-dealing or just acting in his own interest?

The two are different, and the Business Organizations Code says so for partners. Section 152.204(c) provides that a partner does not violate a duty merely because his conduct furthers his own interest. Voting your interest, negotiating hard over your own buyout, or declining to invest more is self-interest, not self-dealing. Self-dealing begins when the partner uses his authority over company decisions to move value from the company to himself. The partner's duty of loyalty under section 152.205 requires him to account for any property, profit or benefit he derives from partnership business or property, and to refrain from dealing with the partnership on behalf of a person with an adverse interest. The full list for each entity type is in what fiduciary duties partners and LLC managers owe.

The Texas safe harbor for related-party transactions

For LLCs, section 101.255 states when a contract between the company and one of its governing persons or officers, or an entity they have a financial interest in, is valid despite the conflict. Either of two routes works:

1. Disclosure and disinterested approval. The material facts of the relationship and the contract are disclosed to or known by the governing authority or the members, and they approve it in good faith. When the governing authority approves, the vote must be by a majority of the disinterested managers or members, even if they are not a quorum.
2. Fairness. The contract is fair to the company at the time it is authorized, approved or ratified.

If either route is satisfied, the statute bars a claim for breach of duty based on the interest. Section 21.418 gives corporations the same two routes for interested directors and officers. For general partnerships there is no statutory safe harbor; the question is whether the partner satisfied the duty of loyalty, and a partnership agreement may identify categories of permitted activity if the carve-out is not manifestly unreasonable (section 152.002(b)).

What defeats the safe harbor

Three things, usually. The interest was never disclosed, so the approval does not count. The approval counted the interested person's own vote, or came from a body he controls, so it was not disinterested. Or there was no approval at all and the deal cannot be shown to have been fair: rent above comparable space, a fee that no outside vendor would have charged, a loan the company did not need. In practice the fairness route is where most contested deals end up, and it is decided on evidence of market terms.

Example

Suppose three members own a Richardson medical billing LLC. The managing member moves the office into a building he bought through a separate entity and signs a five-year lease on the company's behalf at $9,000 a month. Comparable space nearby leases for about $6,000. He mentions the move at a members' meeting but not that he owns the landlord. Two years later the other members learn of it from the property records. The lease is a related-party transaction. Disclosure failed because the ownership was never stated. Fairness fails on the rent gap. The company can seek to rescind the lease or reform the rent, recover the excess rent paid, and seek disgorgement of the landlord entity's profit. If the company agreement had required written disclosure and approval by the disinterested members, the same facts would also be a breach of the agreement.

What you can recover

The remedies for self-dealing are broader than ordinary contract damages because the claim is for breach of a fiduciary duty. A court can rescind the transaction, award the company the difference between the deal terms and fair terms, order the fiduciary to disgorge the profit he made even if the company cannot show a loss, impose a constructive trust on property he acquired, and in some cases order him to forfeit compensation for the period of disloyalty. The menu is explained in remedies for breach of fiduciary duty. Because the company is the party harmed, the claim is usually the company's and is brought derivatively, with the closely held exception that lets a court treat it as your direct claim; see suing on behalf of the company.

Evidence that decides these cases

• The company agreement, bylaws or partnership agreement, especially conflicts, approval and exculpation clauses.
• Minutes, written consents and emails showing what was disclosed and who voted.
• The related-party contracts themselves and the payment history.
• Ownership records of the counterparty: Secretary of State filings, deed records, assumed name certificates.
• Market comparables: lease rates, vendor quotes, compensation data for the role.
• Your own records demand and the response, which fixes what the company produced and when.

If the manager controls the books, the records demand under section 101.502 comes first; the company's refusal is itself evidence and carries fee exposure.

Deadline

A claim for breach of fiduciary duty must be filed within four years under Civil Practice and Remedies Code section 16.004(a)(5). The period can begin later where the conflict was concealed and could not reasonably have been discovered, but that is a fact question you should not rely on. Write down when and how you learned of the interest.

When to involve a litigator

Before you accuse anyone in writing. Half of these disputes turn on whether the agreement permitted the deal, and a letter that calls a permitted transaction theft is hard to walk back. A litigator reads the agreement and the approval record, prices the gap between the deal terms and market terms, and tells you whether the claim is the company's or yours and what the recovery would be. Tina Wysk represents owners on both sides of self-dealing and conflict-of-interest disputes in Dallas state and federal courts. The scope of that work is at breach of fiduciary duty.