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Litigation: Delaware court rules LLCs owe fiduciary duties to the LLCs they manage

The Delaware Court of Chancery tries again

The Delaware Court of Chancery has once again issued an opinion holding that managers of Delaware Limited Liability Companies (LLC) owe fiduciary duties to the LLCs they manage, even in the absence of a provision in the operating agreement establishing the existence of the fiduciary duties.

In Auriga Capital Corp. v. Gatz Properties, LLC, Chancellor Leo E. Strine Jr. stated that default fiduciary duties exist, but in an opinion released on Nov. 7, in Gatz Properties LLC v. Auriga Capital Corp., the Delaware Supreme Court declared that part of the opinion to be “dictum without any precedential value” because the issue of whether the manager owed fiduciary duties was admitted by the manager, making the inquiry unnecessary. However, on Nov. 28, in Feeley v. NHAOCG, LLC, where the question was squarely presented, Vice Chancellor J. Travis Laster held that managers of Delaware LLCs do owe default fiduciary duties.

In Auriga, the Delaware Supreme Court affirmed an award of damages to investors for breach of an LLC agreement, but rejected as dicta the court’s finding that “default” fiduciary duties apply to any LLC organized under Delaware law. The court found that the LLC agreement at issue created contractually agreed fiduciary duties when it prohibited the manager from “enter[ing] into any additional agreements with affiliates on terms and conditions which are less favorable [than] similar agreements which could then be entered into with arms-length third parties.”  The Delaware Supreme Court also held that Delaware law did not require any “magic words” and that such language was the “contractual equivalent of the entire fairness equitable standard of conduct” and requirement that the manager obtain a “fair price.” The court thus affirmed, “exclusively on contractual grounds.”

More significantly, however, the Delaware Supreme Court rejected as “dictum without any precedential value” the Chancery Court’s decision that created default fiduciary duties as a matter of construction of the Delaware LLC Act.  The court held it was “improvident and unnecessary” for the Chancery Court to extend its holding where the parties had not specifically raised the issue. Instead, the court stated that “reasonable minds could differ” on the statutory question and refused to “express any view regarding whether default fiduciary duties apply as a matter of statutory construction [to a Delaware LLC].” By doing so, the Delaware Supreme Court made clear that the issue of default fiduciary duties is a “question [that] remains open.”

Three weeks later, in Feeley v. NHAOCG, LLC, the Chancery Court again held that LLC managers owe default fiduciary duties to the LLC. To support this holding, the court referenced Chancellor Strine’s analysis in Auriga. Although the Delaware Supreme Court clearly stated that passage lacked precedential value, Vice Chancellor Laster nevertheless treated it as persuasive authority, and emphasized two points made in Auriga. First, the court held that the LLC Act’s commitment to the traditional rules of law and equity meant that LLC managers owe fiduciary duties because they bear the traditional characteristics of a fiduciary—a person in whom another reposes special trust, a person upon whose judgment another relies. Second, an amendment to the LLC Act clarified that fiduciary duties can be expanded, restricted or eliminated, and unless the duties exist as a default, nothing exists to be expanded, restricted or eliminated.

The court in Feeley went on to compare the two types of LLC members, managing members and nonmanaging members, to general and limited partners in the Limited Partnership context. In LPs, general partners run the enterprise and so owe fiduciary duties to the partnership; the limited partners are passive investors. The court held that the LLC Act embodies a similar structure, meaning that the managing members owe fiduciary duties to the enterprise, and therefore held that the law protects the investment made by the nonmanaging members by imposing fiduciary duties upon managers.

Neither in Auriga nor in Feeley did a member of the Chancery Court cite the two law review articles published by Chief Justice Myron T. Steele of the Delaware Supreme Court that argue LLC managers should not owe any fiduciary obligations beyond what is contained in an LLC’s operating agreement.

With the issuance of the Feeley opinion, the Delaware Supreme Court may soon have an opportunity to decide whether managers of Delaware LLCs owe fiduciary duties in the absence of a provision in the operating agreement imposing them.

 

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John Reed

John Reed is a partner the Delaware office of DLA Piper, where he concentrates his practice on corporate litigation and counseling. He can be contacted...

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