April 01, 2019 Practice Points

Do Fiduciaries of Fiduciaries Owe Duties?

As a growing number of states adopt default fiduciary obligations between members of LLCs, issues may arise in the context of departing members.

By Ben Barnes

It is easy to identify who owes fiduciary duties to a corporation. Under Delaware law, corporate directors owe the corporation and its shareholders the duties of care and loyalty. See, e.g., N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 101 (Del. 2007). It is not so easy for LLCs and partnerships. Although well-settled law provides that the LLC’s or partnership’s manager owes duties to the entity, there are additional potential fiduciaries because of the flexible governance options Delaware law furnishes for alternative entities. See Sonet v. Timber Co., L.P., 722 A.2d 319, 322 (Del. Ch. 1998) (“Delaware’s limited partnership jurisprudence begins with the basic premise that, unless limited by the partnership agreement, the general partner has the fiduciary duty to manage the partnership in its interest and in the interests of the limited partners.”); Auriga Capital Corp. v. Gatz Properties, 40 A.3d 839, 855 n. 65 (Del. Ch. 2012) (“[M]anagers of LLCs owe fiduciary duties because they fit within the classic definition of a fiduciary of a business enterprise under traditional principles of equity.”).

Unlike corporations, whose directors must be “natural persons,” alternative entities may appoint other entities as managers. This raises a question: Do the natural persons in control of the managers also owe fiduciary duties to the LLC or partnership? Consider fictional Acme, LLC, whose managing member, Acme Co., has two directors: Mr. Smith and Ms. Jones. It is clear that Smith and Jones owe fiduciary duties to Acme Co., but do they, as the “natural persons” actually in control of Acme, LLC, owe duties to that entity as well?

In re USACafes, L.P. Litig. is the leading case addressing this question. In re USACafes, L.P. Litig., 600 A.2d 43 (Del. Ch. 1991). USACafes involved a limited partnership whose general partner, a corporation, had two controlling shareholders who also served as directors. Id. at 45-46. The limited partners brought breach of fiduciary duty and related claims against the general partner and the controlling shareholders for approving a sale of substantially all the partnership’s assets. Id. at 46. The controlling shareholders of the general partner moved to dismiss, arguing that their only fiduciary duty ran to the general partner, not to the partnership. Id. at 47. The Delaware Chancery Court denied their motion to dismiss, holding that when a corporation is the general partner of an LP, the directors of the general partner owe a duty directly to the LP and its members. Id. at 49. Subsequent cases have applied USACafes to LLCs. See Bay Ctr. Apartments Owner, LLC v. Emery Bay PKI, LLC, Civ. A. No. 3658-VCS, 2009 WL 1124451, at *9 (Del. Ch. Apr. 20, 2009) (applying USACafes to an LLC). The court based its conclusions on the general principle of fiduciary duty law “that one who controls the property of another may not, without implied or express agreement, intentionally use that property in a way that benefits the holder of the control to the detriment of the property or its beneficial owner.” USACafes, 600 A.2d at 48. Accordingly, the court declined to “delineate the full scope of [the] duty,” instead limiting the holding of USACafes to situations where a general partner’s directors have control over the partnership’s property.

Subsequent Delaware decisions expand USACafes’ reach to include not only directors of the general partner but also officers. See Wallace v. Wood, 752 A.2d 1175, 1180-82 (Del. Ch. 1999). Further, “upstream entities and individuals” now may owe fiduciary duties under USACafes’ framework. See Bigelow/Diversified Secondary P’ship Fund 1990 v. Damson/Birtcher Partners, Civ. A. No. 16630-NC, 2001 WL 1641239, at *8 (Del. Ch. Dec. 4, 2001). But several decisions have also limited USACafes’ reach, notably the relatively recent Bay Center Apartments Owner, LLC v. Emery Bay PKI, LLC. 2009 WL 1124451 (Del. Ch. Apr. 20, 2009). In Bay Center Apartments, the court observed that “to have any fiduciary duties to an entity [under USACafes], the affiliate must exert control over the assets of that entity.” Id. at 9. Thus, unlike corporate directors, who are fiduciaries to the corporation as a matter of law, the natural persons in control of a partnership’s corporate general partner might owe a duty or might not, depending on whether, as a matter of fact, they exert control over the partnership’s assets. Bay Center Apartments also observes that “USACafes suggests that controlling affiliates do not have the full range of traditional fiduciary duties,” and instead limits their duty to “the duty not to use control over the partnership’s property to advantage the corporate director at the expense of the partnership.” Id. at 10.

So, in stereotypical fashion, whether an upstream manager or director owes a duty depends on the facts. However, the most important thing to consider in answering this question is whether the case involves an abuse of control by the potential fiduciary over the underlying entity’s property.

Ben Barnes is a senior associate in the Dallas office of Reid Collins & Tsai LLP.

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