Chancery Court Explains Basis for Default Rule
In Auriga Capital, Chancellor Strine, the highest judge in Delaware’s Chancery Court, a specialized trial court highly regarded for its business decisions, ruled in favor of minority investors who argued their manager breached his contractual and fiduciary duties. In a post-trial decision, the court concluded that the manager “failed to take any steps at all” to protect the LLC’s investors after it was clear to the manager the LLC’s sublessee, a golf management corporation, would not renew its lease with the LLC for land owned by the manager.
The manager knew for at least five years that the sublessee would exercise its early termination option but did nothing to protect the LLC’s interests in anticipation of the early exit. Instead, the manager made numerous choices that placed the LLC “in an economically vulnerable position” to squeeze out the minority members and deliver the LLC to the manager on unfair terms. The court found that the manager breached the fiduciary duties and contractual duties owed to the LLC’s minority members by engaging in a “protracted course of self-interested conduct conceived and implemented in bad faith” to eliminate the minority members’ interests.
The chancery court first analyzed what duties the manager owed to the members of the LLC. Delaware law has no provision expressly imposing fiduciary duties of care and loyalty on LLC managers. Although Delaware corporations law is similar to LLC law in many ways, Delaware imposes fiduciary duties on directors and officers of Delaware corporations at common law.
The court noted § 18-1104 of the LLC Act specifically states “the rules of law and equity . . . shall govern” if the act is silent. Auriga Capital held “the LLC Act is more explicit,” however, than Delaware corporate law “in making the equitable overlay mandatory,” and, therefore, the LLC Act imposes fiduciary duties on managers of LLCs “to the extent that such duties have not been altered or eliminated under the relevant LLC agreement.”
The court went on to consider the role of managers of an LLC, which under “traditional principles of equity” qualify managers as fiduciaries. As further support for this principle, the court examined legislative amendments to the LLC Act that confirmed for the court that a LLC manager owes fiduciary duties unless the parties disclaimed or modified those duties in the LLC agreement.
Avoiding Default Fiduciary Duties
According to § 18-1101(c), the duties of LLC managers may be expanded, restricted, or eliminated by the LLC agreement. “The case addresses an important issue to which litigators need to pay attention because many problems could be avoided by addressing this issue in the LLC agreement,” says Stephen C. Norman, Wilmington, Delaware, chair of the Corporate Governance Subcommittee of the ABA Section of Litigation’s Committee on Corporate Counsel. Norman noted that he “always thought there were default duties, but [he] understand[s] there is a counter interpretation” that fiduciary duties must exist at common law for the statute to restrict or eliminate the duties, for example.
Auriga Capital’s thorough and detailed marshaling of Delaware statues, common law, and legislative history warrants attention by both litigators and transactional attorneys. For litigators, Auriga Capital provides an additional cautionary tale. The court found the manager acted in bad faith, counsel advanced frivolous arguments in the client’s defense, and both counsel and client failed to fulfill discovery obligations. The court awarded one-half of the minority investors’ attorney fees as a sanction to ensure “that the disloyal manager is not rewarded” for “his serious infidelity.”
Will Default Fiduciary Duties for LLC Managers Stand?
Auriga Capital is a decision from the Delaware’s chancery court, which notes itself that it is “widely recognized as the nation’s preeminent forum for the determination of disputes involving the internal affairs of” many business entities. The chancery court is not, however, the highest court in the jurisdiction.
“Given Delaware Chief Justice Myron T. Steele’s writings on the subject off the bench, however, it is possible that a majority Delaware Supreme Court will not reach the same conclusion [as in Auriga Capital] if the issue is presented on appeal,” opine Lewis H. Lazarus, Wilmington, Delaware, vice chair of the ABA’s Business Law Section’s Directors and Officers Liability Committee, and Jason C. Jowers, vice chair of the Partnerships and Alternative Business Entities Subcommittee of the Business Law Section’s Business and Litigation Committee. Chief Justice Steele had been vice chancellor of the chancery court before his nomination to the Delaware Supreme Court.
Lazarus and Jowers observe that while the Delaware Supreme Court has not explicitly ruled on whether managers of LLCs owe default fiduciary duties, Chief Justice Steele left the question open in a decision last year. Since the parties in William Penn Partnership v. Saliba did not dispute the suggestion that “managers of a Delaware limited liability company owe traditional fiduciary duties of loyalty and care to the members of the LLC,” the court only assumed without deciding that managers owed any fiduciary duties.
In 2007, Chief Justice Steele published a journal article concluding that managers of LLCs should not owe fiduciary duties unless the LLC agreement states fiduciary duties exist. The Chief Justice relied primarily upon § 18-1101(b), which states the policy of the LLC Act shall “give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements.” Chief Justice Steele has since reiterated his position at a local bar association symposium, while admitting he was not speaking for the court and that he remains open-minded, according to Lazarus and Jowers.
On March 23, 2012, the LLC manager appealed the adverse judgment in Auriga Capital, teeing this issue up for consideration by Chief Justice Steele and the Delaware Supreme Court. Opening briefs are due in May.
Joseph Callanan is an associate editor for Litigation News