Earlier this year, I wrote about an opinion from the Delaware Court of Chancery that, if affirmed, could have broad practical implications for LLC managers and the fiduciary duties owed to their members. We have been monitoring this case and, on November 7, the Delaware Supreme Court issued its decision. As it turns out, whether fiduciary duties are owed by default in a Delaware LLC remains an open question. The Delaware Supreme Court affirmed the earlier Chancery Court’s opinion exclusively on contractual grounds, leaving open-ended the question as to default fiduciary duties by rejecting the Chancery Court’s decision to incorporate fiduciary duties into the Delaware LLC Act. Please continue reading below for the text of DLA Piper’s follow-up Client Alert posted by John Reed and Jennifer Lloyd.
In Gatz Properties LLC v. Auriga Capital Corp., C.A. No. 148 (Del. 2012), the Delaware Supreme Court has affirmed an award of damages to investors for breach of an LLC agreement, but rejected as dicta the Court of Chancery’s finding that “default” fiduciary duties apply to any limited liability company organized under Delaware law.
Chancellor Leo E. Strine, Jr. of the Delaware Chancery Court held in January this year that the Delaware Limited Liability Act imposes “default” fiduciary duties of care and loyalty by the manager to minority members, unless such duties were specifically modified or eliminated by the LLC agreement.
In reviewing Chancellor Strine’s opinion, the Delaware Supreme Court agreed only in part. It found that an LLC agreement 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 the Chancery Court’s decision, “exclusively on contractual grounds,” that the manager had breached his contractually agreed fiduciary duty by failing to obtain a fair price at auction for the golf course property owned by the LLC. In determining fair price, the state’s Supreme Court held that it was proper to also consider the fairness of the process leading up to the sales, as reflected in the price determination. The Court affirmed as reasonable the award of damages of the minority members’ initial investment plus ten percent, and attorney’s fees for bad faith on behalf of the manager.
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 decided by Chancellor Strine, and the Delaware legislature should resolve any ambiguity in the Delaware LLC Act. Thus, the Delaware Supreme Court 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,” and parties can benefit from the careful drafting of clear and unambiguous provisions regarding the scope of fiduciary duties in Delaware LLC agreements.