Lawletter Vol 36 No 12
[For a different perspective on the Auriga case, infra, see the article by Charlene Hicks in the March Lawletter, entitled A Manager's Fiduciary Duty Under the Delaware LLC Act, 36 Lawletter No. 9.
Although all States have enacted statutes authorizing the creation of limited liability companies ("LLCs") (and in fact a number of States have enacted the Revised Uniform Limited Liability Company Act (2006) or its predecessor, see Larry E. Ribstein, An Analysis of the Revised Uniform Limited Liability Company Act, 3 Va. L. & Bus. Rev. 35 (2008)), there still has not yet been an abundance of reported cases involving the organization, structure, and operation of LLCs. For example, there is a substantial body of litigation defining the obligation owed by corporate officers and directors to the corporation and to the shareholders. But there is little reported litigation discussing the correlative duties owed by the manager of an LLC to the other members.
In Auriga Capital Corp. v. Gatz Properties, LLC, No. C.A. 4390-CS, 2012 WL 361677 (Del. Ch. Jan. 27, 2012), an LLC owned the rights to sublease a valuable golf course property to a golf management company. The controlling interest in the LLC was acquired by the managing member and members of his family. There came a time when it became apparent that the sublease would not be renewed since the sublessee management company was not operating the property as profitably as it could have done. The LLC had invested heavily in the property, and it occurred to the managing member that if he could get rid of the unaffiliated members of the LLC, the property could be sold and developed in a lucrative transaction. The managing member brought some deliberately low-ball bids for the property to the minority members, who rejected them and insisted that the manager attempt to secure better offers for the property.
Frustrated by the refusal of the minority members to play along with his scheme, the managing member orchestrated a sham auction for the property at which he was the only bidder at a distress sale price. The minority members brought suit for damages, alleging that the managing member had breached the fiduciary duty he owed to the minority members. The managing member initially denied that he owed any fiduciary duty to the minority, but later he modified his position. He argued that even if he had breached his fiduciary duty, his actions were taken in good faith and with due care, thus insulating him from liability. The court was not persuaded by his arguments.
The court initially observed that Delaware's LLC statute authorizes the LLC to disclaim any fiduciary duties owed by the members to each other. The statute provides that "[i]n any case not provided for in this chapter, the rules of law and equity, including the law merchant, shall govern." Del. Code Ann. tit. 6, § 18‑1104. If those duties are not disclaimed by contract, the duties subsist and are applied by default. The court reasoned that
the statute allows the parties to an LLC agreement to entirely supplant those default principles or to modify them in part. Where the parties have clearly supplanted default principles in full, we give effect to the parties' contract choice. Where the parties have clearly supplanted default principles in part, we give effect to their contract choice. But, where the core default fiduciary duties have not been supplanted by contract, they exist as the LLC statute itself contemplates.
Id. at *9.
The implication is that a Delaware LLC could be created in which the managers could by contract disclaim any fiduciary duties they owed to the passive investor members. The court was not convinced of the wisdom of that result, but it observed that it was for the legislature to change the statute if, on reflection, it concluded that the provisions of the statute permitting disclaimers of fiduciary duty would lead to unacceptable results for investors. Because the LLC agreement in the case before it did not explicitly displace the fiduciary duties owed by a manager that are implied at common law, the court concluded that the defendant was bound by those duties. The court found that those duties had been breached, and it awarded damages and attorney's fees to the plaintiffs.
Most LLC statutes provide that the duties owed by the members to each other may be modified by contract, but few would permit an outright disclaimer of all duties that would otherwise be recognized at common law. Still, prudent counsel in advising clients organizing an LLC should carefully consider language that clearly defines the nature and extent of the duties owed by the members to each other and to the LLC.