On January 27, 2012, the Court of Chancery ruled that a manager of a Delaware limited liability company owes the company traditional fiduciary duties of care and loyalty unless the operating agreement expressly modifies or eliminates those duties.
The case involved a situation in which the limited liability company leased land from the manager for use and development of a golf course. The manager was solely managed by an individual, whose family owned the land that was leased to the limited liability company. The limited liability company, in turn, subleased the land to American Golf Corporation. The terms of the sublease gave American Golf an early termination option, which American Golf exercised in 2010. Rather than trying to maximize the return to the members, the manager rejected a serious offer for the limited liability company that would have earned the members a full return on their investment. Instead, the manager made an offer to purchase the company for a very low price. The individual that controlled the manager ultimately bought the company in an auction at which he was the only bidder, resulting in a return to the minority members of only $20,000 from their initial investment of $750,000.
The minority members sued the manager, claiming breaches of fiduciary duties in connection with the management of the limited liability company. The Court of Chancery found that the manager's course of conduct constituted clear breaches of his contractual duties and his default duties of care and loyalty. The court noted that while the Delaware Limited Liability Company Act (the Act) does not expressly provide that the traditional fiduciary duties of care and loyalty apply by default to the managers or members of a limited liability company, the conclusion that such duties are implicit, unless contractually modified, is strongly confirmed by a review of the Act's history. Since the operating agreement did not expressly eliminate the duties of care and loyalty, the court found that the manager owed such duties to the members. The Court of Chancery noted further that the Act allows the members of a limited liability company to modify or eliminate the default fiduciary duties, and Delaware courts will enforce the contractual choices made by the members.
At a seminar in Miami Beach, Florida, on February 16, 2012, Chief Justice Myron T. Steele of the Supreme Court of Delaware commented that the Chancellor's arguments that LLC managers owe default fiduciary duties may not persuade the Delaware Supreme Court because limited liability companies are new entities based on contracts (unlike corporations or partnerships that are the descendants of entities upon which common law has traditionally imposed fiduciary duties). He further noted that equity has nothing to say about whether fiduciary duties should apply as a default and neither the Delaware Supreme Court nor the Delaware General Assembly has stated whether fiduciary duties apply as a default.
In light of this decision and Chief Justice Steele's comments, drafters and parties to a limited liability company's operating agreements should be careful to include unambiguous language when they intend to include, eliminate or restrict fiduciary duties. Existing operating agreements should be reviewed and modified as necessary to expressly provide for the inclusion, elimination or modification of fiduciary duties, if desired by the parties to the agreements.
Auriga Capital Corporation et al v. Gatz Properties, LLC and William Gatz, No. 4390-CS (Del. Ch. Jan. 27, 2012)