Fiduciary duties waivers in limited liability company (LLC) operating agreements can effectively shield managers from claims by members. However, as the Delaware Chancery Court illustrated in an April 20 decision, if such waivers are not carefully drafted, managing members and their controlling affiliates may be exposed to liability for breach of fiduciary duties.
The case arose from a real estate development transaction in which Bay Center provided the property and a portion of the debt financing, and the defendants were to provide development and property management expertise. In that transaction, Bay Center and defendant PKI formed Emery Bay Member, LLC (Bay LLC), a Delaware LLC, with PKI as its managing member. Bay Center brought suit against Bay LLC, its managing member PKI, its development manager and the owner of the managing member in Delaware in March 2008, claiming breach of contract, breach of the implied covenant of good faith and fair dealing, breach of fiduciary duties and common law fraud. The defendants moved to dismiss all claims other than the breach of contract claims. The court denied the motion in its entirety, in essence, holding that the actions of a controlling affiliate in managing an LLC through an entity may give rise to liability to the other members of the LLC.
The court began by noting that “the Delaware LLC Act gives members of an LLC wide latitude to order their relationships, including the flexibility to limit or eliminate fiduciary duties. But, in the absence of a contrary provision in the LLC agreement, the manager of an LLC owes the traditional fiduciary duties of loyalty and care to the members of the LLC.” Because of two contradictory provisions relating to member duties, the court determined that the LLC’s operating agreement may not have eliminated the fiduciary duties of the managing member, stating that “drafters of chartering documents must make their intent to eliminate fiduciary duties plain and unambiguous.” The court then examined whether, assuming such duties exist, the defendants’ conduct constituted breaches of fiduciary duties. The court dealt with the managing member summarily, noting that its alleged diversion of rental income to avoid capital calls, modification of a senior loan without Bay Center’s consent and other matters would, if proven, constitute breaches of its fiduciary duties.
The claim against the owner of the managing member, who was also a personal guarantor of the LLC’s senior loan, was less straightforward. The owner was not a member or officer of the LLC, and thus beyond the normal scope of those who owe fiduciary duties in the corporate context. However, the court noted that “affiliates of a general partner who exercise control over the partnership’s property may find themselves owing fiduciary duties to both the partnership and its limited partners,” and that those affiliates have “the duty not to use control over the partnership’s property to advantage the corporate director at the expense of the partnership.” The court then held that, given the benefit to the owner in avoiding liability under his personal guarantee, and the actions taken by the managing member at his direction in order to do so, Bay Center had alleged sufficient facts to state a claim and denied the motion to dismiss.
The impact of this decision could be very broad. For example, if affiliates of a controlling preferred investor use their position to maximize the investor’s return to the detriment of minority common investors, and such actions benefit the controlling investor’s affiliates (increasing their carried interest, for example), the affiliates may be personally liable to the minority as fiduciaries. This highlights the need for careful drafting and negotiation in LLC operating agreements. (Bay Center Apartments Owner, LLC v. Emery Bay PKI, LLC, Del. Ch., No. 3658-VCS (April 20, 2009))