Eliminating Fiduciary Duty Uncertainty: The Benefits of Effectively Modifying Fiduciary Duties in Delaware LLC Agreements

Unincorporated business entities, and in particular limited liability companies, are fast becoming a preferred form of business entity for structuring businesses and transactions. Such legal entities serve a wide range of functions. As with corporations, Delaware is often the jurisdiction of choice for forming unincorporated entities. Delaware limited liability companies are creatures of contract; they afford the parties involved the maximum amount of freedom of contract, private ordering and flexibility. To that end, the Delaware Limited Liability Company Act, 6 Del. C. §§ 18-101, et seq. (the LLC Act), makes certain statutory rules applicable only by default (i.e., only in situations in which members of a Delaware limited liability company (an LLC) have not otherwise provided in their limited liability company agreement (an LLC agreement)). As a result, members of an LLC are free to contract among themselves concerning a myriad of issues, including the management and standards governing the internal affairs of an LLC. Members of an LLC may also choose to govern their relationships exclusively by contract, without regard to corporate-style fiduciary duties of loyalty and care.
Fiduciary Duties and Delaware LLCs
Fiduciary duties generally apply to those who are entrusted with the management or control of another party’s property or assets. See, e.g., In re USACafes, L.P. Litig., 600 A.2d 43, 48 (Del. Ch. June 7, 1991). The LLC Act does not affirmatively establish default fiduciary duties, but the existence of fiduciary duties is contemplated by the LLC Act and such duties have been applied by the Delaware Court of Chancery. In Auriga Capital Corp. v. Gatz Properties, LLC, 40 A.3d 839 (Del. Ch. Jan. 27, 2012), the Court of Chancery applied default fiduciary duties to a manager of an LLC. The court reasoned that the LLC Act contemplates the application of principles of equity, LLC managers are fiduciaries, and fiduciaries owe the fiduciary duties of loyalty and care. The court concluded that the LLC Act provides that managers of LLCs owe default fiduciary duties of loyalty and care. The Delaware Supreme Court affirmed the Auriga decision in Gatz Properties, LLC v. Auriga Capital Corp., ___ A.3d ___, 2012 WL 5425227 (Del. 2012) on the grounds that the LLC agreement at issue imposed fiduciary duties, but noted that the lower court’s reasoning applying default fiduciary duties to managers of LLCs was mere dicta and had no precedential value. The Delaware Supreme Court observed that the LLC agreement in Auriga contractually adopted fiduciary standards and so the issue of whether default fiduciary duties apply in the LLC context should not have been addressed by the Court of Chancery. Notably, the Delaware Supreme Court did not take a position on the existence of default fiduciary duties under the LLC Act, but did indicate that reasonable minds may disagree on the issue. Nevertheless, in Feeley v. NGAOCG, LLC, 2012 WL 5949209 (Del. Ch. Nov. 28, 2012), the Court of Chancery recognized that while the Court of Chancery’s reasoning in Auriga does not represent controlling precedent, it is persuasive and consistent with prior opinions of the Court of Chancery on the issue of default fiduciary duties in the unincorporated entity context. In Feeley, plaintiffs alleged that the managing member of the LLC breached the default fiduciary duties it owed as a manager. The LLC agreement in Feeley did not modify fiduciary duties. Thus, directly at issue in the case was whether default fiduciary duties should apply to the managing member of the LLC. In deciding the issue, the court considered the Court of Chancery’s reasoning in Auriga regarding default fiduciary duties as akin to a law review article informing the court’s decision. Further, the court noted that although the long line of Court of Chancery precedents regarding default fiduciary duties in unincorporated entities does not bind the Delaware Supreme Court, the precedents are viewed as stare decisis by the Court of Chancery. The court concluded that since the Supreme Court has not addressed the issue, and because prior Court of Chancery decisions and the dictum by the Court of Chancery in Auriga were persuasive, default fiduciary duties applied to the managing member of the LLC.
In light of Feeley and prior Delaware Court of Chancery precedents, although the Delaware Supreme Court has not yet decided the question, the authors believe that traditional “corporate” fiduciary duties of loyalty and care are applicable to persons controlling an LLC and its property, unless expressly and clearly modified or eliminated in an LLC agreement. The traditional duty of care essentially requires managers to be attentive and inform themselves of all material facts regarding a decision before taking act