Fiduciary Duties

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In the recent decision of Morrison v. Berry, No. 445, 2017 (Del. July 9, 2018), the Delaware Supreme Court issued an opinion of import in connection with the Corwin doctrine.  In Morrison, the High Court reversed a dismissal by the Delaware Court of Chancery on the grounds that the disclosures at issue did not fully reflect all material facts of the transaction at issue to the company’ stockholders, thus preventing the directors from being afforded the benefit of the Corwin doctrine.

By way of background, in Corwin v. KKR Financial Holdings LLC, No. 629, 2014 (Del. Oct. 2, 2015), the Delaware Supreme Court held that in a merger transaction with a party other than a controlling shareholder, the business judgment standard of review will apply where the voluntary, fully-informed and uncoerced judgment of the majority of the disinterested shareholders to approve the transaction was obtained.  To review a prior blog post discussing this decision, click here.

In Morrison, the complaint alleged, among other things, that the sale process procedure may have been influenced by a founder’s interactions with the private equity buyer, coupled with pressure on the board to approve the transaction.   Aided by documents obtained through a pre-suit Section 220 books and records investigation, plaintiff alleged that the recommendation statement provided to stockholders omitted information that “would have helped the stockholder to reach a materially more accurate assessment of the probative value of the sale process.”  The Supreme Court found the omissions included “troubling facts regarding director behavior,” of the kind that the Corwin court reasoned would prevent ratification if omitted.  The Supreme Court stated that Corwin business judgment review will not apply to stockholder-approved transactions when “partial and elliptical” disclosures leave stockholders less than fully informed.

Key Takeaway:

The Court stated front and center on page one of the memorandum opinion that the decision should serve as a “cautionary reminder to directors and the attorneys who help them craft their disclosures” that disclosures to stockholders must reflect all material facts in order for transaction parties to benefit from the standard established by the Delaware Supreme Court in Corwin.

Carl D. Neff is a lawyer with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes.  You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

In the recent decision of Edinburgh Holdings, Inc. v. Education Affiliates, Inc., C.A. No. 2017-0500-JRS (Del. Ch. June 6, 2018), the Delaware Court of Chancery considered whether claims for breach of contract, breach of fiduciary duty and the implied covenant of good faith and fair dealing could be brought in relation to the same conduct.

Background

In Edinburgh, the dispute arose from the sale of a proprietary education business.  The Asset Purchase Agreement (“APA”) provided for earnout payments to the seller based upon the acquired business achieving certain revenue targets following the closing.  The buyer refused to make the final annual payment, which led to the instant litigation.

Defendants moved to dismiss, asserting, among other things, that certain claims brought by plaintiff were duplicative.  Namely, defendants argued that the claims for breach of contract, breach of the implied covenant of good faith and fair dealing, and for breach of fiduciary duty, all related to the same conduct and thus subject to dismissal.

Analysis

Vice Chancellor Slights noted that a breach of contract claim and a breach of fiduciary duty claim cannot both be asserted for the same conduct, unless “there is an independent basis for fiduciary claims arising from the same general events….” In making this determination, the Court “inquires whether the fiduciary duty claims depend on additional facts as well, are broader in scope, and involve different considerations in terms of potential remedy.”  See Slip op. at 38.  In other words:

Generally, Delaware “[c]ourts will dismiss [a] breach of fiduciary duty claim where [it] overlap[s] completely [with a breach of contract claim] and arise[s] from the same underlying conduct or nucleus of operative facts” as the breach of contract claim.

In addition, the Vice Chancellor discussed whether breach of contract and implied covenant of good faith and fair dealing claims can be asserted at the same time.  The Court took note of Cent. Mortg. Co. v. Morgan Stanley Mortg. Capital Hldgs. LLC, 27 A.3d 531, 539 (Del. 2011), which held that “[a] party may maintain a claim for breach of the implied covenant of good faith and fair dealing only if the factual allegations underlying the implied covenant claim differ from those underlying an accompanying breach of contract claim”.  Slip op. at 21, n. 84.  This is so because “[t]he implied covenant is available only where the terms to be implied are missing from the contract; ‘cannot be invoked to override the express terms of a contract.'”  Slip op. at 21 (citations omitted).

Here, the Court granted defendants’ motion to dismiss in part because it found that the above-referenced claims were improperly duplicative.  The Court determined that plaintiff’s breach of contract claims encompassed the misconduct alleged in the breach of fiduciary duty claim and the implied covenant claim, and thus dismissed the latter two claims.

Carl D. Neff is a lawyer with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes.  You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

When a derivative lawsuit is brought on behalf of a company, the derivative plaintiff will often times attempt to argue that demand upon the board would be “futile” in order to excuse the demand requirement under Delaware Court of Chancery Rule 23.1.  The reason is that when a demand is in fact made upon the board, the propriety of the board’s refusal of the demand is governed by the “business judgment rule” — which is very unfavorable to the demanding shareholder, and generally leads to the dismissal of the claim.

In order to properly plead demand futility, a derivative plaintiff must allege with particularity that the board members are not disinterested in the subject matter of the demand.  This is almost certainly the case when the demand would ask directors to sue themselves. In order to allege demand futility, a stockholder must meet the heightened pleading standards under Delaware Court of Chancery Rule 23.1.

One way in which to assert that demand is excused is under the progeny of either Aronson or Rales, by asserting that a majority of the Board faces a substantial likelihood of liability for breaching the duty of loyalty by causing the company to violate law. This issue was addressed recently in the Delaware Court of Chancery decision of Wilkin v. Narachi, C.A. No. 12412-VCMR (Del. Ch. Feb. 28, 2018).  There, Vice Chancellor Montgomery-Reeves wrote that: “[B]ecause sophisticated and well-advised individuals do not customarily confess knowing violations of law, a plaintiff following this route effectively must plead facts and circumstances sufficient for a court to infer that the directors knowingly violated positive law.”  (Slip. op. at 27).

Wilkin addressed whether failure to follow not the law, but “best practices”, resulted in demand excusal in a derivative suit.  There, Plaintiff argued that demand should be excused because seven of the eight directors on the board knowingly and/or intentionally caused the Company to violate regulations and breach its confidentiality obligations. In rejecting Plaintiff’s demand futility argument, Vice Chancellor Montgomery-Reeves stated:

A review of Plaintiff’s allegations shows the main deficiency in the entirety of Plaintiff’s demand futility analysis. Plaintiff attempts to plead knowing and intentional violations of the law without any violation of the law. Instead, Plaintiff paints a picture of directors who, at worst, failed to follow best practices. But, a failure to follow best practices does not create a substantial likelihood of liability.

Accordingly, the Court granted Defendants’ motion to dismiss Plaintiff’s derivative complaint.

Carl D. Neff is a lawyer with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes.  You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

It is not uncommon for the Court of Chancery to find that a fiduciary duty was breached, but to award only nominal damages or no damages as a result of such breach.  This is so because damages are not an element of a claim for breach of fiduciary duty under Delaware law.  Rather, the elements are that 1) a fiduciary duty exists, and 2) such duty was breached.  This was demonstrated in the recent decision of The Ravenswood Investment Company LP v. The Estate of Bassett S. Winmill, C.A. No. 3730-VCS (Del. Ch. Mar. 21, 2018).

In this case, plaintiff brought derivative claims on behalf of Winmill & Co., Incorporated (“Company”) against its board, alleging they breached their fiduciary duties by 1) granting overly generous stock options to themselves, and 2) causing the Company both to forgo audits of the Company’s financials and to stop disseminating information to the Company’s stockholders in retaliation for Plaintiff’s assertion of its inspection rights pursuant to 8 Del. C. § 220.

Because the defendant directors stood on both sides of the disputed transaction, the Court found that it was subject to the entire fairness test.  Under the entire fairness test, a defendant must establish both fair dealing and fair price in connection with the challenged transaction. The court found that the board failed the entire fairness test, and the individual defendants breached their fiduciary duty of loyalty.

Despite finding breaches, however, the Court only awarded nominal damages.  Although a breach of fiduciary duty occurred, the burden remains upon plaintiff to prove actual damages or that an equitable remedy would be appropriate.  Vice Chancellor Laster noted that although the Court has broad discretion in fashioning such remedies, it “cannot create what does not exist in the evidentiary record, and cannot reach beyond that record when it finds the evidence lacking.”  (Slip op. at 3.)  Accordingly, the Court awarded nominal damages to plaintiff, although leaving the door open for attorneys’ fees to be recovered, which would be considered separately.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

In the recent decision of Oklahoma Firefighters Pension & Retirement System v. Corbett, C.A. No. 12151-VCG (Del. Ch. Dec. 18, 2017), the Delaware Court of Chancery provided a scholarly review of Caremark claims.  In sum, the decision stands for the proposition that in order to survive a motion to dismiss, a plaintiff must plead sufficient facts demonstrating a deliberate violation of the law or a conscious indifference to wrongdoing.

It is worth noting that Caremark claims are notoriously difficult to prove.  The Court of Chancery has previously explained that a “Caremark claim is possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment, and bad faith on the part of the corporation’s directors is a necessary condition to liability.”  Melbourne Municipal Firefighters’ Pension Trust Fund v. Jacobs, C.A. No. 10872-VCMR, slip op. at 19, (Del. Ch. Aug. 1, 2016) (citing  In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959, 967 (Del. Ch. 1996)).

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

Clients can pick their own attorneys but they cannot pick their own facts. A recent case decided by Master Ayvazian highlights the difficulties that unfortunate facts can present.

Creditors have eight months to file a claim against an estate (see 12 Del.C. §2102(a)). After a claim is presented, the executor (or personal administrator) can pay the claim or can deny the claim. Other than failure to timely file the claim (see 12 Del.C. §2102(a)), there is no statutory justification for denial of claim. In fact, Delaware has historically held that fiduciaries owe a fiduciary duty to creditors. See In re Estate of Bennie P. Farren, Del. Ch., C.A. No. 9385-MA (June 18, 2015).

Last will and testament
Copyright: stuartburf / 123RF Stock Photo

Delaware Acceptance Corporation, CACV of Colorado, LLC and 202 Investments, Inc. v. Estate of Frank C. Metzner, Sr., Lona C. Metzner, Executrix and Frank C. Metzner, Jr., the Metzner Family, LLC, C.A. No. 8861-MA involved an executor who denied a claim in the amount of $41,002.59 which had been filed against the estate by a credit card company. After four years of litigation, the Court of Chancery, Master Kim Ayvazian, found that the case hinged on the authenticity of a document, which in turn depended upon the credibility of several witnesses. The Court found that the backdating of documents and the offering of false testimony at trial rendered the Executrix unfit to serve as fiduciary and ordered her removal.

Frank C. Metzner, Sr. (“Frank , Sr.”) and his wife, Lona C. Metzner (“Lona”), deeded their house in Lewes into the Metzner Family Limited Liability Company (the “LLC”) in 2002. Frank, Sr. and Lona each held originally a fifty percent interest in the LLC but subsequently they gave two percent to their son, Frank, Jr.

In 2003, Frank, Sr. and Lona stopped paying their bills, including their credit cards, when the outstanding balance totaled approximately $55,000. Plaintiffs Delaware Acceptance Corporation CACV of Colorado, LLC and 202 Investments, Inc. (“Creditor”) sought a Charging Order based upon the Court of Common Pleas judgments that had been entered against Frank, Sr. and Lona. The Charging Order was signed on December 6, 2010 and served upon the LLC to attach to any distributions from the LLC to either Frank, Sr. or Lona. Frank, Sr. and Lona’s personal residence which was the asset of the LLC clearly did not have any income spitting out so the Charging Order laid dormant.

Subsequently Frank, Sr. died on October 26, 2012 and his Will, which was filed on December 5, 2012, named Nona as executor. The sole asset in the Estate was Frank, Sr.’s 49% interest in the LLC which was left to his son, Frank, Jr. Creditor filed its claim against the Estate on April 15, 2013. The Estate’s attorney denied the claim by letter dated June 3, 2013 on the basis that: (1) the Estate was devoid of assets other than the 49% LLC interest; (2) it was understood that the Charging Order was not dissolved by Frank, Sr.’s death; (3) Frank, Sr.’s 49% interest transferred under the Will to Frank, Jr. remained subject to the Charging Order. This was unacceptable to the Creditor.

Under the LLC Agreement (as was common in those days), the death of a member was considered a withdrawal, resulting in the dissolution of the LLC unless the surviving members elected to continue the LLC within 90 days of the death of the member. If the LLC were dissolved, 49% of the personal residence would have been distributed out to the Estate of Frank, Sr. thereby, the Executrix (faced with the Charging Order) as a fiduciary for the creditor, could have been directed to sell the house to satisfy the claim.

Within the required three month window (under 12 Del.C. 2102(b)) the Creditor filed a complaint alleging its belief that the LLC had dissolved after the death of Frank, Sr. due to the failure of the remaining members, Lona and Frank, Jr., to have consented in writing to continue the LLC within the 90 days after Frank, Sr.’s death.

In response, the Executor alleged that the remaining members (Lona and Frank, Jr.) had effectively elected to continue the LLC after Frank, Sr.’s death and proffered first a signed writing dated November 30, 2012 (the “Election”).

The Court found the Election suspect and in an effort to discern the actual date of the Election, directed the Creditor’s attorney to request the metadata relevant to the Election from the computer of the attorney who had drafted the document and/or such attorney’s former firm’s network server and to produce the data to the Court within 60 days. If the metadata was not produced, the Court would draw an adverse inference that the Election had been created after the 90-day period following Frank, Sr’s death. No metadata was ever delivered to the Court.

The attorney testified that he believed that the Election had been prepared in his office although the Election did not have certain identifiable marks (e.g. file number) that would evidence such preparation, nor was the Election-signing ceremony on the attorney’s calendar.

Undeterred, at trial Lona introduced a second document that had not previously been produced during the litigation (the “November 10th letter”). The November 10th letter (admittedly written by Lona) would have served as a sufficient writing to continue the LLC had the Court believed its provenance or if the metadata associated with the November 10th letter been provided. According to Lona’s testimony at trial, however, the computer that had generated the November 10th letter had “gone bad” a few years ago and had been disposed of.

Unfortunately for her, Lona was not a credible witness.

In concluding that Lona should be removed as Executor for cause, the Court held that a person who backdates documents and offers false testimony at trial should not be a fiduciary of an estate. The Court ordered the appointment of a new personal administrator with an order to: (1) dissolve the LLC; (2) liquidate the assets in the LLC; and (3) make disbursements to pay off the Creditor as required in the Changing Order.

Key takeaways:

First, review LLC Agreements to discern whether mandatory election is necessary and advisable and amend the LLC Agreement if appropriate. Second, only go into trial with a firm belief in the honesty of your client’s version of the facts. Otherwise, don’t let your client pick you as their attorney.

Beth B. Miller is counsel with the law firm of Fox Rothschild LLP, resident in its Wilmington office. She practices business, tax and trusts and estates law. You can reach Beth at (302) 622-4219 or at bbmiller@foxrothschild.com.

The Delaware Supreme Court has just handed down a decision that dramatically illustrates the need to take a holistic approach to an estate plan to ensure that what you want to happen to your assets when you die, can and actually will happen.

Courthouse
Copyright: bbourdages / 123RF Stock Photo

Everett T. Conaway died on May 11, 2010, leaving to survive him his second wife, Janice, and his son from his first marriage, Jesse.  Everett named Janice and Jesse as co-fiduciaries of his Will and his Trust.  That was not successful and eventually the Court appointed a local attorney to independently handle the administration (who promptly thereafter sued both Janice and Jesse (see Conaway I, Conaway II and Conaway III).  Carefully consider your appointment of fiduciaries to ensure that the fiduciaries (whether as successor trustees or as executors) can and will work together to complete the administration.  If you have any concerns or hesitation, trust your gut and designate someone else.

Everett had utilized several estate planning tools: a pour-over Will; a Revocable Trust; and a limited partnership.  However, these separate tools were not viewed holistically and therefore Everett’s estate plan was unsuccessful.

For instance, Everett’s Trust held a 69% interest in a limited partnership that he had entered into with Jesse.  Everett attempted to leave that 69% limited partnership interest to Janice.  That was not successful (as discussed in a previous post by my colleague Carl Neff).  There possibly could have been a way to accomplish Everett’s goal to leave this asset to Janice but simply ignoring the limitations that Everett had placed on the limited partnership agreement did not work.

Everett owned in his own name, Conaway Development Industries, Inc., which Everett had sold prior to his death.  Under Everett’s Trust Agreement, Everett left that stock or the sales proceeds from the sale of the stock, to Janice.  Unfortunately, this was not successful either.  Because the stock was in Everett’s name alone (and not held in his Trust), the stock was available to Everett’s creditors (including an approximately $260,000 outstanding balance on an unsecured line of credit).  Everett’s attempt to leave the proceeds from the sale to Janice failed since creditors have the superior right to be paid before beneficiaries.  Had Everett retitled the Conaway Development Industries, Inc. stock (or the proceeds from the sale of the stock) into his Trust (with a simple assignment assuming it was permitted under the limited partnership agreement) Janice could have inherited the same.

Key Takeaway: Review your entire holdings (including how they are titled and whether there are any restrictions) and annually read your estate planning documents to ensure that what you want to happen to your assets, actually can and will happen.

Earlier this month, the Delaware Supreme Court reversed a decision of the Delaware Court of Chancery in the matter of In re Sanchez Energy Derivative Litig., No. 702, 2014 (Del. Oct. 2, 2015), finding that Vice Chancellor Glasscock’s dismissal of a pension fund’s breach-of-duty suit failed to consider the sufficient doubt that plaintiff had cast on the independence of a pivotal Sanchez Energy director who had a 50 year long friendship with the Chairman of the Board.  The Court of Chancery’s 51 page opinion can be found here: C.A. No. 9132, 2014 WL 6673895 (Del. Ch. Nov. 25, 2014).

Writing for the en banc court, Chief Justice Strine found that the swing-vote director’s friendship and business relationships was sufficient to plead that he lacked the independence to fairly decide whether the pension fund’s suit was in Sanchez Energy’s interests.  Of note, the Chief Justine wrote that the burden to prove a director lacks independence where there is no majority shareholder “can be difficult”, particularly where a plaintiff declines to first make a books and record demand on the company.

The reversal of the Court of Chancery’s dismissal of the case at the pleadings stage will allow the pension fund to move forward with discovery in this matter.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

In the case of The Ravenswood Investment Company, L.P. v. Winmill & Co. Inc., C.A. No. 7048-VCN (Del. Ch., Jan. 31, 2013), the Court of Chancery analyzed motions filed by both plaintiff and defendant in a Section 220 action that was filed simultaneously with a breach of fiduciary duty claim.

Background

Plaintiff Ravenswood Investment Co., L.P. (“Ravenswood”) filed a Section 220 action and a fiduciary duty claim against Defendant, Winmill & Co., Inc. (“Winmill”) for declining to provide books and records to Ravenswood.  Ravenswood’s litigation efforts are premised on the belief that Winmill’s board withholds information with the expectation that Winmill’s share price will fall because of investor reluctance to acquire shares in a company that refuses to disclose corporate documentation. 

Winmill filed a motion with the Court, objecting to the comingling of a Section 220 action with a fiduciary duty action.  Winmill also sought dismissal of the fiduciary duty claim, based on the fact that Delaware law does not impose reporting or disclosure requirements on a corporation’s board of directors except when seeking shareholder approval.  Additionally, Ravenswood filed a motion to compel, seeking to depose Winmill’s board members in support of its Section 220 action.  In addition to the corporate representative produced by Winmill, Ravenswood also seeks to depose two of its directors.

Analysis

The Court stated that the Section 220 and fiduciary duty claim should not have been brought together, and therefore could have dismissed the fiduciary duty claim.  However, the Court determined that the more pragmatic approach would be to separate the Section 220 claim from the fiduciary duty claim.   After adjudicating the Section 220 claim, it will then move onto the fiduciary duty claim, if it remains.  As a result, the Court deferred, for the time being, on the sufficiency, as a matter of pleading, of Ravenswood’s fiduciary duty claim.

In connection with Ravenswood’s motion to compel, the Court noted that the discovery obligation confronted by a corporate defendant is “relatively minimal,” which has been described as “narrow is purpose and scope.”  Accordingly, the deposition of the corporate representative of the corporation, and not its directors, should suffice.  If such representative is not in possession of the requisite knowledge, then deposition of the directors may become necessary.  If Winmill continues to deny Ravenswood the opportunity to depose its directors, however, then Court ruled that they will not be allowed to testify at trial on the Section 220 claims.

Conclusion

This case is significant because it shows the need to assert a Section 220 claim prior to bringing more substantive claims against a company or its directors, such as for breach of fiduciary duty.  See, e.g., our prior post summarizing Central Laborers Pension Fund v. News Corporation, C.A. No. 6287-VCN (Del. Ch. Nov. 30, 2011), which dismissed a Section 220 claim filed after a derivative action.   Not only is it improper to bring such claims simultaneously, but by bringing a books and records action simultaneously with a breach of fiduciary duty claim, a plaintiff will slow the pace of the books and records action, which is intended to be a summary proceeding.   For more information concerning summary proceedings, see our Directors’ and Shareholders’ Reference Guide to Summary Proceedings in the Delaware Court of Chancery.  

 

The issue of whether default fiduciary duties apply to Delaware LLCs when the LLC agreement is silent on the matter is an open issue in Delaware…  
In the recent case of Gatz Properties LLC v. Auriga Capital Corp., No. 148, 2012 (Del. Nov. 7, 2012), the Delaware Supreme Court affirmed the decision of the Court of Chancery, but declined to uphold the lower court’s ruling that default fiduciary duties are owed in the context of limited liability companies.
Background
The Delaware Supreme Court upheld the Court of Chancery’s finding that Gatz, the manager of Gatz Properties LLC (the “LLC”), violated his fiduciary duties by failing to negotiate with a third party bidder and subsequently selling the LLC to himself at an unfair price.  The Supreme Court also upheld the Court of Chancery’s adjudication that Gatz acted in bad faith in connection with the sale of the LLC, and that the LLC Agreement did not provide him with exculpation or indemnification under these circumstances.  
Analysis
Of relevance to this blog post, however, is the fact that the Delaware Supreme Court declined to uphold the Court of Chancery’s finding that default fiduciary duties are owed in the context of Delaware limited liability companies.    The Court of Chancery found that in addition to violating contractual duties owed under the LLC Agreement, Gatz also violated default fiduciary duties owed by managers of an LLC.  The Supreme Court rejected the Chancery Court’s finding as “mere dictum”, specifically stating that the trial court “should not have reached or decided” the issue of whether default fiduciary duties are imposed on LLC managers and controllers unless the parties to the LLC agreement waive such duties.   
Thus, the Supreme Court solely upheld the Court of Chancery’s finding that Gatz violated contractual duties owed under the LLC Agreement, and “decline[d] to express any view regarding whether default fiduciary duties apply as a matter of statutory construction.” 
ConclusionThe Delaware Supreme Court has made it clear that the issue of whether default fiduciary duties are owed by managers or an LLC is an unsettled point of law in Delaware.  Whether the LLC statute does, or does not, impose default fiduciary duties is:  “[o]ne about which reasonable minds could differ.”  Therefore, drafters of LLC Agreements should specifically provide in the agreement whether fiduciary duties are owed by the managers or members of the entity, and should not proceed under the assumption that default duties are owed absent express language in the agreement.

The issue of whether default fiduciary duties apply to Delaware LLCs when the LLC agreement is silent on the matter is an open issue in Delaware…  

In the recent case of Gatz Properties LLC v. Auriga Capital Corp., No. 148, 2012 (Del. Nov. 7, 2012), the Delaware Supreme Court affirmed the decision of the Court of Chancery, but declined to uphold the lower court’s ruling that default fiduciary duties are owed in the context of limited liability companies.

Background

The Delaware Supreme Court upheld the Court of Chancery’s finding that Gatz, the manager of Gatz Properties LLC (the “LLC”), violated his fiduciary duties by failing to negotiate with a third party bidder and subsequently selling the LLC to himself at an unfair price.  The Supreme Court also upheld the Court of Chancery’s adjudication that Gatz acted in bad faith in connection with the sale of the LLC, and that the LLC Agreement did not provide him with exculpation or indemnification under these circumstances.  

Analysis

Of relevance to this blog post, however, is the fact that the Delaware Supreme Court declined to uphold the Court of Chancery’s finding that default fiduciary duties are owed in the context of Delaware limited liability companies.  The Court of Chancery found that in addition to violating contractual duties owed under the LLC Agreement, Gatz also violated default fiduciary duties owed by managers of an LLC.  The Supreme Court rejected the Chancery Court’s finding as “mere dictum”, specifically stating that the trial court “should not have reached or decided” the issue of whether default fiduciary duties are imposed on LLC managers and controllers unless the parties to the LLC agreement waive such duties.   

Thus, the Supreme Court solely upheld the Court of Chancery’s finding that Gatz violated contractual duties owed under the LLC Agreement, and “decline[d] to express any view regarding whether default fiduciary duties apply as a matter of statutory construction.” 

Conclusion

The Delaware Supreme Court has made it clear that the issue of whether default fiduciary duties are owed by managers or an LLC is an unsettled point of law in Delaware.  Whether the LLC statute does, or does not, impose default fiduciary duties is:  “[o]ne about which reasonable minds could differ.”  Therefore, drafters of LLC Agreements should specifically provide in the agreement whether fiduciary duties are owed by the managers or members of the entity, and should not proceed under the assumption that default duties are owed absent express language in the agreement.