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What Does Chancellor Strine’s Auriga Capital Decision Teach Us About Fiduciary Duties of New York LLC Managers? (Part Two)

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[This is the second of a two-part series on the basis for imposition of fiduciary duties on LLC managers. Part One (read here) reviewed a recent Delaware Chancery Court decision in which Chancellor Leo Strine, Jr. formulated that court's most comprehensive statement to date on the subject. Part Two compares New York's framework for holding LLC managers responsible as fiduciaries.]

While not without its critics (read here Widener Law Professor Ann Conaway’s commentary), the core of Chancellor Strine’s opinion last month in Auriga Capital v. Gatz presents an elegantly straightforward analysis of fiduciary duties of Delaware LLC managers. Simply stated, the Delaware LLC Act expressly in §18-1104 and impliedly in §18-1101 incorporates traditional default duties of loyalty and care to which LLC managers must adhere except to the extent such duties are modified or eliminated in the members’ LLC agreement.

Chancellor Strine’s use of a statutory launching pad to explore fiduciary duties of Delaware LLC managers invites a similar approach to the question of New York LLC manager fiduciary duties. Starting with the statute also makes sense given the LLC’s relatively recent birth as an entirely new, hybrid species of business entity whose DNA comes entirely from its legislative parentage, without any common-law ancestry.

Before looking at the New York statutory scheme, which I’ll follow with a brief look at New York case law, permit me to offer the following caveat. I’ve yet to come across judicial opinion or other legal scholarship that offers, à la Auriga, a comprehensive analysis of New York statutory and case law analyzing and defining the fiduciary duties of LLC managers. Such examination of this complex question is far beyond the scope of this post which merely attempts to identify the pieces of the puzzle, not to solve it.  

Comparison and Analysis of New York’s LLC Law

In Auriga, Chancellor Strine begins his statutory analysis by observing that the Delaware LLC Act has no affirmative provision expressly imposing fiduciary duties on LLC managers. Rather, he looks primarily to §18-1104 of the Act, providing that "[i]n any case not provided for in this chapter, the rules of law and equity . . . shall govern," to conclude that the Act incorporates default duties of loyalty and care upon managers whose exercise of discretionary powers to direct the LLC’s affairs qualify them as fiduciaries under "traditional principles of equity." The court’s resulting construction creates a coherent interplay between traditional equity principles, statute, and the LLC agreement.

New York’s LLC Law has a radically different footing that, at first glance anyway, raises interesting questions about the source and scope of manager duties. Not only does the LLC Law have no analog to §18-1104 of the Delaware LLC Act, it contains in subsection (a) of LLC Law §409, entitled "Duties of Managers," an affirmative, mandatory statement of the LLC manager’s duties:

A manager shall perform his or her duties as a manager, including his or her duties as a member of any class of managers, in good faith and with that degree of care that an ordinarily prudent person in a like position would use under similar circumstances.

Taking our cue from Auriga, the threshold questions presented by §409(a) are twofold.

First, under generally applicable canons of statutory construction, what impact does the mandatory provision have on the application of traditional equity principles of fiduciary duty in resolving claims brought against LLC managers? I see three possible answers:

  • The legislature’s positive articulation of mandatory manager duties displaces entirely the imposition of traditional common-law fiduciary duties.
  • The provision by its terms incorporates (channels) the traditional common-law fiduciary duties.
  • The provision sets forth non-exclusive duties that courts are free to supplement with the traditional common-law fiduciary duties.   

Second, what duties does §409(a) impose? If we parse the language of the statute, it requires a manager (1) to "perform his or her duties" (2) "in good faith" and (3) "with that degree of care that an ordinarily prudent person in a like position would use under similar circumstances."

The first clause mentions "duties" without defining them. Did the legislature intend that "duties" means the traditional duties of loyalty and care? That seems unlikely given the third clause which clearly references and defines the traditional duty of care. None of the clauses specifically refers to the other traditional fiduciary duty, i.e., the duty of loyalty. This omission potentially is significant given that the vast majority of fiduciary breach claims against persons who control closely held business entities, including LLCs, is based on allegations of self-interested conduct at odds with the duty of loyalty. 

Does the second clause’s reference to "good faith" implicate the duty of loyalty? It’s a question that, in the context of corporate directors’ duties, has generated much controversy in the case law (particularly in Delaware) and much debate in academic circles. The late Professor Ribstein described good faith as "a distinct set of non-fiduciary duties that are applied to people who may, or may not, also be fiduciaries," such as a director’s duty to assure that "transactions are based on adequate information." A February 2009 Harvard Law School paper co-authored by Chancellor Strine, called "Loyalty’s Core Demand: The Defining Role of Good Faith in Corporation Law," characterized the duty of good faith as "a subsidiary component of the duty of loyalty" and "as the key element in defining the state of mind that must motivate a loyal fiduciary." Neither description seems to suggest that the words "good faith" standing alone equate with the duty of loyalty.

Are there other provisions of the LLC Law that shed light on the scope of manager duties mandated by §409(a)? Recall that in Auriga, Chancellor Strine looked at the Delaware LLC Act’s fiduciary-out and exculpation provisions in subsections (c) and (e) of §18-1101, respectively, and found by implication that they supported the imposition of default fiduciary duties of loyalty and care. The only comparable provision in the New York LLC Law is §417(a), which authorizes the operating agreement to eliminate or limit the personal liability of managers to the LLC or its members "for damages for any breach of duty in such capacity" except when the manager’s action or omission involved bad faith, intentional misconduct, knowing violation of law, or the manager gained an unlawful profit or financial advantage. Since this provision merely refers to "breach of duty in such capacity," however, it’s hard to see how it adds anything to our understanding of the scope of manager duties mandated by §409(a).

If, however, we step away from a purely textual analysis of the statute, the answer to this riddle may lie in §409(a)’s derivation. Its operative language was lifted verbatim from New York Business Corporation Law §717(a) entitled "Duty of Directors." In Foley v. D’Agostino, 21 AD2d 60 (1st Dept 1964), the court construed the directors’ duties under §717(a) as inclusive of the duty of loyalty, stating:

[Directors] may not assume and engage in the promotion of personal interests which are incompatible with the superior interests of their corporation. (See 19 C. J. S., Corporations, § 761, and cases cited.) "Officers and directors of a corporation owe it to their undivided and unqualified loyalty. * * * They should never be permitted to profit personally at the expense of the corporation. Nor must they allow their private interests to conflict with the corporate interests. These are elementary rules of equity and business morality. Courts of equity must ever enforce strict compliance with these rules."

Sixteen years after Foley, in Limmer v. Medallion Group, Inc., 75 AD2d 299 (1st Dept 1980), the same court cited BCL §717(a) for the proposition that "directors and officers are bound by their duty of undivided and unqualified loyalty to their corporations, a duty which encompasses good faith efforts to insure that their personal profit is not at the expense of their corporations."  

Based on these and similar precedents decided before 1994, when the New York legislature enacted the LLC Law, it may be reasonable to assume that the legislature’s verbatim incorporation of BCL §717(a)’s operative language in LLC Law §409(a) carried with it the duty of loyalty, consistent with the former statute’s authoritative judicial interpretation. However, the analysis may have at least one glitch, namely, BCL §720, which authorizes an action against directors and officers for misconduct, states in subsection (c) that "[t]his section shall not affect any liability otherwise imposed by law upon any director or officer" (italics added). The LLC Law has no similar provision.

Cases Applying LLC Law §409(a)

As noted above, I haven’t found any New York cases that offer a critical analysis of LLC manager fiduciary duties, such as the one undertaken by Chancellor Strine in Auriga. Instead, the cases I’ve found seem to share a common, uncritical assumption that traditional fiduciary duties of loyalty and care apply to managers of New York LLCs, based on explicit analogy to the fiduciary obligations traditionally imposed on partners and corporate officers and directors.

The analogies have a surface appeal, but perhaps not if we keep in mind, as Justice Leonard Austin wrote in the 1545 Ocean Avenue case involving judicial dissolution of LLCs, that "[l]imited liability companies thus fall within the ambit of neither the Business Corporation Law nor the Partnership Law."

One of the first, and most frequently cited, New York appellate decisions addressing LLC manager fiduciary duties is Blue Chip Emerald LLC v. Allied Partners, Inc., 299 AD2d 278 (1st Dept 2002), in which the court reinstated a complaint against the manager of a real estate holding LLC that bought out the minority member’s interest without disclosing that it had received a third-party offer to purchase the property at a substantially higher valuation. The decision does not even cite §409(a), and instead relies on classic statements of fiduciary duties under New York corporate and partnership law, including quotations from Meinhard v. Salmon. What’s also odd about Blue Chip is that the subject LLC was formed in Delaware, although it’s nowhere mentioned in the opinion.

There are a number of subsequent appellate decisions addressing LLC manager duties that explicitly mention or quote §409(a), but with little or no further analysis. Examples include Nathanson v. Nathanson, 20 AD3d 403 (2d Dept 2005) (self-dealing); Salm v. Feldstein, 20 AD3d 469 (1st Dept 2005) (non-disclosure of third-party offer for LLC assets); Out of the Box Promotions, LLC v. Koschitzki, 55 AD3d 575 (2d Dept 2008) (diversion of company assets); and Cottone v. Selective Surfaces, Inc., 68 AD3d 1038 (2d Dept 2009) (waste, mismanagement and self-dealing).

As a reward for readers who’ve made it this far, by clicking here you can access a chronological list I prepared with citations to about 20 cases, including some federal court cases, involving fiduciary breach claims against managers of New York LLCs. The citations are followed by the pertinent excerpts from the decisions. If any readers know of any other such cases, please post a comment or email me with the citation, and I’ll be glad to update the list.