How are lawyers supposed to advise clients who want to form or are already operating Delaware limited liability companies on the critical question of manager fiduciary duties in the wake of last week’s blockbuster ruling by the Delaware Supreme Court in the Auriga Capital v. Gatz case?
As this blog reported in a two-part series last February (here and here), in Auriga Chancellor Leo Strine of the Delaware Court of Chancery found liable the controlling member and manager of a Delaware LLC for engineering the sale of the LLC’s assets to himself on terms that were highly unfair to the minority members. Chancellor Strine’s 74-page post-trial opinion (read here) included a lengthy analysis of relevant provisions of the Delaware LLC Act, legislative history and case precedent leading to his broad pronouncement that managers of Delaware LLCs owe traditional, common-law default duties of loyalty and care unless eliminated or modified in the operating agreement.
Chancellor Strine’s Auriga opinion also analyzed the LLC agreement in that case, Section 15 of which prohibited the manager from causing the company to enter into any agreement with affiliated persons “on terms and conditions which are less favorable to the Company than the terms and conditions of similar agreements which could be entered into with arms-length third parties” except with the consent of a super-majority of the unaffiliated members. Chancellor Strine found that this provision did not ”displace” the traditional default fiduciary duties but, rather, it ”distill[s] the traditional fiduciary duties as to the portion of the Minority Members’ claims that relates to the fairness [of the asset sale to the managing member] into a burden to prove the substantive fairness of the economic outcome.” In other words, Section 15 functioned more as a potential ”safe harbor” from the rigors of the traditional fiduciary standard — a safe harbor into which the managing member in Auriga failed to navigate.
The losing manager appealed to the Delaware Supreme Court from Chancellor Strine’s award of damages and attorney’s fees. On November 7, 2012, the Supreme Court issued a 34-page, per curiam decision (read here) affirming the award based solely on the manager’s violation of the “contracted-for fiduciary duty” expressly contained in Section 15 of the LLC agreement. In what one commentator called a “benchslap,” the Supreme Court devoted five pages of its opinion to Chancellor Strine’s ”improvident and unnecessary” statutory construction of default fiduciary duty. That part of Chancellor Strine’s ruling, the higher court declared, “must be regarded as dictum without any precedential value.”
The Supreme Court enumerated five separate reasons for its rebuke:
- The subject LLC agreement “explicitly and specifically addressed the ‘fiduciary duty issue’ in Section 15, which controls this dispute.”
- “[N]o litigant asked the Court of Chancery or this Court to decide the default fiduciary duty issue as a matter of statutory law.”
- Chancellor Strine incorrectly (“hubristically”) suggested that “judicial eradication of the explicit equity overlay in the LLC Act could tend to erode our state’s credibility with investors in Delaware entities.” Supreme Court seemingly bristled at the idea that, as the “court of last resort in this State,” it somehow was constrained “because people have been conforming their conduct” in compliance with Chancery Court decisions.
- “[T]he merits of the issue whether the LLC statute does–or does not–impose default fiduciary duties is one about which reasonable minds could differ.” Ultimately this is the most potent point made in the Court’s decision, suggesting that Chancellor Strine’s finding of default fiduciary duties incorrectly relied on Section 18-1101(c) of the Delaware LLC Act which provides that, “[t]o the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member’s or manager’s or other person’s duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement.” The Court characterized the introductory phrase, “to the extent that,” as “consciously ambiguous” and even suggested that the legislature may want “to resolve any statutory ambiguity on this issue.” Interestingly, the Supreme Court’s opinion does not comment on Chancellor Strine’s even greater reliance on Section 18-1104 of the LLC Act as confirmation of default fiduciary duties. That section provides that “[i]n any case not provided for in this chapter, the rules of law and equity, including the law merchant, shall govern.” Professor Ann Conaway, in her withering critique of Chancellor Strine’s decision (read here), presents the argument against reading into Section 18-1104 the incorporation of traditional fiduciary duties. We’ll have to wait for another occasion to learn if the Supreme Court agrees with Professor Conaway.
- Chancellor Strine’s “excursus on this issue strayed beyond the proper purview and function of a judicial opinion.” A judge’s duty, the Court explained, is “to resolve the issues that the parties present in a clear and concise manner,” and “is not a license to use [judicial] opinions as a platform from which to propagate their individual world views on issues not presented” or to “ruminate on what the proper direction of Delaware law should be.” Ouch!
So, as I queried at the top of this post, what’s a lawyer to do when called upon to advise a client concerning manager duties in a Delaware LLC? Given that the state’s highest court has now declared ”ambiguous” one of the key statutory provisions arguably supporting default fiduciary duties, a lawyer seeking to protect the interests of a non-controlling member in a Delaware LLC against potential manager abuse can no longer confidently rely on the LLC agreement’s omission of fiduciary disclaimers. Instead, pending future judicial or legislative developments, the lawyer should bargain for provisions in the LLC agreement expressly imposing standards of conduct on the managers. A lawyer who represents the manager side has no less an incentive as he or she did pre-Auriga to include a broad disclaimer of traditional fiduciary duties by including language to the effect that the only duties owed by the manager to the LLC and its members are set forth in the agreement itself.