September 1, 2012
DEFAULT FIDUCIARY DUTIES IN
DELAWARE LLCs: WHY THE HIGHLY
ADAPTIVE LLC FORM CALLS FOR A
FLEXIBLE DEFAULT FIDUCIARY DUTY
RULE
Richard D Lahey
DEFAULT FIDUCIARY DUTIES IN DELAWARE LLCs: WHY THE HIGHLY ADAPTIVE LLC
FORM CALLS FOR A FLEXIBLE DEFAULT FIDUCIARY DUTY RULE
I. INTRODUCTION ... 2
II. THE CURRENT FIDUCIARY DUTY LANDSCAPE IN DELAWARE LLCS ... 4
A.The Delaware Limited Liability Company Act ... 4
B. The Delaware Judiciary’s Footprint on LLC Fiduciary Duty Law... 6
C. Auriga Capital and Going Forward ... 8
III. AWORLD WITHOUT DEFAULT DUTIES ... 10
A.Fiduciary Duties: A Staple of LLC Agreement Drafting Negotiations? ... 10
B. Reconciling Fiduciary Duties and the Freedom to Contract ... 12
IV.FIDUCIARY DUTIES IN DELAWARE GENERALLY ... 14
A. Member-Managed and Manager-Managed LLCs ... 15
B. Public Corporations ... 17
C. Close Corporations ... 19
D. General Partnerships ... 20
E. Limited Partnerships ... 21
V.ARE CURRENT DELAWARE FIDUCIARY DUTY MODELS UNFIT FOR THE LLC? ... 23
A. LLCs and Corporations: A Comparison... 24
B. LLCs and Partnerships: Siblings or Strangers? ... 26
I.INTRODUCTION
The limited liability company (LLC) has grown to become one of the most prevalent business forms in the entire United States. Born out of the Wyoming legislature in 19771 as special
interest legislation for oil companies2, all fifty states now allow for some form of the LLC
business structure. As the LLC’s popularity has swelled, unforeseen issues have emerged. The latest issue drawing the attention of corporate law scholars in Delaware is the presence, or absence, of default fiduciary duties in Delaware LLCs. This issue is of particular significance in Delaware due to the state’s unrivaled respect for the freedom of contract. The conflict between judicially imposed fiduciary duties and the freedom of contract, coupled with Delaware’s widely accepted position as the leading corporate law jurisdiction in the United States, makes the ultimate resolution of this matter by Delaware courts of paramount importance.
If the current divide over default fiduciary duties in LLCs was a fire, the fire marshal would discover that the attempt to rationalize fiduciary duties was the accelerant. Justifying the application or non-application of default fiduciary duties must rest on some theoretical basis, after all. For those currently involved in the debate, they have an abundance of rationales to choose from.3 For purposes of this paper, the canvas on which all analyses and conclusions are
created is D. Gordon Smith’s critical resource theory of fiduciary duty.4 This theory “proposes . .
. that fiduciary relationships form when one party (the ‘fiduciary’) acts on behalf of another
1 WYO.STAT.ANN. §§ 17-15-101 to 17-15-101 (1977). Current version is WYO.STAT.ANN. §§ 17-15-101 to 17-15-147
(Lexis 2007).
2 See Robert R. Keatinge et al., The Limited Liability Company: A Study of the Emerging Entity, 47 BUS.LAW. 375, 383
(1992).
3 For a breakdown of the notable attempts by legal scholars to rationalize and classify fiduciary relationships see D.
Gordon Smith, The Critical Resource Theory of Fiduciary Duty, 55 VAND.L.REV. 1399, 1423-1431 (2002).
party (the ‘beneficiary’) while exercising discretion with respect to a critical resource belonging to the beneficiary.”5 Smith avoids concretely defining critical resource but does allude that a
critical resource could range from a tangible form, such as money or land, to something merely valued by the beneficiary, such as confidential information.6 A further demarcation is made in
regards to the discretionary nature of the relationship. A relationship where one party merely has access to the critical resource of another does not amount to that of fiduciary and
beneficiary, rather:
[F]iduciaries must exercise discretion with respect to a critical resource belonging to the beneficiary, where “discretion” connotes the power to use or work with the critical resource in a manner that exposes the beneficiary to harm that cannot reasonably be evaded through self-help. Discretion
typically involves the exercise of control by the fiduciary to a greater extent than would occur with mere access. Discretion is granted to the fiduciary by the beneficiary or someone acting for the beneficiary. This grant is something short of a conveyance of the critical resource, however, because the
beneficiary retains residual control over the critical resource.7
As this paper will show, it is impossible to label the relationship among the members of an LLC as ‘fiduciary’ with a broad sweep of the brush. The relationships between parties of an LLC are as distinct and unique as the LLC agreement in which they were created. The critical resource theory serves as an independent criterion aptly fit to classify the nature of the relationship between parties in an LLC. Labeling the relationship between parties in an LLC as fiduciary in nature is not dispositive of the issue, however.
5 Id. at 1402.
6 Id. at 1404. (“Whatever [definition] is selected, it must serve on crucial function: It must convey the idea that
something resides at the core of the fiduciary relationship.”) Id. at 1443.
The rest of this paper will explore current Delaware fiduciary duty law in regards to LLCs and other business entities as well as provide a model for applying default fiduciary duties to LLCs. Part II will analyze the Delaware Limited Liability Company Act (DLLCA), its pertinent
amendments, and the Delaware court’s recent and historical interpretation of the DLLCA in regards to default fiduciary duties. Part III addresses and contends the growing support, championed by Delaware Supreme Court Chief Justice Myron T. Steele, for not applying fiduciary duties by default in Delaware LLCs. Part IV explains and contrasts the fiduciary duties present in various other Delaware business entities. Part V analyzes the compatibility between the LLC form and fiduciary duties found in other Delaware business entities before ultimately suggesting that default fiduciary duties should be applied after an analysis of the relationship between the parties under the critical resource theory. This paper ultimately concludes that determining the application of default fiduciary duties should rest on the elementary distinction between member-managed and manager-managed LLC forms.
II.THE CURRENT FIDUCIARY DUTY LANDSCAPE IN DELAWARE LLCS
A.The Delaware Limited Liability Company Act
Although the LLC is a contract driven business entity, an analysis of the fiduciary duties among its members begins where the analogous corporate analysis would embark, the relevant statute. As of 2004, the DLLCA provides that an LLC’s member’s or manager’s fiduciary duties “may be expanded or restricted or eliminated by provisions in the [LLC] agreement.”8 Aside
from the possible constitutional issues such a provision creates9, Delaware courts have
generally yielded to the Delaware General Assembly on the matter and have not attempted to insert fiduciary duties into LLC agreements where such duties were explicitly eliminated. An LLC agreement, however, may not alter the contractual covenant of good faith and fair dealing.10
Assuming the source of fiduciary duties being applied is the traditional triad of fiduciary duties11, this would leave the duties of loyalty and care as fair game for an LLC agreement to
modify or eliminate altogether. This permissive language represents a stark departure from prior Delaware corporate common law.12 The alteration provision of the Delaware statute is
relatively straightforward, however it begins with the language “[t]o the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to an [LLC] or to another member or manager or to another person that is a party to or is otherwise bound by an [LLC] agreement.’13 This language seems to suggest that fiduciary duties are not present
by default, leaving the presumption that fiduciary duties are to be applied on a case by case basis. This presumption takes on a more literal meaning when further analysis of Delaware’s LLC law yields no standards or criteria for determining when default fiduciary duties should be applied, ultimately punting the decision to Delaware courts. In a situation where LLC members
9 See Lyman Johnson, Delaware’s Non-Waivable Duties, 91 B.U.L.REV. 701 (2011) (“The argument made here . . .
contends that the Delaware General Assembly is constitutionally prohibited from preventing the judges of the Delaware Court of Chancery from applying fiduciary duties as those judges think best.”) Id. at 702.
10 tit. 6, § 18-1101(c)
11 See infra Part V for a discussion regarding whether the source of default fiduciary duties should be the
equivalent duties in the corporate environment, a partnership or some hybrid entity.
12 See Metro Comm’n Corp. v. Advanced Mobilecomm. Tech., Inc., 854 A.2d 121, 142 (Del. Ch. 2004) (“The
proposition that the managers of an LLC have no fiduciary at all to ensure that the LLC lives up to its contractual duties is one that is difficult to accept”).
have drafted an agreement with no reference to the fiduciary duties of loyalty and care that are to be present, a Delaware court is charged with deciding whether those duties existed.
B. The Delaware Judiciary’s Footprint on LLC Fiduciary Duty Law
Based upon the different language for LLCs, a Delaware court should be apprehensive to inject the corporate fiduciary duties of loyalty and care into an LLC agreement when the members failed to do so themselves, regardless of the parties’ intentions. The DLLCA14, like the Delaware
Revised General Partnership Act15 (DRUPA), includes a provision stating “[i]t is the policy of this
chapter to give the maximum effect to the principle of freedom of contract and to the
enforceability of limited liability company agreements.”16 A court modifying an LLC agreement
to include fiduciary duties that the drafters of the LLC agreement did not intend to operate under is ostensibly against the spirit of this provision. In fact, Delaware courts are already cautious when turning to the duties of good faith and fair dealing to alter terms of an LLC agreement17, although these specific duties are explicitly off limits for parties to limit or
eliminate. It comes as no surprise, then, that Delaware courts have shown great generosity in deferring to LLC agreement drafters when determining what is required in an LLC agreement to eliminate the fiduciary duties of loyalty and care. In Fisk Ventures, LLC v. Segal, the disputed LLC agreement included a provision stating, “[n]o member shall have any duty to any [m]ember of the [c]ompany except as expressly set forth herein or in other written agreements.”18 Despite
14 DEL.CODE ANN. tit. 6, § 18-1101(b) (West 2011). 15 DEL.CODE ANN. tit. 6, § 15-103(d) (West 2011). 16 Id.
17 Superior Vision Servs., Inc. v. ReliaStar Life Ins. Co., No. 1668-N, 2006 Del. Ch. LEXIS 160, at *6 (Del. Ch. Aug. 6,
2006) (“Imposing an obligation on a contracting party through the covenant of good faith and fair dealing is a cautious enterprise and instances should be rare.”).
the high level of ambiguity in this sweeping language, a description Chief Justice Steele also accepts19, the court held that this language “eliminate[d] fiduciary duties to the maximum
extent permitted by law by flatly stating that members have no duties other than those
expressly articulated in the [a]greement.”20 After reviewing the LLC agreement in question, the
court found that “[b]ecause the [a]greement does not expressly articulate fiduciary obligations, they are eliminated.”21 If the fiduciary duties of loyalty and care were assumedly present in the
LLC agreement by default, the court’s analysis shows that their presence was fragile and vulnerable to even the broadest of disclaimers.
While the court in Fisk Ventures was quick to displace default fiduciary duties, assuming they existed to begin with, Delaware courts in areas not directly involving LLC agreements have been far more reluctant to do so. In Twin Bridges Partnership v. Draper, the court stated that in a limited partnership, a general partner must “exercise the utmost good faith, fairness and
loyalty.”22 Although Twin Bridges was a case interpreting Delaware limited partnership law,
because Delaware’s Limited Partnership Act includes language essentially identical to the DLLCA in regards to fiduciary duties, the analysis is relevant.23 The fact that Delaware law prohibits
LLC members from modifying the fiduciary duties of good faith and fair dealing has already been noted, therefore their inclusion in the court’s language is expected. However, the court went further than the statutorily protected fiduciary duties and included loyalty among the
19 Myron T. Steele, Freedom of Contract and Default Contractual Duties in Delaware Limited Partnerships and
Limited Liability Companies, 46 AM.BUS.L.J.221, 230 (2009) (“However, this language is somewhat ambiguous because it speaks only generally of ‘duty.’ It does not specifically reference fiduciary duties.).
20 Fisk Ventures, No. 3017-CC, at *42. 21 Id.
22 Twin Bridges Ltd. Partnership v. Draper, No. 2351-VCP, 2007 Del. Ch. LEXIS 136, at *75 (Del. Ch. Sept. 14, 2007),
quoting Boxer v. Husky Oil Co., 429 A.2d 995, 997 (Del. Ch. 1981) (emphasis added).
duties expected of a general partner. This language demonstrates the court’s belief that applicable Delaware law, in this case DRULPA, provides for the default fiduciary duty of loyalty. In fact, a footnote explanation by the court stated that “a limited partnership formed under Delaware law is presumed to incorporate [fiduciary] duties in its governance structure.”24 In
what Chief Justice Steele has termed the ‘Twin Bridges approach’, a court operates under the belief that “fiduciary duties are fundamental and must be unambiguously eliminated in the [] agreement.”25 The disclaimer at issue in Fisk Ventures would surely have failed to satisfy this
approach given the fact that it did not speak to fiduciary duties specifically, only duties in general, therefore providing a different outcome than that which came to fruition. This represents a divergence in Delaware courts as to the presence and weight default fiduciary duties should carry in LLC agreements.
C. Auriga Capital and Going Forward
Auriga Capital Corporation v. Gatz Properties, LLC, the latest holding regarding default fiduciary
duties decided in the Delaware Chancery Court, implicitly followed the Twin Bridges approach.26 In coming to the conclusion that the fiduciary duties of loyalty and care were
present by default, the court focused on the statutory language of the DLLCA, stating “the rules of equity apply in the LLC context by statutory mandate” which “creat[es] an even stronger justification for application of fiduciary duties . . . to the extent that such duties have not been altered or eliminated under the relevant LLC agreement.”27 The chancery court went on further,
24 Twin Bridges, No 2351-VCP, at *76 n.123. 25 Steele, supra note 19, at 232.
26 Auriga Capital Corp. v. Gatz Properties, LLC, 40 A.3d 839 (Del. Ch. 2012).
27 Id. at 850. (emphasis in original) (Focusing on the DLLCA’s provision that “[i]n any case not provided for in this
describing the relationship between a manager of an LLC and the LLC’s members as “more than an arms-length, contractual relationship.”28 The court summarized its analysis of default
fiduciary duties by stating “[t]hus, because the LLC Act provides for principles of equity to apply, because LLC managers are clearly fiduciaries, and because fiduciaries owe the fiduciary duties of loyalty and care, the LLC Act starts with the default that managers of LLCs owe enforceable fiduciary duties.”29 Further buttressing the court’s finding is a plain language interpretation of
§18-1101(c) of Delaware’s LLC Act. §18-1101(c) allows for the expansion, restriction or
elimination of fiduciary duties in an LLC agreement, however explicitly states that the duties of good faith and fair dealing are to be left untouched. 30 Therefore, as the court in Auriga Capital
construed, “why would the General Assembly amend the LLC Act to provide for the elimination of . . . ‘something’ if there were no ‘something’ to eliminate . . . in the first place?”31 Given the
exclusion of good faith and fair dealing from §18-1101(c), the only fiduciary duties Delaware’s legislature could have been referring to were those of loyalty and care. Although the court in
Auriga Capital chose to apply default fiduciary duties, this hardly means that this will be the
norm going forward in Delaware LLC law. As one team of scholars so aptly concluded,
“[p]redicting the course of Delaware law from prior case law is like watching clouds. They seem, at times, to take on recognizable shapes and forms, even to resemble something familiar. But you know that whatever shapes you think you can see vanish in a puff of wind.”32 Assuming for
a moment that the decision in Auriga Capital is followed by later courts, there will still be those
28 Id. at 850-51. 29 Id. at 851.
30 DEL CODE ANN. tit. 6, § 18-1101(c) (West 2011). 31 Auriga Capital, 40 A.3d. at 852.
32 Lawrence A. Cunningham & Charles M. Yablon, Delaware Fiduciary Duty Law After QVC and Technicolor: A
who challenge the necessity and rightful place of the duty of loyalty and care in Delaware LLCs. The rest of this paper will discuss the arguments supporting the inclusion of corporate common law fiduciary duties in LLC agreements by default; additionally, this paper will discuss the proper source for such duties.
III. AWORLD WITHOUT DEFAULT DUTIES
A.Fiduciary Duties: A Staple of LLC Agreement Drafting Negotiations?
Chief Justice Steele and his many supporters paint a landscape of sophisticated parties bargaining for and ultimately making a “conscious and deliberate choice” to not provide for fiduciary duties in an LLC agreement.33 In 2010 alone, 82,027 LLCs were formed in Delaware.34 It
is more than unlikely that each of these LLC formations were the end result of a bargained for exchange between sophisticated parties. Ever prescient, Chief Justice Steele shielded himself from this attack by making the assumption in his analysis “that each partner, member, and manager had a bargained-for exchange when entering the [LLC].”35 He further removes an
arrow from his critics’ quiver by “assum[ing] that the parties’ organic agreement is not an agreement imposed on . . . a passive LLC member who simply purchased units in the LLC.”36
Making assumptions in order to more concisely make an argument is par for the course in legal academia; however, here Chief Justice Steele has essentially eradicated from his analysis the parties that are chief to those who support the need for default fiduciary duties. If the reality in
33 Steele, supra note 19, at 237.
34 A. Gilchrist Sparks, Legislative Developments in Delaware’s ‘Alternative Entities’, Harvard Law School Forum on
Corporate Governance and Financial Regulation, (September 8, 2011 11:07 AM),
http://blogs.law.harvard.edu/corpgov/2011/09/08/legislative-developments-in-delaware%E2%80%99s-%E2%80%9Calternative-entities%E2%80%9D/.
35 Steele, supra note 19, at 225. 36 Id.
Delaware was that LLCs were only being formed between sophisticated parties in bargained for exchanges, then perhaps Chief Justice Steele’s notion that there should be no fiduciary duties by default would be satisfactory. This is not the reality, however. Aside from its highly
customizable attributes, parties are electing to form LLCs as opposed to other business
structures for a variety of other benefits, including tax purposes and limited liability.37 Further,
when parties elect to form an LLC for the more traditional benefits without knowledge of the specificity by which they can alter their particular LLC agreement, is it fair to assume the parties will contemplate their fiduciary duties? To answer in the negative, a conclusion the scenario seemingly begs for, would take the absence of a fiduciary duty provision out of Chief Justice Steele’s ‘conscious choice’ realm and position it squarely in the vast land of ‘drafter oversight.’ While Chief Justice Steele surely recognizes that, at a minimum, a sizeable portion of LLCs are not formed between sophisticated parties, his default rule of no fiduciary duties purports to exist in just such a world. The inapplicability of this rule to an LLC agreement not entered into by sophisticated parties necessitates the creation of a sliding scale of duties based on a parties’ sophistication.
Conditioning the presence of default fiduciary duties on the sophistication of the parties to the LLC may ultimately result in the Delaware courts injecting themselves into an LLC’s dealings more than the mere presence of default fiduciary duties would. Critics of Chief Justice Steele’s position argue that the designation of ‘sophistication’ as the most relevant variable in a
fiduciary duty analysis would compel the court to “engage in a multivariate calculus equation in which sophistication, involvement, level of bargained-for exchange, and other factors would . . .
determin[e] . . . whether there are default [fiduciary duties] and the extent to which they apply.”38 The impact of the above conclusion is not necessarily sufficient on its face to counter
Chief Justice Steele, as surely a Delaware court is fit for the task of completing such an analysis, and is perhaps arguably the best suited for the job compared to other state courts. However, when coupled with Chief Justice Steele’s economic rationale for excluding default fiduciary duties39, the contradiction clearly emerges. If default fiduciary duties will purportedly increase
the transaction and litigation costs of LLCs, surely the associated costs of litigating and determining the sophistication level of a party will also increase such costs. Furthermore, whether a party qualifies as sophisticated is an exercise in subjective evaluation. If
‘sophisticated’ were clearly defined in Delaware law, a court would be better suited to assess the sophistication of a party against an objective set of criteria, however, such a definition does not exist.
B. Reconciling Fiduciary Duties and the Freedom to Contract
The conclusion that no fiduciary duties of loyalty and care should apply by default in an LLC also necessitates the outcome to a subsequent determination: that claims arising under contract law and the duty of good faith and fair dealing suffice as protective measures for an aggrieved party in an LLC. To conclude otherwise would leave members of an LLC with no protection against the self-interested or bad faith actions of other members or managers of the LLC. The
38 J. William Callison & Allan W. Vestal, Triple Error: Chief Just Steele and Default, WIDENER LAW BLOG (last visited
May 25, 2012), http://blogs.law.widener.edu/delcorp/on-line-symposium-default-fiduciary-duties-in-llcs-and-lps/j-william-callison-and-allan-w-vestal-triple-error-chief-justice-steele-and-default/.
39 Steele, supra note 19, at 224 (“When courts assume default fiduciary duties, parties bear the costs of those
traditional tools at the disposal of a court to unwind a contract include duress40, undue
influence41, mutual mistake42, and unilateral mistake.43 The presence of any of these during the
formation of a contract, a category of legal documents which fully encompasses LLC
agreements, renders that contract voidable.44 Additionally, a court may find that a contract is
void against public policy45 or unconscionable in whole or in part.46 This list is not exhaustive,
however illustrates the range of techniques available to a court when it is given the opportunity to interpret or render a contract as enforceable or unenforceable. A unique tool in the contract world is the contra preferentum doctrine.47 Often found in insurance contract disputes48, the
doctrine states that when faced with an ambiguous term in a contract “[the] meaning . . . generally preferred [is one] which operates against the party who supplies the words or from whom a writing otherwise proceeds.”49 This interpretation technique creates an additional
layer of protection for parties to a contract who had less discretion or influence in deciding the language or terms of the contract. Although Delaware law is undeveloped on the application of such a doctrine in an LLC agreement, the Delaware Supreme Court has applied it in the
interpretation of a limited partnership agreement.50
The fiduciary duties of loyalty and care and the contract policing tools available to a Delaware court are assuredly unequal. For starters, the contractual implied covenant of good faith is far
40 Restatement (Second) of Contracts §174-175 (1981). 41 Id. at §177. 42 Id. at §152. 43 Id. at §153. 44 Id. at §7. 45 Id. at §178. 46 Id. at §208. 47 Id. at §206.
48 See Prudential Ins. Co. of America v. Prusky, 473 F. Supp. 2d 629 (E.D. Penn. 2007). 49 §206, supra note 39 (emphasis added).
less demanding than the expectations of a fiduciary. An arm’s length-contract typically provides for some sort of residual control over the underlying resources of the contract, thus creating an environment unfit for self-serving behavior.51 While an LLC agreement is wholly contractual,
one Delaware court has explicitly stated that the agreement between managers and members in a manager-managed LLC does not constitute an arm’s length agreement, but rises to a greater level.52 What propels this relationship beyond that of typical contracting parties is the
discretionary power vested upon the manager by the members of the LLC. This delegation of authority serves as the justification for applying fiduciary duties. Fiduciary duties provide far broader protection and are able to be implemented without proving the restrictive criteria necessary in most contract claims. While neither contracting parties nor fiduciaries are required to act wholly without regard to self, a “fiduciary must refrain from self-interested behavior that wrongs the beneficiary, whereas contracting parties may act in a self-interested manner even where the other party is injured, as long as such actions are reasonably contemplated by the contract.”53 The absence of a “reasonably contemplated” caveat in fiduciary law restricts the
self-interested behavior of a fiduciary to a far greater level than an ordinary contracting party.
IV.FIDUCIARY DUTIES IN DELAWARE GENERALLY
The analysis of default fiduciary duties in Delaware LLCs is a multi-step endeavor. Assuming that a court finds an LLC relationship fiduciary in nature, a critical question still remains: what should the source of the fiduciary duties be? Is a court to insert the fiduciary duties expected in a
51 Smith, supra note 3, at 1489. 52 Auriga Capital, 40 A.3d at 850-51. 53 Smith, supra note 3, at 1410.
Delaware partnership, or the fiduciary duties placed on the officers in a Delaware corporation, or perhaps a hybrid baseline? Given the differing expectations placed on LLC managers under each set of duties, a baseline rule is necessary to prevent LLC managers from being held accountable for actions they genuinely believed would not violate their fiduciary duties to the LLC. As discussed below, however, the myriad of LLC structures frustrates the creation of such a uniform rule. The alternative, to develop an entire body of fiduciary duty law tailored toward the LLC, is also troublesome. To do so would cast aside an intricately developed and adaptable body of Delaware corporate case law.54 While adapting existing Delaware corporate law to fit
the LLC entity is the efficient route, Delaware’s conscious choice to create a unique,
fundamentally different business form in the LLC may ultimately call for the creation of equally unique law. Alternatively, members and managers of LLCs, like all business entities in Delaware, can be liable for damages arising out of breaches of their fiduciary duty.55 This fact is not
surprising, however does back the importance of reaching uniformity in the application of fiduciary duties in LLCs. If LLC members or managers are to be liable for their breaches of fiduciary duty, it is only fair that a clear rule exists outlining which fiduciary duties are expected of them and to what extent.
A. Member-Managed and Manager-Managed LLCs
The array of customization available in an LLC formation contributes to an equally diverse range of LLC structures. Although LLC structures and agreements are as unique as snowflakes,
together, they can be grouped into two over-arching categories. These categories are
54 See Myron T. Steele, Judicial Scrutiny of Fiduciary Duties in Delaware Limited Partnerships and Limited Liability
Companies, 32 DEL.J.CORP.L. 1 (2007).
managed LLCs and member-managed LLCs.56 In Delaware, LLCs are member-managed unless
the LLC operating agreement specifically calls for the LLC to be manager-managed.57 Each
structure style is conducive to a discrete set of circumstances. If an LLC includes several passive members who do not wish to engage in the management of the LLC, or more importantly, do not wish to have the authority to bind the LLC in transactions with third parties, the manager-managed structure style is preferred. In contrast, an LLC comprised of entities that all wish to engage fully in the day to day operations and decision-making of the LLC are better served by a member-managed structure. The manager-managed LLC is a far more centralized system of management, akin to a corporate board of directors managing a corporation on behalf of the shareholders whereas a member-managed LLC is analogous to a general partnership.58 These
comparatives are simplified greatly.
Due to the level of customization available in an LLC agreement, an LLC’s management
structure may mirror that of a limited partnership in one regard, and fall in line with a corporate separation of power model in the next. As Professor Larry E. Ribstein illustrates, “[A]n LLC may be centrally managed for purposes of limiting agency power of individual members to bind the firm, but give substantial power to members for internal purposes. Conversely, an LLC can formally adopt decentralized management but delegate power to managing members.”59 Due
to the vastly different roles a member of an LLC may hold, applying a blanket default fiduciary duty rule could be inefficient and may sometimes be incompatible with the specific
management structure employed by LLC members. Rather, default fiduciary duties need to be
56 DEL.CODE ANN. tit. 6, § 18-402 (West 2011). 57 Id.
58 See Kelly v. Blum, No. 4516-VCP, 2010 Del. Ch. LEXIS 31, at 47-48 n. 73 (Del. Ch. Feb. 24, 2010). 59 Larry E. Ribstein, Are Partners Fiduciaries?, 2005 U.ILL.L.REV. 209, 249 (2005).
as flexible and adaptive as the LLC operating agreements into which Delaware courts seek to insert them. Despite the potential for increased costs stemming from the lack of a clearly defined rule60, this outcome would produce better results than a ‘one size fits all’ rule where
LLC members are governed by the same level of fiduciary duties regardless of their authority or level of managerial discretion. Despite the incompatibility of existing sets of fiduciary duties and the spectrum of LLC management structures, the similarities between existing business forms and specific LLC structures are useful in construing the appropriate fiduciary duties in each context.
B. Public Corporations
LLCs and public corporations share obvious superficial similarities, however “[u]ltimately, LLCs and corporations are different . . . an LLC [] offers one bundle of rights [and] . . . a corporation [] offers an entirely separate bundle of rights.”61 Additionally, the LLC is regarded as a contract
driven entity in which “interested parties [can] define the contours of their relationships with each other to the maximum extent possible.”62 Despite an LLC being a creature of contract63,
fiduciary duties are typically characterized as arising in tort.64 In Delaware, a corporate officer’s
fiduciary duties are wholly judicially created. Initially, they were characterized as a triad: due
60 Id. at 236.
61 CML V, LLC v. Bax, 28 A.3d 1037, 1043 (Del. 2011). 62 Id. at 1043.
63 Fisk Ventures, LLC v. Segal, No. 3017-CC, 2008 Del. Ch. LEXIS 158, at *28 (Del. Ch. May 7, 2008) (“[L]imited
liability companies . . . are creatures not of the state but of contract.”);
64 1LARRY E.RIBSTEIN &ROBERT R.KEATINGE,LIMITED LIABILITY COMPANIES §9:1 (2011); Contra Daniel S. Kleinberger, Why
Justice Cardozo Was Right, and Chief Justice Steele is Wrong, WIDENER LAW BLOG (last visited May 25, 2012),
http://blogs.law.widener.edu/delcorp/?page_id=335&preview=true (“An LLC depends for its existence on a statute that empowers the LLC’s formation and recognizes the LLC’s existence as an entity separate from its owners.”).
care, good faith, and loyalty.65 Recently, the Delaware Supreme Court held that good faith did
not stand on the same independent footing as the duties of loyalty and care; rather, a failure to act in good faith could only result in liability when committed in conjunction with a breach of either the duty of loyalty or care.66 The duty of due care requires that a director “use that
amount of care which ordinarily careful and prudent men would use in similar
circumstances.”67 Also, “directors must consider all material information reasonably available”
when making a business decision.68 The duty of good faith is typically defined in the negative.
Delaware courts have come to define bad faith in numerous ways, including entering “a transaction that is authorized for some purpose other than a genuine attempt to advance corporate welfare or is known to constitute a violation of applicable positive law.”69 If a
corporate director’s duty of loyalty is challenged, a Delaware court looks to whether
stockholders were deprived of a “’neutral decision-making body.’”70 This test inherently allows
for corporate directors to engage in behavior and activities that personally benefit themselves so long as they do not create bias in their decision making regarding corporate affairs. A formidable moat surrounding a corporate director’s discretion is the business judgment rule, which is a “presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.”71 A Delaware court’s presumption that a corporate director’s
65 Malone v. Brincat, 722 A.2d 5, 10 (Del. 1998). 66 Stone v. Ritter, 911 A.2d 362 (Del. 2006).
67 In re Walt Disney Co. Derivative Litigation, 907 A.2d 693 (Del. Ch. 2005). 68 Brehm v. Eisner, 746 A.2d 244, 259 (Del. 2000).
69 Gagliardi v. TriFoods Intern, Inc., 683 A.2d 1049, 1051 n.2 (Del. Ch. 1996) (emphasis in original).
70 Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1170 (Del. 1995) (quoting Oberly v. Kirby, 592 A.2d 445, 467
(Del. 1991).
decision did not breach any fiduciary duties owed to the corporation or the shareholders pins the burden of proving otherwise on plaintiff shareholders. Alternatively, a court may apply the entire fairness standard in order to scrutinize a corporate director’s decision.72 Fairness is
comprised of both a fair dealing and fair price component.73 These components are
differentiated in the following manner:
The former embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained. The latter aspect of fairness relates to the economic and financial considerations . . . including . . . assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company's stock.74
C. Close Corporations
A subcategory of corporate entities is the closely held corporation, or close corporation.75 The
similarities between a publicly held corporation and a close corporation far outweigh the differences, however the differences are critical. A close corporation in Delaware can have no more than thirty stockholders76 and shall make no public offering of its stock.77 Minority
shareholders in close corporations are more vulnerable to abusive control by majority shareholders than their counterparts in a publicly held corporation.78 This is because in large
publicly held corporations, a shareholder control group’s power is often exerted solely in its ability to elect members of the Board. However, in a close corporation, the formation of a
72 See Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983). 73 Id.at 711.
74 Id.
75 DEL.CODE ANN. tit. 8, § 342 (West 2011). 76 DEL.CODE ANN. tit. 8, §342(2) (West 2011). 77 DEL.CODE ANN. tit. 8, §342(3) (West 2011).
control group of shareholders goes much further and reaches the actual management of the corporation directly, which ultimately increases the potential for “exploitive” behavior.79
Delaware case law has held that only controlling shareholders owe fiduciary duties in a close corporation setting, and that the controlling shareholder must be acting in a corporate capacity in order for such duties to arise.80 Controlling shareholder status can not only be invoked by
owning a requisite portion of the corporation’s stock, “but also if [the shareholders] have the ability to dictate the terms of a transaction.”81
D. General Partnerships
The fiduciary duties between partners in a general partnership have been codified by the Delaware General Assembly in DRUPA §15-404, which reads in pertinent part:
I. A partner’s duty of loyalty to the partnership and the other partners is limited to the following:
(1) to account to the partnership and hold as trustee for it any property, profit or benefit derived by the partner in the conduct or winding up of the partnership business or affairs or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity;
(2) to refrain from dealing with the partnership in the conduct or winding up of the partnership business or affairs as or on behalf of a party having an interest adverse to the partnership; and
(3) to refrain from competing with the partnership in the conduct of the partnership business or affairs before the dissolution of the partnership II. A partner’s duty of care to the partnership and the other partners in the conduct
and winding up of the partnership business or affairs is limited to refraining from
79 Id. at 384. Additionally, the absence of a market for close corporation shares and the fact that close corporation
shareholders often invest a high percentage of their wealth combine to further expose close corporation shareholders to abusive control. Id.
80 See Thorpe v. CERBCO, Inc., 676 A.2d 436, 441 (Del. 1996). 81 Siegel, supra note 78, at 414.
engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law.
III. A partner does not violate a duty or obligation under this chapter or under the partnership agreement solely because the partner’s conduct furthers the partner’s own interest.82
Although codified, the fiduciary duties of loyalty and care are subject to elimination by the parties much like in the LLC context.83 The codification merely provides a concrete definition of
the fiduciary duties of loyalty and care in a general partnership when they are not eliminated. A possible justification for the Delaware General Assembly’s decision to codify these duties in the general partnership context is the possibility for a partner to be held vicariously liable for another partner’s wrongdoing, regardless of whether the innocent partner had knowledge of the wrongdoing.84
E. Limited Partnerships
The role of fiduciary duties in limited partnerships is far less settled. Uncodified, fiduciary duties have been defined and implemented into limited partnerships in the same manner as
corporations, judicially. Delaware’s Limited Partnership Act features a provision facially identical to the correlative fiduciary provision in DLLCA; it allows for the restriction or
elimination of fiduciary duties and protects the implied contractual covenants of good faith and fair dealing.85 Interestingly, Delaware courts have remained far more devoted to the doctrine of
freedom of contract in the context of limited partnerships than they have in the comparable
82 DEL.CODE ANN. tit. 6, § 15-404 (West 2011). 83 DEL.CODE ANN. tit. 6, § 15-103(a) (West 2011). 84 DEL.CODE ANN. tit. 6, § 15-305 (West 2011).
85 DEL.CODE ANN. tit. 6, § 17-1101(d) (West 2011) (“To the extent that, at law or in equity, a partner or other person
has duties (including fiduciary duties) to a limited partnership or to another partner or to another person that is a party to or is otherwise bound by a partnership agreement, the partner's or other person's duties may be expanded or restricted or eliminated by provisions in the partnership agreement; provided that the partnership agreement may not eliminate the implied contractual covenant of good faith and fair dealing.”).
LLC setting. When dealing with a conflict between default fiduciary duties and a limited partnership agreement, default fiduciary duties are reconciled with the terms of the limited partnership agreement, and where “such a reconciliation is possible, the court will apply default fiduciary duties in the absence of clear contractual language disclaiming their applicability.”86
This portion of a court’s approach is indistinguishable from that employed by a court when analyzing an LLC agreement.
The two analyses separate, however, when a court is incapable of reconciling default fiduciary duties with the limited partnership agreement. The same roadblock in the context of an LLC agreement would be navigated solely by the existence or non-existence of a provision
eliminating or modifying fiduciary duties. If such fiduciary duties are not explicitly eliminated, then the default rules of loyalty and care would apply.87 The court’s solution to irreconcilability
in the limited partnership agreement setting appears to begin with the presumption that the freedom to contract should be enforced wherever possible, finding that “the irreconcilability of fiduciary duty principles with the operation of the partnership agreement can itself be evidence of the clear intention of the parties to preempt fiduciary principles.”88 This logic is part and
parcel with Chief Justice Steele’s contention that the parties forming an LLC agreement who fail to draft a provision regarding fiduciary duties are, in fact, declaring their intention to waive all applicable fiduciary duties.89 It’s unclear whether such an omission would, on its own,
constitute a waiver of fiduciary duties or whether such a provision would need to be omitted in conjunction with other supporting evidence pointing towards a clear intention by the drafters
86 R.S.M. Inc., v. Alliance Capital Mgmt. Holdings L.P, 790 A.2d 478, 497 (Del. Ch. 2001). 87 See Auriga Capital Corp. v. Gatz Properties, LLC, 40 A.3d 839 (Del. Ch. 2012).
88 R.S.M., 790 A.2d at 498 (emphasis added).
of the limited partnership agreement to eliminate fiduciary duties. Unlike the flexibility given to the drafters of an LLC agreement to select their management structure, the management structure of a limited partnership is dictated by statute. All limited partnerships must consist of at least one general partner and one limited partner.90 Further, unlike the member-managed
structure available in an LLC formation, in order to limit their liability in a limited partnership, a limited partner must not participate in the control of the business.91 General partners, both in
general and limited partnerships, are able to utilize the business judgment rule in order to defend their discretion.92 The protection of the business judgment rule, however, is withheld
from a general partner “when appearing on both sides of [a] transaction or when deriving a personal benefit in the sense of self dealing,” and the rule cannot be used “as a shield if [the general partner] [is] not informed of material information reasonably available to them before making a business decision.”93 The former exception is simply a parroting of the corporate rule
that the business judgment rule may not be invoked in order to defend against claims for a breach of loyalty.
V.ARE CURRENT DELAWARE FIDUCIARY DUTY MODELS UNFIT FOR THE LLC?
Which set of fiduciary duties is appropriate for the LLC entity? The judicially broad and
adaptable duty of loyalty and care in corporations or the restrictively codified, clearly defined fiduciary duties found in general partnerships? If the court is to apply a hybrid approach to default fiduciary duties, such as that used in the limited partnership environment, how much deference should be given to the freedom of contract and the intent of the parties?
90 Del. Code Ann. tit. 6, § 17-101(9) (West 2011). 91 Del. Code Ann. tit. 6, § 17-303(a) (West 2011).
92 Seaford Funding Ltd. P’ship v. M & M Associates II, L.P, 672 A.2d 66, 70 (Del. Ch. 1995). 93 Id. at 70.
A. LLCs and Corporations: A Comparison
The existing similarities between a manager-managed LLC and a corporation suggest that the appropriate fiduciary duties are those which are employed in the corporate realm. An LLC manager acting on behalf of a group of passive LLC members is analogous to a corporation’s board of directors advocating for the best interests of the corporation’s stockholders. However, Chief Justice Steele, among others, contends that “the LLC form was an intentional form, chosen by sophisticated parties because that form provides the contracting parties with the maximum ability to customize their relationship” and the presence of this explicit choice should “point . . . away from adopting default corporate-like fiduciary duties.”94 Aside from the
previous discussion regarding the potential for differing rationales driving the decision to form an LLC as opposed to a different business entity95, this logic is flawed for an entirely different
reason. Namely, the subjective intent of parties to a contract does not trump the objective nature of the contract.96 True, Delaware courts feel “the role of a court is to effectuate the
parties’ intent.”97 However, Delaware has an extensive history of case law calling for contract
language to be interpreted as a reasonable, objective third party would interpret the contract, regardless if such an interpretation contradicts the original intent of one or more of the parties to the contract.98 A reasonable interpretation of a manager-managed LLC is one in which it is
94 Steele, supra note 19, at 237. 95 See supra Part III.
96 Sassano v. CIBC World Markets Corp., 948 A.2d 453, 462 (Del. Ch. 2008).
97 Lorillard Tobacco Co. v. American Legacy Foundation, 903 A.2d 728, 739 (Del. 2006).
98 See Fletcher Intern., Ltd. v. ION Geophysical Corp., No. 5109-VCS, 2011 Del. Ch. LEXIS 53 (Del. Ch. May 28, 2010);
Medek v. Medek, No. 2559-VCP, 2009 Del. Ch. LEXIS 120 (Del. Ch. July 1, 2009); Ruffalo v. Transtech Serv. Partners, Inc., No. 5039-VCP, 2010 Del. Ch. LEXIS 183 (Del. Ch. August 23, 2010).
viewed as parallel to a corporation.99 This rudimentary analysis is not a sufficient basis for
assigning corporate fiduciary duties to LLC managers, however, because Delaware contract law calls for a court to interpret a contract as a whole in order to prevent reducing any provisions of a contract to mere waste.100
By classifying an LLC as analogous to a corporation for fiduciary duty purposes, a court may very well render other provisions of the LLC agreement meaningless. Consider the situation where an LLC agreement calls for a manager-managed structure and also seeks to eliminate all
corporate common law fiduciary duties through provision. When the two provisions are read in concert, a court may be persuaded towards classifying the LLC as more akin to a limited
partnership than a corporation. Regardless of this possible scenario, however, Delaware’s doctrine of objective interpretation should preclude a court from giving substantial deference to the intent of the parties who drafted an LLC agreement. When deciding whether default common law corporate fiduciary duties should apply, the court should objectively analyze whether the respective relationship between the managers and members of an LLC is more analogous to a corporation or limited partnership. Passive LLC members are in a situation comparable to that of a stockholder in a public corporation; therefore it follows that they should be protected by the same fiduciary duties placed on a corporate board of directors.
Theoretical foundation for this conclusion can be found in the critical resource theory. The trio of prerequisites under the critical resource theory required to establish a fiduciary relationship:
99 It’s absurd, and not this author’s intention, to extinguish the divide between manager-managed LLCs and public
corporations by virtue of contract interpretation. However, it is reasonable to categorize the relationship between members and managers in a manager-managed LLC as relatable to that of a stockholder and the board of directors in a public corporation.
1)when party A, 2)acts on behalf of party B, 3) while exercising discretion over party B’s critical resource,101 are satisfied under the manager-managed LLC form. A passive member
contributing a monetary investment by way of purchasing units in a manager-managed LLC, a paradigm transaction in manager-managed LLCs, is allowing the managing party of the LLC to exercise discretion over their investment. This relationship is fiduciary in nature, and therefore should give rise to fiduciary duties.
B. LLCs and Partnerships: Siblings or Strangers?
The link between LLCs and partnerships, whether general or limited, is far more convoluted for fiduciary duty purposes. Where the relationship between members of an LLC and stockholders in a public corporation lent itself well to comparison, the correlation between LLC members and partners in a partnership is more strenuous. The most glaring distinction between the two business entities is the ability of the members to create liabilities for other members and the entity itself. A key feature in Delaware LLCs, perhaps the most attractive feature, is the fact that individual members are not liable for LLC obligations nor can they vicariously be held liable for another member’s actions.102 The persuasive argument has been made that the absence of
vicarious liability between members in the LLC model eradicates the need for default fiduciary duties.103 This conclusion is drawn in conjunction with the belief that vicarious liability in
general partnerships and the separation of power and control between general partners and
101 Smith, supra note 3, at 1402.
102 DEL.CODE ANN. tit 6, § 18-303 (West 2011).
103 See Ann E. Conaway, Challenging Traditional Thought: Chief Justice Steele’s Proposition on Default Contractual
Duties for Delaware Limited Liability Companies Tests Delaware Jurists and Practitioners’ Presumptions That All Business Entities Must Necessarily Be Formed With Fiduciary Duties, WIDENER LAW BLOG (last visited May 25, 2012), http://blogs.law.widener.edu/delcorp/on-line-symposium-default-fiduciary-duties-in-llcs-and-lps/ann-e-conaway- challenging-traditional-thought-chief-justice-steele%E2%80%99s-proposition-on-default-contractual-duties-for-delaware-limited-liability-companies-tests-delaware-jurists-and-practitio/
limited partners in a limited partnership are the driving forces behind the justification of default fiduciary duties.104
Accepting the conclusion that vicarious liability is the relevant variable in determining the presence of default fiduciary duties; the above logical train is sound. However, under the critical resource theory of fiduciary duties, exposure to liability is supplanted by the fiduciary’s exercise of discretion over a beneficiary’s critical resource as the chief factor in determining whether a fiduciary relationship exists.105 However, the theory’s relevance ends there. Its principal use is
in determining whether or not a fiduciary relationship exists, not to identify which fiduciary duties and to what extent.106 Typically, the amount of discretion allocated towards a centralized
manager or team of managers will be less in a member-managed LLC, the default form under Delaware law107, than a manager-managed LLC. Measuring the amount of discretion allocated
creates a continuum on which a Delaware court can mold a benchmark. At one end of the spectrum is a delegation of discretion over a critical resource coupled with a great deal of reserved control. For illustration, assume a member in a member-managed LLC structure contributes investment capital (a critical resource) to the LLC, thus allowing other LLC members to exercise discretion over it; however, the member is granted certain managerial authority in a member-managed structure and therefore retains a degree of control over their investment. In this situation, the member is less susceptible to having his investment exploited by the
managing body of the LLC because he is part and parcel with the managing body and he is also active in the operations and decision-making of the LLC. The necessity for fiduciary protection is
104 See id.
105 Smith, supra note 3, at Part C. 106 Id. at 1457-58.
less imperative in this situation. When a Delaware court is faced with this type of LLC
organization, and the LLC agreement doesn’t speak to fiduciary duties, fiduciary duty disputes should be resolved under the limited partnership model. At its base, this approach pays respect to Delaware’s freedom of contract environment while still injecting common law fiduciary duties unless the parties make it abundantly clear that such duties do not apply to their agreement.108 In the context of an active LLC member in a member-managed structure, it is
safe to assume that such a member would have the opportunity to bargain for the inclusion of fiduciary duties in the agreement, or alternatively, agree to the elimination of common law fiduciary duties in exchange for concessions elsewhere in the agreement.109 Under this
assumption, a member has adequately bargained for their interest and the LLC agreement reflects this. A court should be hesitant to act “as a protector for ill-advised contract makers”110
or to impose a “’fairness’ or ‘equality’ standard for parties to a bargain”111 in situations where
the LLC member had an adequate chance to protect their interest during the negotiation of the LLC agreement. While the assumption cannot be made that all parties to an LLC agreement are
108 See R.S.M., 790 A.2d 478, 497 (Del. Ch. 2001); Westpac, LLC v. JER Snowmass, LLC, No. 5001-VCS, 2010 Del. Ch.
LEXIS 158, at *28 (Del. Ch. July 23, 2010) (“When, as the parties here did, they cover a particular subject in an express manner, their contractual choice governs and cannot be supplanted by the application of inconsistent fiduciary duty principles that might otherwise apply as a default.”) (citation omitted); Werner v. Miller Tech. Mgmt., L.P., 831 A.2d 318, 333 (Del. Ch. 2003) (“Where there is no clear contractual language that preempts default fiduciary duty rules, the courts of this state will continue to apply them.”) (citation omitted).
109 Ann E. Conaway, Challenging Traditional Thought: Chief Justice Steele’s Proposition on Default Contractual
Duties for Delaware Limited Liability Companies Tests Delaware Jurists and Practitioners’ Presumptions That All Business Entities Must Necessarily Be Formed With Fiduciary Duties, WIDENER LAW BLOG (last visited May 25, 2012), http://blogs.law.widener.edu/delcorp/on-line-symposium-default-fiduciary-duties-in-llcs-and-lps/ann-e-conaway- challenging-traditional-thought-chief-justice-steele%E2%80%99s-proposition-on-default-contractual-duties-for-delaware-limited-liability-companies-tests-delaware-jurists-and-practitio/ (“A contract is a bargain sought and returned; each promise exchanged in return for the other.”).
110 Steele, supra note 19, at 238. 111 Conaway, supra note 109.
sophisticated112, the nearest acceptable setting for such a blanket conclusion is the
member-managed LLC. Delaware’s uniquely strict adherence to the freedom of contract should
persuade a court to avoid unwinding a bargained for exchange between LLC parties with an ex post fiduciary duty analysis.113 To do so would ultimately devalue the bargaining process during
the formation of an LLC and allow aggrieved parties to dress what would otherwise be frail contract claims in fiduciary clothing.114
On the opposing end of the allocated discretion continuum is the giving up of discretionary control over a critical resource with little or no reserved control. In the LLC setting, this type of arrangement can be found where a party purchases units in an LLC, is passive and does not possess managerial authority or discretionary influence in terms of the operation or decision-making of the LLC. This type of arrangement creates analogous risks to those present in the close corporation.115 For the passive LLC members, the lack of reserved control or authority
over their investment subjects them to possible abuses and exploitation on the part of the manager. In fact, this type of self-interested, opportunistic behavior on the part of an LLC manager led the court in Auriga Capital to declare that common law fiduciary duties must exist in manager-managed LLCs.116 Given the fact that passive members are more susceptible to
abusive control when they lack managerial authority over their asset, courts should be wary of interpreting the absence of a fiduciary duty provision in the LLC agreement as evidence that the parties wished to eliminate such duties. If, in an attempt to simplify LLC fiduciary duty disputes,
112 Supra Part III.
113 Steele, supra note 19, at 236.
114 Carter G. Bishop, Are Delaware LLC Members Status Fiduciaries Imbued With Loyalty?, WIDENER LAW BLOG (last
visited May 25, 2012), http://blogs.law.widener.edu/delcorp/?page_id=339&preview=true.
115 Siegel, supra note 78, at 384.
the court elected to apply the limited partnership approach across the board, the balance of protection would be unfairly tilted toward the managing body of the LLC. The deference to the freedom to contract in the limited partnership setting is unsuitable here because a passive LLC member may not have had the same level of bargaining power when the LLC agreement was formed and they surely do not have the same type of continued authority or control once the LLC is in operation. Critics are sure to argue that contracting is not meant to place the parties on equal footing117, and this is true. However, the court is only undertaking such an approach in
the absence of clear language displacing common law fiduciary duties.118 When a
manager-managed LLC agreement is ambiguous, the more sensible approach is to apply traditional fiduciary duties, lest a court leaves passive members entirely vulnerable to an opportunistic manager’s whims. Applying the close corporate model of fiduciary duties will sufficiently protect passive members without unduly hindering a manager’s actions. The close corporate model would hold managers and members capable of binding the LLC to fiduciary duty standards, but only while they were acting in their corporate capacity. This would allow managers to continue to pursue self-interested transactions so long as they were not acting in their capacity as the LLC manager.
VI.CONCLUSION
The LLC is a highly customizable, adaptable business form. It is surprising, then, to see many of Delaware’s leading corporate scholars advocating for such a black and white default fiduciary duty rule. A bargained-for exchange regarding fiduciary duties is possible in the creation of an LLC. For instance, parties may choose to limit the fiduciary duties of the LLC managers while
117 See Conaway, supra note 109. 118 See Supra note 108.
correlatively easing the process and requirements for members to leave the LLC. This type of agreement would unburden managers of common law corporate fiduciary duties while
simultaneously bridling their possible abusive or bad faith behavior by allowing LLC members to easily leave the LLC, along with their investment or assets. The LLC members would also still enjoy the protection of contract law, and if appropriate, remedies such as damages or
restitution. Unfortunately, for every LLC agreement that adequately addresses fiduciary duties, countless others will surely fail to properly settle the issue. When faced with this dilemma, a Delaware court should undertake a multi-step analysis. First, the court should classify the LLC as member-managed or manager-managed in terms of its organizational structure. This should be a simple step given the fact Delaware law provides for the default form to be
member-managed, thus the court can assume the default form unless the LLC operating agreement specifies otherwise. If the LLC is manager-managed, the court should mirror the application of fiduciary duties to those in the close corporation setting. Fiduciary duties should apply to those who have managerial power and any LLC member who has the ability to construct and dictate agreements the LLC enters into. Additionally, the party must be acting in their managerial capacity in order to be held to fiduciary standards. This method provides greater protection for passive members while still allowing for the managers to engage in expected self-interested behavior. Should the LLC elect a member-managed organizational structure in their agreement, the court should undertake a fiduciary duty analysis parallel to that used in the limited
partnership environment. Default fiduciary duties should not be applied if they cannot be reconciled with the LLC agreement as a whole. Additionally, the absence of any language regarding fiduciary duties should serve as evidence, although scant at best, of the parties’
intention to waive the presence of common law fiduciary duties. The member-managed LLC model leaves parties less vulnerable to abusive control, and the assumption can be made that the parties had a more active role in the creation of the LLC agreement. This type of
environment is more analogous to contracting parties at a bargaining table, and therefore greater deference should be given to Delaware’s overarching adherence to the freedom to contract.
