February 16, 2012
Default Fiduciary Duties in Delaware LLCs
Posted by Gordon Smith

The Delaware Limited Liability Company Act provides:

(b) It 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.

Del. Code Ann. tit. 6, §18-1101. 

With regard to fiduciary duties, the DLLCA allows for complete waiver. See, e.g., Gerber v. Enter. Prods. Holdings, LLC, 2012 WL 34442, at *13 (Del. Ch. Jan. 6, 2012) ("Alternate entity legislation reflects the Legislature's decision to allow such ventures to be governed without the traditional fiduciary duties, if that is what the ... governing document provides for, and allows conduct that, in a different context, would be sanctioned.").

But what if the participants in an LLC are silent about fiduciary duties? Should the courts impose fiduciary duties, even though the DLLCA does not expressly provide for them? 

In 2009 Chief Justice Myron Steele of the Delaware Supreme Court wrote a law review article arguing "that default fiduciary duties violate the strong policy favoring freedom of contract enunciated by Delaware's legislature" and that "the costs of default fiduciary duties outweigh the minimal benefits that they provide." Freedom of Contract and Default Contractual Duties in the Delaware Limited Partnerships and Limited Liability Companies, 46 Am. Bus. L.J. 221, 223-224 (2009). This prompted Larry Hamermesh to organize an online symposium on the topic of Default Fiduciary Duties in LLCs and LPs over at the The Institute of Delaware Corporate & Business Law.

In Auriga Capital Corp. v. Gatz Properties, LLC, Chancellor Strine confronts the issue of default fiduciary duties in a manager-managed LLC and reaches a different conclusion than Chief Justice Steele’s. Chancellor Strine's composed a section of the opinion under the heading "Default Fiduciary Duties Do Exist in the LLC Context," analogizing to fiduciary law in the corporate context. The text and history of the DLLCA provide some important clues, but Strine's analysis also depends heavily on the structure of the relationship between an LLC's manager and the LLC's members:

The manager of an LLC –- which is in plain words a limited liability “company” having many of the features of a corporation –- easily fits the definition of a fiduciary. The manager of an LLC has more than an arms-length, contractual relationship with the members of the LLC. Rather, the manager is vested with discretionary power to manage the business of the LLC.

While Professor Ann Conaway objects to Chancellor Strine's opinion on several grounds, I think Chancellor Strine is on solid ground. Professor Conaway purports to identify several "errors" in the opinion, none of which seems like an error to me, though, admittedly, each involves a contestable interpretation of the DLLCA. Facing uncertainty in the governing statute, Chancellor Strine analyzes the structure of the LLC and interprets the statute accordingly. He is taking the approach I advocated in The Critical Resource Theory of Fiduciary Duty:

The theory proposed here is animated by the view that fiduciary relationships form when one party (the "fiduciary") acts on behalf of another party (the "beneficiary") while exercising discretion with respect to a critical resource belonging to the beneficiary. The italicized typeface highlights the three core requirements of a fiduciary relationship. Each requirement plays an important role in distinguishing fiduciary from nonfiduciary relationships. When combined, these requirements show how the duty of loyalty that is the essence of fiduciary duty protects beneficiaries against opportunistic behavior by fiduciaries.

Note the last sentence of the passage from Chancellor Strine's opinion, quoted above (taking some liberty to imply the beneficiary): "the manager is vested with discretionary power to manage the business of the LLC [on behalf of the members]." Fiduciary duties serve a useful function in contexts like these. Participants in a Delaware LLC are permitted to waive the duties, but when they don't, courts should assume they apply ... just as they have done in similar relationships for hundreds of years.

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